Home / Opinion / Views /  Savvy investors won’t be swayed by LIC’s 1,000% rise in net profits

LIC is the 800 kg gorilla in the life insurance segment. But the PSU has disappointed investors ever since its public issue. The offer price was 949, and it listed at an opening price of 873 in May. While the Q2 FY23 results may have made a positive difference to sentiment, it still trades nearly 26 per cent below the listing price.

LIC lags its private sector rivals in terms of profits and returns on its portfolio. This is one reason for a low valuation. Savvy investors will not be swayed by the apparently astounding 1,000 per cent rise in net profits, from  1,433.71 crore a year ago,  to 15,950 crore. That’s thanks to an accounting adjustment. 

Government control (the government holds 96.5 per cent) remains a factor, which retards growth. The IPO prospectus cited the government’s influence on management decisions as a key risk. LIC has been forced to invest in other PSUs to support the disinvestment programme. That has yielded poor returns.

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But there are some good signs. LIC has gained market share. It is creating a more profitable policy mix, and promises to generate higher future profits. LIC’s market share of new policies (“first year premium") rose to 68.3 per cent in the first half (Apr-Sep 2022), from 63 per cent in fiscal year 2021-22. This is a serious gain in a very competitive segment.

Overall sales growth was strong. The Value of New Business (VNB) was up 64 per cent QoQ to 2,290 crore in Q2 compared to Q1, and the VNB margin improved to 15.25 per cent in Q2, from 13.6 per cent in Q1. A higher VNB margin indicates higher future profits.

Life insurers offer non-participatory (“non-par") and participatory (“par") policies. Par policies pay out a share of profits to policyholders, non-par don’t. Non-par policies offer better returns for the insurer. LIC has a mix of 9 per cent non-par (policies with high-profit for the insurer) to 91 per cent par (low-profit for the insurer). It is trying to increase the ratio of non-par by launching new non-par schemes.

The jump in PAT is connected to changes in the payout. LIC has reduced the payout on par policies, from an earlier 98 per cent paid to policyholders to 95 per cent paid in the past three quarters. It intends to cut this to 90 per cent paid to policyholders, in future. LIC clubbed the three quarters of surplus income created by this shift in payout ratio and declared it as PAT in Q2.  

Insurance works by collecting premiums which are surplus to payouts on claims. That “float", as it is known, is invested. It’s critical for an insurer to generate decent returns on this portfolio.

Rising rates generally reduce returns on financial portfolios, and interest rates have been rising since May. LIC has Assets Under Management (AUM) of 42,93,778 crore, (a rise of 9.7 per cent compared to 39,50,633 crore a year ago). The Yield on Investments made using policyholders’ funds is 8.32 per cent for the first half of 2022-23, against 8.62 per cent for H1 2021-22. This seems reasonable, given the stock market turmoil and rising interest rates. But private insurers have much higher yields.

The valuation of an insurance company is done through the concept of Embedded Value (EV) which is also affected by interest rate swings. The higher the EV, the better.

Here's how it works. Let’s say, government debt offers 5 per cent return – that’s a “risk-free return". If you invested 95.24 at 5 per cent, you would receive 100 a year later. Hence, 95.24 is considered to be the current value of 100. If the risk-free rate rises to 6 per cent, the current value of 100 falls to 94.34. 

The EV calculation estimates future returns to the insurer and calculates the present value. In effect, it compares the return to the return available with zero risk. Given the arithmetic, EV tends to fall if rates are rising.

But despite rising risk-free rates, LIC has a small gain in EV to 5,44,291 crore (Sep 2022) against EV of 5,41,492 crore (March 2022) and 5,39,686 crore (Sep 2021).

Insurers are valued by comparing price to EV per share, rather than to earnings per share as is commonly done for other businesses. LIC went public at an estimated Price/EV ratio of 1.1. It currently trades at a P/EV of below 1. Rivals like HDFC Life, SBI Life and ICICI Prudential all have P/EV valuations of 2.5 or more. LIC Investors will be hoping for positive revaluations based on the encouraging results.

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