Primary Offer. ICICI Prudential Life Insurance: A good entry point for investors

The insurance sector, which has been buzzing with a lot of investor activity over the past year, has received a further leg-up with ICICI Prudential Life Insurance’s primary offer — the first by an Indian insurance company — hitting the market today. So far, retail investors wanting to own a piece of the action had to buy shares of the listed parent companies having stakes in Indian insurers.

ICICI Pru Life’s IPO offers a good entry point for investors wanting to take direct exposure in the sector. The asking price is also reasonable, considering deals that have happened in the past. The IPO is an offer-for-sale (OFS) for 18.1 crore equity shares, with a reservation of 1.81 crore shares for shareholders of ICICI Bank.

After going through a series of regulatory changes since 2010 that impacted the growth of insurance players, the tide appears to be turning for the sector over the last two years. Private sector players, in particular, have regained significant market share in the last two years, driven by healthy demand of unit-linked products (ULIPs).

ICICI Pru Life managed to re-structure its product portfolio after 2010 while maintaining its leadership position. Between 2012 and 2016, the company’s retail weighted received premium (RWRP: sum of first year premiums on regular premium policies and 10 per cent of single premiums), grew 15 per cent annually, as against a 6.7 per cent growth in the private sector. The company ranked first within the private space in FY16 based on RWRP. Looking ahead, increase in financial savings and low insurance penetration vis-à-vis other countries should drive growth.

The insurance sector now is in a much better shape, with most players, including ICICI Pru Life, focusing on cost rationalisation in recent years. ICICI Pru Life’s total cost (commissions plus operating expenses) as a per cent of total premium, has fallen to 13 per cent in FY16 from 17 per cent in FY12.

The long-term nature of a life insurance product is important, as most of the expenses are taken upfront and returns are generated over the life of a policy. Hence, persistency in life insurance policies, which measures the number of policies (or premium amount) retained by an insurer across different time periods, is a critical factor.

ICICI Life Pru’s 49th month (fifth year) persistency ratio has seen notable improvement in the last two years from 20.3 per cent in FY14 to 62.2 per cent in the FY16. The 61st month persistency, which was very low at 14.5 per cent in FY15 — as this mostly included policies issued before the 2010 regulatory changes — has seen a sharp improvement to 46 per cent in FY16.

ICICI Pru Life also has a comprehensive multi-distribution model. Aside from a strong agent network, its bancassurance network with ICICI Bank — the company’s largest shareholder — gives it an edge over other players.

Diversification is important, as dependence on a single product can be risky from a regulatory perspective. For ICICI Pru Life, a chunk of its portfolio consists of ULIPs. In FY16, 83 per cent of its retail weighted received premium was from ULIPs.

While most private players have their product portfolio skewed in favour of either ULIPs or traditional policies, having a well-diversified product mix will be critical to compete, going ahead. The merger of HDFC Life and Max Life, which will create the largest private life insurer (pushing ICICI Pru Life to the second spot), will give the merged entity an edge over others as it will have a more balanced product portfolio.

Deals in the insurance space used to happen at two to three times the embedded value of life insurance business. Embedded value is a measure used to value a life insurance business which, among other parameters, takes into account the future earnings of the company.

At the upper end of the price band of ₹300-334, the IPO values ICICI Pru Life at ₹47,857 crore, which is 3.4 times its embedded value as of March 2016. This is far higher than ICICI Bank’s stake sale in ICICI Prudential Life last year, which valued the insurance company at ₹32,500 crore or about 2.4 times embedded value.

However, valuations have run up sharply across deals in the last year, particularly after the Insurance Bill was passed (which increased the FDI limit to 49 per cent from 26 per cent). Most of the deals in 2015 happened at 20-30 per cent higher value than the earlier estimated value for these insurance companies. Bank of India’s stake sale in Star Union Dai-ichi Life, for instance, happened at 3.8 times embedded value.

Moreover, the deal structure of the HDFC Life and Max Life merger has set the bar high, pegging the valuation of the two insurance players (HDFC Life at 4.6 times and Max Life at 3.7 times) and the combined entity (4.3 times embedded value) at a premium to recent deals in the life insurance space.

ICICI Pru Life’s valuation at 20-25 per cent discount to this is reasonable, given the company’s sound financials. ICICI Pru Life’s solvency ratio — essentially excess of assets over liabilities — stood at 320 per cent in 2015-16, much above the minimum regulatory requirement of 150 per cent. Its strong return on equity of over 30 per cent is also a positive.