Measuring Up

Two big insurance initial public offers, or IPOs, hit the markets recently. Both left investors puzzled, as while Price to Earnings multiples and Profit After Tax are good indicators of a companys financial position, things are not so simple when it comes to a life insurance company in India. There are two reasons for this. One, before these two, there were no listed insurers in India, and so relative valuation was not possible. Two, the valuation of a life insurance business is not based on just the present value of the company but also on the future value of its business. Both quantitative and qualitative factors come into play while analysing a life insurer, right from persistency ratio (total business a company is able to retain in a year) to distribution network.

The good news is that ICICI Prudential Life and SBI Life have got listed, setting a precedence for valuation of life insurers such as HDFC Life. More insurers are expected to line up for public offerings over the next couple of years.

Before looking at the companies numbers, it is important to understand that the life insurance business has different metrics than what people generally use for companies in manufacturing and services. It is a unique business because of its long payback period. In the initial years, insurers put in a lot of capital on expansion and covering underwriting risks. There are losses in initial years as strain on new policies wipes out profits from old policies. It is only when expenses shrink and the company stabilises that it achieves break even. Generally, it takes a life insurance company 8-10 years to break even. In India, a handful of insurers have started reporting profits, and that too only recently. The industry was opened to private players in 2000. Anuj Mathur, Chief Executive Officer of Canara HSBC OBC Life, says, "If you have accumulated losses, you have to wipe off those losses. In our case, we have been having a discrete profit for five years but still have accumulated losses. It will take time to wipe off losses in the first three-four years. You are in a position to pay dividend once the accumulated losses are wiped off." Lets take a look at the parameters one should consider before investing in life insurance companies.

Insurers abroad calculate the value based on existing embedded value. But in India, a major portion of the value is coming from future business.

Shashwat Sharma, partner and head of insurance, KPMG India, says, "In India the listed life insurance companies have approximately 25 per cent of the overall valuation from embedded value, while in mature markets almost all of comes from this. This means capitalising on future potential and the ability of the insurer to expand into the higher margin protection businesses shall be the key to sustaining valuations."

Vishakha says, "Since unlocking of these profits will happen in the future, there is a belief that EV should be considered. This could be true at the current stage of business that the companies are at. Discounted cash flow can be used but it will need the market to be more mature to have a reasonable prediction of cash flows."

Remember that the valuation of a life insurance company is based on both existing and future value (where assumptions play a key role).