Markets
LIC investors' policy of patience paid off
Summary
Despite the significant gap in value of new business margin, LIC’s shares have gained as much as 76% in the past one year, compared to gains of 28% and 9% seen in ICICI Prudential and HDFC Life.
Life Insurance Corp. of India Ltd’s (LIC) June quarter results show that it continues to lag behind some big private sector peers on key parameters, notwithstanding its large base. LIC’s annualized premium equivalent (APE) growth and value of new business (VNB) margin in Q1FY25 stood at 21% and 14%. The corresponding numbers for HDFC Life Insurance Co. Ltd were 23% and 25%, and for ICICI Prudential Life Insurance Co. Ltd at 34% and 24%. For insurance companies, APE is a measure of sales growth and VNB a profitability parameter.
Despite the significant gap in VNB margin, LIC’s shares have gained as much as 76% in the past year, compared to the 28% gain and 9% gain seen in ICICI Prudential and HDFC Life. A part of the outperformance can be explained by the recent sharp rally seen in public sector undertaking (PSU) stocks, including LIC. Further, value investors seem to have piled up on LIC stock to take advantage of the huge valuation gap vis-à-vis private sector peers.
Price-to-earnings multiple
As such, the valuation gap still persists. A simple way to understand this is in terms of price-to-earnings multiple based on the profit after tax (PAT) in shareholders’ profit & loss account while ignoring the policyholders’ profit & loss account. Annualizing LIC’s Q1FY25 PAT of ₹10,461 crore, the price-to-earnings multiple works out to 20x for FY25, while the same for peers is over 80x plus.
To be sure, the price-to-earnings multiple is not the most preferred valuation metric for life insurance companies. That’s because the expenses in the life insurance business are recognized upfront, depressing the profits in the initial years. Thus, faster growth may mean slower growth in reported profit and vice versa.
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In the Q1FY25 earnings call, LIC’s management said they are not fixated on margins and remain focused on delivering absolute VNB growth. Still, FY25 VNB margin is likely to be higher year-on-year. Also, they are striving to push the VNB margin higher towards 20% plus in the medium term. But they also want investors to appreciate that the margin is an outcome of the business where margin cannot be the only focus.
For instance, if a customer wants a participating policy, he cannot be sold a non-participating policy just because the management wants to reduce the share of less profitable participating policy. Participating policies are less profitable for shareholders as these policyholders are entitled to a share the insurance company's profit. LIC’s VNB margin in non-participating policy in Q1FY25 at 40% is five times that of its participating policy.
Term insurance
LIC, being the oldest life insurance company, will take some time to reduce the share of participating policies even though its share in APE fell from 56% to 44% in Q1FY25. However, it has a lot to catch up with its private sector peers in terms of the premium earned from selling term insurance or pure protection policies.
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While LIC earns less than 1% of its total APE from term insurance, the same for HDFC Life and ICICI Prudential was at 14% and 18%. Given that the profitability of term insurance is the highest, LIC continues to suffer as it has a negligible presence in the segment. In Q2FY25, LIC launched Yuva Term and Yuva Credit Life with their digital versions to take on competition.
LIC’s Q1 results have been met with subdued reaction by the Street. But there is a possibility that if it is able to grow its absolute VNB even at a lower margin than peers, there is scope for valuation discount to keep on narrowing, going by the past year’s trend, at least.
