Valuation of Indian Life Insurance Companies

Demystifying the Published Accounting and Actuarial Public Disclosures

Prasanna Rajesh

• Publisher: Business Expert Press
• Year: 2019
• ISBN:
  9781949991536
• Topic: Business
• Subtopic: Insurance
• Index: Business

This book bridges the gap between the accounting and the actuarial sides of Indian life insurance companies, by exploring the relationships between the embedded value calculated by actuaries and the revenue account and balance sheet prepared by the accountants.

The author provides publicly available sources of information to place a value on the shares of Indian life insurance companies from an outsider's point of view. Life insurance company accounts are complex and require knowledge of specific concepts in order to analyze and appreciate them.

This book will help a layperson with reasonable numerical abilities understand the calculation of the share price of a life insurance company. In particular, it will help analysts and accountants with no actuarial background understand the concepts of embedded and appraisal value. Cash flow statements of these companies are often ignored and delegated to the background or usually to a single page in their annual reports.

This book examines the cash flows in detail and rearranges them to get a better picture of the financial health of the underlying companies. It also explains the relationship between the different measures of profit such as cash reserves, surplus, profit after tax, and embedded value. Often this information is only available internally or to consultants. The author uses alternative approaches based purely on public disclosures by these companies, thereby enabling professionals without access to internal information to come to informed judgments about the actual performance of the companies.

CHAPTER 1

Indian Insurance Companies

Introduction

1.1.This chapter explains how insurance companies differ from other companies and also looks at the challenges faced by them. It gives a brief history of the private players and touches on the diversity of the Indian insurance market. It also lists the kinds of published financial information available and specifies the basic structure of this information.

How are insurance companies different from other companies?

1.2.Insurance companies, just like other companies, sell their products to the general public and expect to profit from them. Therein ends the similarity, however, because insurance products are by nature very different from the products sold by companies in other industries.

1.3.Insurance companies collect premiums for a long time before the benefits become due, which means that profits or losses can be known only after the policies go off the books.

1.4.Also, profits or losses can be assessed only for groups of policies and not individual ones, because the meaning of insurance is that groups of people come together and subsidize one another in the event of a claim. This makes the calculations very complicated but interesting.

1.5.This also means that general rules and regulations are inadequate and we need special rules to monitor these companies.

How easy and how profitable is it to sell insurance?

1.6.This is the basic question that a prospective shareholder must ask. The answer to this question will determine whether she is willing to invest in the business. The common perception is that insurance is easy money. Nothing can be farther from the truth. This industry is one of the most difficult to do business in and also one of the most profitable. Here is a phrase commonly used in this industry: “Insurance is sold, not bought.” Most financially savvy people only know that they hold a life insurance policy with a particular company and are completely unaware of the details of the policy they have bought.

1.7.To sell an insurance product to persons who are financially unaware, the companies have to first make them aware that they need insurance, and then convince them to part with their money for a number of years, in return for a benefit payment many years later.

1.8.Many have a change of heart as soon as the product is sold. This is the reason why there is a free look period (usually about 15 days) during which customers can take their money back without any questions asked and also the reason why there are high lapse rates in the very first policy year. Sometimes, this rate is as high as 30 percent. Companies lose the most in this first year of operation if the policy lapses, mainly because they experience very high costs in this first year, usually more than the premium collected. Once the companies are past the first-year hurdle, the challenge is to make sure that the policyholder keeps the policy in force and continues to pay the premium year on year.

1.9.If we assume the average term of a policy to be 20 years, the company has to keep the policyholder committed for 20 years. During this time, if the policyholder decides to surrender the policy, the company has to pay the surrender value, which may or may not cover the expenses, and make a profit. The company may not have to pay a surrender value if the policy is surrendered within, say, the first three years, but even without a surrender payment, it makes a loss if the expenses are not fully recovered. Surrenders also depend on the movements in the stock market and general financial conditions. In addition, there will be competition from other players in the market. Combine this with the basic distrust of anything private, and these companies have their work cut out. Factoring all this in, the business is not an easy one.

1.10.Assuming that the company overcomes all the aforementioned problems, the business is a very profitable one and rewards the shareholders more than adequately for the risks taken. Just how profitable the business is, varies from market to market and from company to company.

What is the history of private insurance companies in the Indian insurance market?

1.11.The history of Indian Insurance is set out in detail in the website of Insurance Regulatory And Development Authority of India (IRDA). The Indian insurance industry was opened to private players in the year 2000, after a very long time. Until then, the Life Insurance Corporation of India, with the brand name LIC, was synonymous with life insurance and the General Insurance Corporation of India, GIC in short, was synonymous with general insurance. There were no stand-alone health insurance companies at all in the market.

1.12.Now there are as many as 24 life insurance companies and 34 nonlife and health insurance companies. Some of these companies entered the market in the year 2000 and have in the recent past had initial public offerings (IPOs) of their shares.

What is the size of the Indian insurance market?

1.13.The annual reports and accounts of all the companies talk about how underinsured India is and claim that the growth in the industry, and by default, their company’s growth is expected to be sky high. This needs to be taken with a pinch of salt because even if the ocean is vast, their collection can be only as big as their pail. Another point is, do they want the ocean?

1.14.Just for the sake of argument, if we assume that the whole of India is available to be insured and the companies only have to nod their heads to get the business, would they rush into it? Without any doubt, they would want to cherry-pick the profitable portions of the business. What then is this profitable percentage of the entire population? My calculated guess is that it is not a very high percentage because not all of India has witnessed economic growth in the same measure. Some parts of India are economically forward and financially savvy than most others, more likely the cities, and the competition in these areas with the other insurance companies is usually cutthroat. This competition may bring down the profitability of the business written. Socio cultural norms also may play a very important role in the purchase of insurance contracts. For example, the joint family system is no longer as prevalent in cities as it was in the past. This has increased the need for insurance in nuclear families and has opened up the market some more. It is too early to comment whether the insurance industry has already capitalized on these new social norms. The insurance companies also need infrastructure to penetrate untapped markets, which will eat up a lot of capital and also may not be as profitable. To sum it all up, the size of the insurance market is a small percentage of India, rather than the entire country as it is made out to be.

What kind of growth can we expect in insurance? Is the industry similar to the information technology (IT) industry, where some companies had phenomenal growth, or is it more similar to the auto industry, where you need to set up considerable infrastructure to get a modest level of growth?

1.15.This sector is unique and very different from the IT sector, where the biggest investment is in human capital. This is also different from the auto sector, where you need to set up huge factories. The closest sector that is comparable to insurance is banking, but then again, because of the nature of products sold, even this sector is markedly different. As I mentioned earlier, the insurance sector was opened to private players in 2000, after a very long time. The companies that I will be analyzing in the following chapters are the earliest ones that started doing business in India. We therefore do not have any other companies that can be used as historical reference points. These are also the very first to come out with IPO’s. LIC falls in a very different category and cannot be used for comparison.

1.16.All this put together means that insurance is quite unlike any other industry and India is quite unlike any other market and so it is also not as easy to succeed here as it is perceived or made out to be.

How do we assess the profitability of these private insurance companies?

1.17.Here is where the published information comes in handy. Our starting point for this would be to collect relevant information that is easily available and then choose those bits that will help us in our analysis of the profitability of the companies.

What is the published information available?

1.18.The IRDA monitors insurance companies in India. It also specifies all the guidelines and reports that need to be published and amends these rules and regulations to reflect changing scenarios.

1.19.The published information is very much like those of all other companies and consists of the...