Cracking the LIC IPO code

“Listing of companies on stock exchanges disciplines a company and provides access to financial markets and unlocks its value. It also allows retail investors to participate in the wealth so created. The government now proposes to sell a part of its holding in LIC by way of Initial Public Offer (IPO)”​ – Nirmala Sitharaman

Human needs are unlimited. According to Maslow’s hierarchy theory, human needs are fragmented into five categories among which safety and security needs, prevail as the second most important need after basic needs. When a person starts earning, he/she also desires to plan for the future by investing in insurance policies, stocks, bonds, pension funds, etc.

Likewise, human life and human needs are equally important. So, Life Insurance companies have emerged based on the need to secure the short term and long term needs in human life. And, when it comes to life insurance, the company which first arises in a customer’s subconscious mind is Life Insurance Corporation of India. LIC has succeeded in creating a cold image in the minds’ of the people on the life insurance policy. Lemonade is trying to change this but that's a separate story altogether.

The incorporation of Life Insurance Corporation of India (LIC) dates back to September 1, 1956, under the law Life Insurance Corporation Act, 1956. The Government-owned insurance group and Investment Corporation. In the recent scenario, a massive alteration was done when the government decided to open up the shareholdings of LIC to the public. This was decided to be done through an Initial Public Offering (IPO). 10% stake in LIC is to be disinvested through the IPO.

Two Sides of a Coin

The scenario needs to be looked upon from two fronts. One is the business potential LIC holds and the other is the challenges that would come along its way.

The penetration of LIC in the Indian market has been quite successful over the years. It would be difficult to find any such family in India, who won’t own a LIC policy. The market share of LIC in the first year of the premium underwritten was 70% in the current financial year. This manifests the robust business model of LIC.

The premium collected by the Insurance Company is then invested in different areas. This

investment is known as Assets Under Management (AUM). The total AUM of the entire Insurance industry was INR 40 lakh crore, out of which LIC is managing almost INR 31 Lakh crore AUM. According to AUM, the market share of LIC is 77.5%. Four major factors further add on to the potential of LIC i.e. strong corporate structure, strong distribution network, notable brand value, and high-efficiency level. The acceptance of policyholders for LIC products is quite higher than other investment opportunities. There are more than 30 crore policies in force with LIC.

It is only the insurer providing a sovereign guarantee that ensures that the funds of the policyholders are safe. That is why the LIC policy premiums are higher than the private sector counterparts.

Even though it has been two decades since the privatization of the insurance industry; LIC as been able to hold a lion’s share in the entire industry. The growth progress of LIC (Annual Income) has been persistent over the years. The annual income of LIC has grown from INR 1,12,392.74 crore in the year 2004-05 to INR 5,23,611.11 crore in the year 2017-18. There has been a 365.87% growth in the case of the annual income of LIC.

The net total income was INR 5.61 lakh crore in the financial year 2018-19, which included premium income and investment profits.

The growth of the new business has been increasing at a stable rate. It is important to identify the performance of LIC over the years.

The amount transferred to the Central Government against the 5% share in the Life Business category has been growing at an increasing rate. There has been a growth of 20.95% and 158.35% in the financial year 2018-19 when compared to the financial years 2016-17 and 2008-09 respectively.

In the 10 years between FY09 and FY19, LIC saw a 291 percent increase in its investment income. Data from the LIC Annual Report 2018-19 showed that the investment income at the end of the Financial year 2019 was INR 2,21,573.72 crore.

At the end of the Financial Year 2019, LIC’s investment amounted to INR 29.84 Lakh Crore. Out of the total investment, INR 28.3 lakh crore constituted securities, while INR 1.17 lakh crore constituted loans, including policy loans and mortgage loans. The remaining of the total investments amounting to INR 34,849.4 crore went to other investments.

Despite the slowdown experienced in the Indian economy due to demonetization and faulty implementation of GST, the investment income increased from INR 2.08 Lakh crore when compared to a year ago.

Analogously, LIC's rental income from the estate portfolio increased to INR 388.18 crore in FY19 compared to INR 341.43 crore a year ago. It was 90.18 percent of the annual target that LIC held. Ten years ago, in FY09, gross income from estates amounted to INR 193.21 crore.

When investing in stock markets, LIC follows a 'contrarian' investment approach, which is 'selling' when sentiments in the stock market are bullish and 'buying' when sentiment is bearish.

Life insurers book a profit of INR 18,000 crore to INR 25,000 crore in equity gains alone in each subsequent year. During the financial year 2018- 2019, LIC had an equity income of about INR 23,600 crore, which was lower than INR 25,650 in the preceding year.

Challenges Ahead

The whole plan to offer IPO may be lucrative but at the same time, it has brought in a lot of challenges. The first of many challenges that lie ahead of LIC is the valuation-related challenge. The problem is the computation of the embedded value of LIC. Every insurance organization is required to show the embedded value report and get approvals accordingly. The embedded value is the net sum of the present values of the company’s future net profits after discounting plus adjusted net asset value. LIC has not yet declared anything about the embedded value which brings in perplexity in the system. The next challenge is regarding the conflict relating to the distribution of profit earned by LIC through AUM which is shared by policyholders and shareholders. As per the annual report of LIC for the financial year ending March 31, 2019, the profit earned through AUM was INR 2.5 Lakh crore. The ratio at which the profit got divided among the policyholders and the shareholders was 95:5. The shareholders are entitled to get only INR 3,125 crore as profit in each quarter. This is not a very healthy number. This challenge can be conquered but the fact is, to overcome this challenge, a new challenge would emerge. The challenge would be regarding altering the law. This also stands as an exhaustive option. LIC would have to get a nod from the parliament, then the alterations need to be done in the Act. Other private Insurance companies are in a better position concerning this issue. They have both participatory (95% profit goes to policyholders) and non-participatory schemes (Insurer’s profits are not shared). In the case of LIC, there is no such scheme as participatory or non-participatory; all the policies come under a single umbrella i.e. participatory.

The government’s intervention also poses a challenge. It may have a negative impact. If LIC becomes a public limited company with institutional investors then the intervention from the government still would remain high, gradually leading to a strong business of LIC.

From a financial perspective, there might be a major disruption in the financial markets as a result of the listing of the Indian LIC. Private insurance firms in India, such as HDFC Life, SBI Life, and ICICI Pru Life, are rising faster than LIC due to their limited economies of scale. Via the new version, LIC will have to equate itself with private insurers and multinational insurance giants.

The growing exposure of LICs to companies facing a financial meltdown has been a matter of concern. Although the insurer has enough reserves to cover the bad debt, an escalation in provisions will also affect the overall financial report.

In the Financial year 2018-19, the provision for doubtful debt amounted to Rs 3.439.3 crore (rising from Rs 2.744.5 crore in Financial Year 2017-18) for participating portfolio while for non-participating it amounted to Rs 32.2 crore in Financial Year 2018-19 rising from Rs 2.37 crore in Financial Year 2017-18. For the Financial year 2019-20, the gross non-performing assets (GNP) ratio was 6.1 percent compared to 5.95 percent in the previous year. It is close to the amount of India's largest lender state bank, which had a gross NPA ratio of 6.94 percent in Quarter three of the Financial Year 2019-20.

What are the stakeholders saying?

Market analysts conclude that the LIC IPO would mean that all financial decisions of the insurer relating to investment, as well as involvement in government disinvestment initiatives would be currently at the forefront.

“Many factors go into the valuation of a company. The surplus and the investable amount arising out of the difference between the inflow of premiums and outgo on account of different expenditures is one of the factors. Then there is the quality of the investments made, the quality of the underwriting portfolio,”- Kamalji Sahay, former managing director, and chief executive of Star Union Daiichi Life Insurance Company.

“We strongly oppose the government’s plan to sell a part of its shares in LIC and the move is against the national interest,” - a spokesman of an employees’ union.

The contribution of LIC has been significant in the overall economic growth of India, but the cutback of the government’s stake in the organization would deplete the economic sovereignty of India.

According to him, there might be protests from the employee’s union of LIC shortly if the plan continues. At the same time, the impact of such a move will also be visible on the policyholders’ side.

“I would never touch LIC as an investor. The government sold their unsold items to LIC and now they are selling the owner of those unsold items to us,” – Shankar Sharma, Co-founder, and Chief Global Strategist.

In the next series of measures, the Parliament will have to clear the route circumventing the modifications to the LIC Act of 1956. There is a strong chance of opposition to the change by the government. Current workers association of more than 1,08,000 people can face pressure. Employee unions are now fighting a disinvestment push. Nevertheless, the point is that the government will continue to hold 90% of the share. There are several public sector undertakings in which the government holds just 51% or less of the shares.

From a personal finance point of view, if you are a policyholder of LIC, you don't have to stress about it. You can expect the insurance company to provide better quality and productivity. From an investment point of view, you can look forward to the IPO later this year. Despite selling thousands of policies since its conception, LIC officials have acknowledged that India's insurance sector needs a transformational change. The insurance sector can expand at a rapid pace. This is probably another very truly revolutionary occurrence not only in the insurance business but also in the capital markets of India.

Author: Arushi Mallick

Disclaimer: This post should not be construed as investment advice from Galactic Advisors.