Big Story: Life insurance stocks hit a sweet spot

The life insurance space in India has been gaining significant traction, with top private sector players delivering strong performances over the past two to three years.

After several ups and downs and regulatory upheavals, the sector is emerging as an attractive opportunity for investors looking to invest in the financial services space.

Since the 2010 regulations that impacted sale of unit-linked insurance plans (ULIPs) and the 2013 regulations that hit non-linked products, top life insurers have restructured their product portfolios, and focussed on cost efficiency and persistency to drive profitability. Given that life insurance is a long-gestation business, players with solid long-term track record, scale and strong business models are well-placed to ride the opportunity within the sector.

Over the past three years, the overall premium (individual weighted received premium) has grown about 16 per cent CAGR, led by private players reporting 21 per cent growth. The growth so far this fiscal has been upbeat, with private life insurers reporting 21 per cent year-on-year (y-o-y) growth in the first-year premium between April and September .

But a few private life insurance players have managed to build scale through strong product portfolios and bancassurance networks. The top seven private players still constitute 72 per cent of the market (in terms of individual weighted received premium). Of these, four are listed — SBI Life, ICICI Prudential Life, HDFC Life and Max Financial Services (holding company of Max Life). We deep dive into key drivers of the life insurance business and take a look at the performance of each of the listed players.

There are broadly two types of life insurance policies — savings and protection. Savings products essentially comprise ULIPs, participating and non-participating policies.

Protection products provide cover for life, disability, critical illness and accidental death.

ULIPs

ULIPs are essentially life policies where a portion of the premium is invested in equity or debt or in a combination of both, based on the risk appetite of the policyholder. For insurance companies, ULIPs require relatively lower capital than other products as the market risk is passed on to the customer. These products generate steady margins. Market volatility impacts the business and there can be a second- order impact on fund management charges, owing to decline in AUM (assets under management).

Participating policies

In participating policies, 90 per cent of the profit is shared with the policyholder and thereforemargins are limited but steady.

The maximum commission payable depends on the premium- paying term of the policy.

While the capital requirement and business strain is low, persistency is an issue.

Non-participating polices

These policies offer guaranteed returns with an IRR (internal rate of return) of 4-6 per cent. The capital requirement and business strain is high. There is also reinvestment risk in a falling interest-rate scenario. High guaranteed returns can pinch insurers, if not hedged appropriately or repriced when interest rates move.

Protection

Profitability in protection products is a function of actual mortality experience (frequency of deaths) vis-a-vis expectations built into the pricing of the product. The ability to underwrite, hence, is critical. Margins are high, though capital and business strain is also high.

Diversification of product portfolio is important, as dependence on a single product can be risky from a regulatory perspective. Life insurers have recently been focussing on protection business to drive growth and profitability. This is likely to continue.

By focussing on protection business, players have been driving value of new business (VNB) — a key measure to assess the financial performance of insurers.

Essentially, VNB is a measure that values future profit streams of the new business written during the year.

Given that protection products are relatively simpler to comprehend and compare, sales through digital platforms (company websites or through aggregator sites such as Policybazaar) have been strong.

While there is intense competition in protection policies, leading players believe that irrational and low pricing can hurt.

The rural market, in particular, could be a test case, and mortality risks could be high if not priced properly.

Currently, ULIPs constitute about half of the total WRP (weighted received premium) within private players. Given that the product is tax-efficient and remains an attractive option to create wealth, long-term prospects still remain healthy.

Distribution is critical given the push nature of the product. In the past four to five years, bancassurance-led players have gained market share. About 55 per cent of the total individual new business premium comes from banca channels for private players. Following regulatory changes a few years ago, each bank can sell policies of up to three life insurers. However, there have been limited tie-ups so far.

While the bancassurance model will continue to drive market share gains, over the long run, agency channel is equally critical.

SBI Life and ICICI Pru Life have a relatively higher share of annualised premium equivalent or APE (20-27 per cent) coming from agency, while HDFC Life has a higher share from direct channels (21 per cent).

Aside from banca and agency, building alternative channels of distribution by partnering with NBFCs or fintech/telecom players is also important. For instance, HDFC Life has partnered with various NBFCs (non-banking finance companies), MFIs (micro-finance institutions) and small finance banks, and also with the likes of Paytm and Airtel.

SBI Life, aside from leveraging on the strong network of SBI, has one of the most productive agency networks.

SBI Life is also using new-age distribution tools — SBI’s YONO app, for example — to tap new customers; through this channel , SBI Life has covered over 1 lakhlives (small-ticket group policies).

ICICI Pru Life focusses on its banca model to sell ULIPs (65 per cent of retail ULIP APE from banca) and protection (37 per cent). Participating policies (45 per cent) and protection (23 per cent) are the focus under the agency model.

SBI Life

SBI Life reported a strong growth of 40 per cent in new business premium (NBP) in the first half of FY20, led by protection, annuity and individual non-par savings businesses. Protection NBP increased by 59 per cent y-o-y. This has aided a robust 33 per cent growth in VNB (value of new business), with 100 basis points expansion in VNB margin.

The management is focussing on reducing the share of ULIPs and increasing the share of protection. Within par and non-par, the company will follow a balanced approach; it is not keen on going very aggressive on the non-par front given the possibility of margin compression in a falling interest-rate environment. SBI Life has re-priced its non-par guarantee product on account of a reduction in interest rates. On par policies, the management believes that these products can offer good value to the customer and the company, if bought for the long term, ie, 15-plus years. SBI Life has discontinued five- and seven- year terms, and even the 12-year term in one of the products.

The management is looking to reduce pricing in its term plans. While this may lead to losses in VNB margins, the management expects this to be partially offset by increase in volumes.

In the September quarter, SBI Life’s profit was impacted by provision for diminution in the value of investments; ₹67 crore pertained to DHFL exposure. SBI Life has exposure of ₹380-400 crore to stressed companies such as Indiabulls Housing, Yes Bank, which are standard accounts as of now.

SBI Life trades at about 3.7 times its embedded value as on September 2019. Continual focus on product diversification, multi-channel distribution, consistent improvement in VNB margins and cost efficiencies will continue to drive valuations. At current levels, the stock presents a good buying opportunity.

HDFC Life

HDFC Life held its strong performance in the first half of FY20. The insurer’s individual APE grew by a strong 37 per cent y-o-y , while NBP grew 26 per cent. In the September quarter though, the growth moderated somewhat from the robust up-tick in the June quarter. This is because the growth in the June quarter was led by the strong response for its Sanchay Plus product — a non-par savings product. Resultantly, non-par constitutes a high 54 per cent (in terms of individual APE), from 15 per cent in FY19.

The management expects the product mix to be more balanced by the end of FY20.

As such, other segments have also grown by a healthy clip. The total protection APE has grown 43 per cent in H1FY20. VNB grew a robust 57 per cent in H1FY20; VNB margin expanded by a tidy 320 bps to 27.5 per cent, though fall in share of non-par led to moderation in margins in the September quarter from the June quarter.

In the long run, the management expects to have a product portfolio mix with par and non-par savings constituting 25-35 per cent each, protection about 10 per cent, annuity 7-8 per cent and the balance being ULIPs. While Sanchay Plus has been a big success, there have been concerns over the risk associated with the product. The management though is confident of managing the risk well, even in a falling-rate scenario.

HDFC Life trades at about 5.9 times its embedded value as of September 2019. The company’s ability to drive product innovation, a strong distribution network and robust financials are positives, but rate risk around its non-par guarantee product will be watched. Given the steep valuation, the upside may be limited in the near term, but the stock remains an attractive long-term bet.

ICICI Prudential Life

ICICI Prudential Life Insurance, too, has been focussing on its protection business. In the first half of FY20, the insurer’s VNB grew 20 per cent, led by growth in protection APE by 86.8 per cent (on a low base). VNB margin shot up to 21 per cent against 17.5 per cent in the first half of last fiscal.

The strong growth in protection aided the overall performance, which was otherwise pulled down by the company’s change in business strategies — de-focussing on ULIPs being a key one.

In the first half, the overall APE fell 0.4 per cent, owing to a fall of 16 per cent in ULIPs — mainly in the higher ticket size segment. The share of ULIPs, though lower, is still a high 69 per cent of total APE. A strong growth in protection saw the share of protection in overall APE go up to 14.7 per cent from 7.9 per cent last year. Within protection, retail continues to dominate the mix. Annuity APE, too, on a low base, doubled in the first half vis-a-vis last year. ICICI Pru Life, through its focus on protection business, believes it can sustain profitability. The management expects to double VNB over the next three to four years. On the persistency front, there has been a dip in the early 13th month persistency — 83.6 per cent from 84.6 per cent in FY19. This was mainly due to a decline in large-ticket ULIPs.

The company is taking efforts to improve persistency. On the distribution front, the share of non-bancassurance channels went up to about 47 per cent from about 44 per cent in FY19.

ICICI Pru Life trades at about 3.1 times its embedded value as of September 2019, a discount to peers such as SBI Life and HDFC Life. While the insurer’s relatively higher ULIP portfolio (higher ticket size) is possibly weighing on valuation, the management’s focus on diversifying the product mix through a higher share of protection should drive profitability.

Attractive valuations offer a good opportunity for long-term investors.

Max Financial Services

Max Financial Services is the holding company (71.8 per cent) of Max Life. Max Life enjoys good VNB margin, thanks to a higher share of par policies and a good share of protection policies.

In the first half of FY20, individual APE grew 22 per cent. The share of non-par has gone up sharply to 20 per cent in the first half from 5 per cent last year.

While VNB margins went up, driven by a higher share of non-par, they have not gone up sharply as the company has been focussing on short-term products within non-par which are more endowment-oriented than income- oriented.

While this works better from a risk-management perspective, margins on these products are ideally lower (than those sold last year). The management in its concall stated it would keep the share of non-par around 15 per cent, to manage risk.

Along with its bancassurance partnership with Axis Bank, Max Life has built a strong agency network. But with Axis Bank recently roping in another life insurance partner, it needs to be seen if the growth off Max Life will be impacted. Currently, 53 per cent of individual APE is through Axis Bank.

The company had initiated a transaction, swapping part of a joint venture partner Mitsui Sumitomo stake in Max Life into Max Financial Services, in a bid to simplify the holding company’s structure. This was, however, terminated due to non-agreement on certain terms. The management has stated that this would not impact the process of reverse merger between the holding company and the life insurance company. Holding company discount is a key dampener to valuations.

There is also the overhang of promoter- pledging of shares that has gone up to 91.3 per cent as of September from 80.4 per cent in June quarter. The management stated that this was mainly due to a fall in share price.

Max Financial Services trades at a significant discount to peers at about 1.4 times its embedded value as of September 2019. Healthy margins, a good portfolio mix and a strong agency network are key positives for the stock.

The above- mentioned risks, however, can continue to weigh on the stock. Investors can hold on to the stock.

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