Primary Offer. General Insurance Corporation of India: Cover for the long run

The insurance sector has been buzzing with investor activity over the past year, as insurers — both life and non-life — have been making their debut in the primary market. General Insurance Corporation of India (GIC) is the latest to join the IPO bandwagon. GIC is the largest reinsurance company in India in terms of gross premiums in FY-17, accounting for about 60 per cent of the premiums ceded by Indian insurers to reinsurers during the year.

Reinsurance essentially is the arrangement whereby insurers transfer part of the risks to one or more insurers or reinsurers. Currently in India, non-life insurance business constitutes the chunk (95 per cent in FY-17) of the total premium ceded.

GIC provides reinsurance across segments such as fire (property), marine, motor, agriculture, aviation, and health, among others. Thanks to the Centre’s Pradhan Mantri Fasal Bima Yojana scheme, the company saw a sharp jump in the share of its agriculture business, which constituted 29 per cent of its gross premiums in FY-17 (from about 7 per cent in FY-16).

While the near seven-fold increase in gross premium of crop insurance drove the 82 per cent jump in the company’s overall gross premium in FY-17, it also led to a 34 per cent increase in operating profit, thanks to the lower claims ratio in agriculture (ratio of claims incurred to net earned premium) due to normal monsoon in FY-17. This, along with higher investment income, offset some of the higher claims incurred across other businesses. On the net level, GIC’s profit grew 11 per cent in FY-17 after slipping by 2 per cent in the previous year.

Given that non-life business contributes the chunk of the reinsurance business in India, healthy growth in the underlying non-life insurance space, given the low insurance penetration level in India, augurs well for the growth in reinsurance premiums too. However, profitability could remain volatile, given the rising risk from catastrophic losses, competition from foreign reinsurers, higher amount of crop insurance being reinsured in recent times and adverse regulatory changes. While GIC’s gross premium grew 32 per cent annually between FY-14 and FY-17, its profit has increased at a lower 9 per cent annually during this period. Given all of this, at the upper price band, GIC’s issue, priced at around 24 times its FY-17 earnings, is not cheap. Global reinsurers trade at around 9-13 times their earnings. Given the weak listing of insurance companies such as SBI Life and ICICI Lombard on the back of pricey valuations, investors should also temper their expectations around listing gains.

That said, it is important to understand that the higher growth in reinsurance premiums, superior yield on investment and return ratios in India vis-à-vis global players, make a like-to like comparison difficult. Also, on a price-to-book basis (FY-17), the issue is priced at about four times, which is reasonable.

While spectacular gains in the short term are unlikely and risks in the business could lead to volatility in earnings in certain years, GIC’s offer holds promise for investors with a long-term perspective. Growing opportunity in the reinsurance space, possible unlocking of value from GIC’s large legacy investment book, healthy return on equity of 17-20 per cent, and longstanding relationship with domestic insurers, still remain a big draw.

The offer comprises a primary issue of 1.72 crore shares and an offer-for-sale of 10.75 crore shares by the Union Government. There is a ₹45 discount on the offer price for retail investors.

GIC offers reinsurance across key segments in India as well as outside India. Some of the segments such as fire, marine and aviation derive most of their business from outside India. For instance, fire constituted 24 per cent of total gross premiums in FY-17, of which 16 per cent was from outside India. On the other hand, besides agriculture, motor (20 per cent of total gross premiums in FY-17) and health (12 per cent), derive most of their business from India. Overall, 30.5 per cent of gross premiums came from outside India for GIC in FY-17.

Besides agriculture, fire, motor and health too witnessed a healthy growth in gross premiums in FY-17.

GIC’s top clients, including both public and private insurers, such as Agriculture Insurance Company, National Insurance, ICICI Lombard General Insurance, United India, New India Assurance and HDFC ERGO, among others, account for 56 per cent of GIC’s gross premium in FY-17.

Just as insurers pass on a portion of their risk through reinsurance, a reinsurer, in turn, passes on its risk by reinsuring its own book by purchasing what is known as a retrocessional coverage from other reinsurers. GIC purchases retrocessional coverage to mitigate large risks from businesses such as marine, fire, agriculture and health, among others, thus capping each risk loss to ₹100 crore in case of domestic and $15 million outside India.

The economics of an insurance business principally rides on the concept of ‘float’, wherein insurance companies collect premiums upfront and pay claims afterwards. This creates a float or investable asset base that can be deployed to generate returns. Additionally, if premiums exceed the total expenses and the eventual losses, then the underwriting profit adds to the investment income.

Hence, two ratios — claims and combined ratio — are used to measure the profitability of an insurance business. Claims ratio (ratio of claims incurred to net earned premium) is essentially total incurred losses in relation to the total premiums. Combined ratio measures the incurred losses and expenses in relation to the total premiums.

GIC’s combined ratio fell to 100.1 per cent in FY-17, from 107 per cent in FY-16 and 108.8 per cent FY-15, mainly on account of a fall in claims ratio to 81.6 per cent in FY-17 from 84-87 per cent in previous years. This decline has been due to the sharp fall in claims ratio in the agriculture business, thanks to strong growth in premiums and normal monsoon during FY-17. But given the vagaries in the agriculture business, claims ratio could shoot up in a year. In FY-16, for instance, claims ratio had jumped to 154 per cent from 95 per cent in FY-15, on account of lower rainfall in certain regions, increasing claims. As the exposure of the insurance industry to the agriculture segment increases, volatility in earnings could also go up.

That said, profitability is also dependent on float management. On this count, GIC’s large investment book (₹41,929 crore — book value and ₹73,902 crore — market value as of June 2017) is a key positive. The yield (without unrealised gains) has been in the 12-14 per cent range.

A risk that GIC could face is the increase in competition from foreign players.

Foreign reinsurers have been accepting reinsurance from Indian insurance companies without a physical presence in India. IRDAI regulations now permit private Indian reinsurers to be licensed, foreign reinsurers to open branches in India.