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The LIFE Insurance Industry

The Insurance Industry in India has 2 major years or 2 turn around dates to remember FY08 and FY15.
Where in the FY08 it was dominated by ULIPS and followed by a recession - Until this period the
insurance industry was running on Top gear. Then followed a pain period with Government regulations
complete ban on NAV-Guaranteed products, alignment of Cost structures, Commission charges, and
removal of surrender charges and surrender value. In 2016 then came the FDI investment up to 49%
from 26%.

In 2017 the insurance companies accounted for 62% of the funds raised from IPO. In the listed space
the companies with biggest share in Life insurance space are:

1. HDFC Standard Life

2. ICICI Prudential Life
3. Max Financial services
4. SBI Life Insurance

Opportunity of the Insurance Sector in India: The population estimate in India is around 130 Bn people
and the Lives insured are a meager 2.5 Cr. This shows the gap of the No of lives to be insured. On a
Market share basis

Market Share of (Total industry) Total Premium : Source HDFC STANDARD LIDE RHP
The Density and Penetration Trend :

The Density trend is very low when compared to the other countries; Insurance Density is Premium Per

Protection Gap: Protection gap is nothing but for 100$ of protection in India only 8$ was insured when
compared to Singapore where for 100$ of protection 56$ is insured. Ex: In India for a person earning 100
he is protected with 8, whereas in Singapore a person 100 is protected with 56 so when a loss of life
arises the difference in insured amount is hefty in india.

Insurance Penetration: This is the % of GDP for a given period. In India this has been on a downward
slope. See the below trend
The House hold finances is the next big opportunity , Where the % of Insurance in the Household savings
tends to rise from 13.4% its at 18.3% , Bank deposits have attracted the most of the household funds
( Feb 2018 , After PNB and other cases there can be a perception change to this and according to the
DIGGC - Deposit Insurance and Credit Guarantee corporation which is set up by government where if a
bank is in Bankruptcy the maximum a depositors would be eligible would be a 1 lakh rupees only after
paying all the other debtors) With such things in mind there are people moving towards other
instruments like ULIPS and Equity as an investment option

Some ULIPS have generated good returns compared to their MF counterparts and thus there are more
people buying in ULIPS and with IRDAI imposing stringent regulations and more transparency is bought
into the system.
Working Population and the distribution: In 2020 63% is estimated to be in 15-59 category so more
Life insurance needs are to be addressed and with people in the 27.5% who are in age 0-14 will move to
the next category where then the more educated and aware % of people will insure for their life needs .
Out of 130 billion the 27.5% would be 35 cr roughly so they would be in their 50’s in next 40 years and
then the estimated % in 0-14 would increase with ever increasing population, This would be the
addressable market that we would like to see as a big opportunity. Even though the LIFE INSURANCE
products have been here for years I see 3 very important reasons for people not opting them and there
is no grand plans by any government to control Population like China.

1. Awareness of Life insurance products , Now it’s become a necessity in everyone’s life
2. Lack of penetration by Government agencies like Pvt Players. I will buy a Insurance product from
HDFC with more colorful and Vivid advertised who are approachable with benefits than a LIC
product where the agent stands at my door when I’m going out. Private players are just
provoking the need through a different game altogether - The Sociology aspect
3. To Persuade appeal to interest than persuade - The Private players are exactly doing this .This
can be evident from the market share gains of the New Business Premiums the players are
enjoying. Thus I see a great expansion for the private players

The Cycle of Revenues for the Insurance Companies: The Life insurance companies have to earn money
in 2 ways; The Premium earned from the Policy holders and the Shareholders funds. These are the 2
primary sources of revenues. The Premium from the Policy holders is then classified further

NON -Linked portfolio Linked Portfolio

Non-Participating Participating Linked policies

Float for the Insurance

Non -Participating - It’s the portion of policy holders who are insured and are not entitled to profits of
the business. They usually include the Long term life policies of the Insurance companies, this part of the
premium is usually the FLOAT available to the insurance company as a investment tool in other
businesses (We know what warren did with the Float)

Participating Policies: This portion of the policies are provided with the Insurance cover and also that
claim a certain percentage on the profits of the business. The name says it They Participate in the profits
of the business of the company.

Linked Policy: The ULIPS portion where the policy is having a certain portion to cover insurance and the
balance funds to be invested in instruments as given by the company to generate returns, these policies
are of shorter term duration and do not qualify for the Float portion of the company.

What is different in the P&L and Balance sheet of a Insurance company

1. Balance sheet
2. Revenue accounts of Shareholders and Policy Holders.

Balance sheet: In the Balance sheet the Investment portion In application of funds (Shareholders +
Policy holders) would be the Float that the insurance company has to invest and manage. The funds are
deployed in Debt and Equity as proposed by IRDAI, The funds cannot be invested as per the
management but there are strict guidelines to deploy funds.

Borrowing: This would capture the borrowings (Like the capital raised by a bank) in case of Insurance
Company it would be the amount received as premium from Linked + Non-Linked portion, The
Provisions therefore for the funds collected. The Insurance Company has to maintain funds that should
be paid to the Policy holders this would be captured in the Solvency ratio

Assets : The assets of the Insurance company is also a liability where the major portion would be the
investments made of the Policy holders which should be paid out in the future and Assets held to cover
Linked liabilities would be a main portion of it.

The major portion of an Insurance company would be the Provision for Linked Liability (ICICI would have
greater portion of this as the % of linked funds are the highest in Pvt players , HDFC has a balanced
portion of Linked liabilities )
The Profit and Loss Statement:

The Insurance companies have 2 Revenue Statements as compared to the regular companies which
show all the income and Expenditure in a single P&L statement.

1. The Revenue account of Policy holders

2. The Revenue account of Share holders

The main reason to capture is the Allocation of funds in 2 accounts to the proper receptors and which
can be mixed up or Overstating or understating in any of the accounts. As opposed to a bank, Insurance
companies should pay back all money received from Policy holders with benefits and claims but they
need to pay out only the Invested amount to shareholders. To make assumptions easier this is being

From the Policy holders account the Profits are then transferred to the Shareholders account based on
the assumption of the Actuary. In the ICICI AR it has mentioned that 1/9th bonus is transferred to the
shareholders. This is a Gray area and would need more time to come up with a possible math on this.

When there is a loss in Policy holders account then there will be contributions from the shareholders
account to the Revenue account of Policy holders

Tax: For an insurance company the tax is charged in 2 places as opposed to a single tax on other
financial companies 1. On the Surplus in the Policy holders account 2.In the P&L of shareholders a
regular tax

Receipts and Payments account: This is the typical Cash flow statement, For a finance business we
usually don’t use Cash flow statements. But just a brief Overview The PBT in the regular cash flow
would be the Premium received in Insurance company , the Depreciation and Non-cash charges and
Working capital changes captured in a regular cash flows would be Substituted by the payments towards
commission , brokerage , expenses , Operating and other preliminary expenses .

CFI - This portion would hold the Investments and sales made ( A major portion for the Insurance
company )

Valuations and Actuarial assumptions:

The valuation part of the Insurance Company depends on external variables than we can come up with.
The management of the Insurance Company has come up with set of variables on how to evaluate the
performance of the insurance company. Actuarial assumptions are very important part of the insurance

I have used the variables presented by the management and some of my own assumptions to get a
overview on the operational efficiencies of the insurance company.
EV - Embedded Value: The most common used variable to measure the Insurance Company.

This is the embedded value of an Insurance company - The definition of EV is the Present value of all
future profits and Net asset value of the capital

The EV is a measure put out by the Actuary of the company taking into consideration the expected
return on the existing business, new value of business (Which is currently being acquired) and other
conditions such as operating variances as seen in the above case.

After reducing the costs on the Premium received the balance is invested in Equity and Debt
instruments then there is a profit arising from that, the profits are realized over a time. This can be
called the FLOAT the insurance company gets . All the cash in excess of costs paid out or the Surplus is
the net amount left over to invest, The Insurance Company has to set aside a portion of funds that has
to be paid out in the future that is the ACTUARIAL LIABILITY

Ex: In 2018 Feb as of writing this report P/EV of HDFC stands at 4.2 x , ICICI 3.5 x , Which ideally means
you are paying 4.2 x greater than PV for the HDFC business , whereas the norm would be to buy
business that is available below Present value and that is where the MOS lies .

To see a further down the road on why Indian insurers are being valued at a higher multiple than EMMA
countries, compared to Chinese counterparts where the highest is 4.1 can be because they are more
matured markets in terms of insurance, penetration and protection gap. India has a big room for growth
in the emerging market. This can be the reason that markets are valuing Indian companies at a higher
To add further Asia is the largest continent in terms of Life Premium collected with 38%. India’s share is
just 2.4% in the global life insurance market as of 2016, indicating the vast potential for growth in India’s
life insurance industry. In India, the recovery over the last few years was propelled by both linked and
non-linked products, growing 12% and 14%.

Persistency Ratios: Another important measure. It’s the number of Policy holders renewing their
premiums and continuing to pay premium on their policies.

This shows the variables of Insurance companies. The 13th month Persistency ratios are highest for ICICI
and lowest for Max life.

Global standards for Persistency ratio - 13th month > 90 %, 61st month > 65 %

This shows the continuity in premium which is accounted in the Embedded value.
Topline: New Business

The New business Premiums - Premium from new Policies When acquiring a new business the VNB
moves higher inching up the EV and Costs of acquiring the business to goes high so initially it can lead to
a loss for the insurance company. The growth of this and Persistency is key to watch out .

When acquiring a new business huge costs are involved and Indian GAAP does not allow the companies
to amortize the costs involved and hence the company should write down the costs in the 1st year
leading to a higher pressure in margins in the initial years.

Total Premium: New business Premiums (Regular and Single) + Renewal premiums.

(Note: In single premiums 1/10th is added in year 1 and then remaining over the next 9 years. As an
insurer calculates a Single premiums value for 10 years)

ICICI - 606 CR

HDFC - 910 Cr

Max - 499 CR

SO the lowest cost producer has an advantage here.

Ratio to see the lowest cost producer = Non Claim expenses / Total premium earned (My assumptions)

Non Claim expenses are expenses that are operating expenses related to the acquisition of the business

Claims Expenses - Claims / Premium This ratio can be compared to a sound underwriting , I would not
want more claims given out as a % of premium . This shows the underwriting is prudently done as to
minimize claims and to increase the Float to the company. If the underwriting premium is ridiculously
low compared to risk then this area will tend to rise.

Expenses: The cost component in a Insurance business as like others which gives the operating
efficiency or the Gross business is important to assess the cost management of the Insurer.

Commission, Distributors costs and Banc assurance channels are all distributors of the insurance product
currently SBI, ICICI and HDFC use their Banc assurance channels to sell products but in the long run the
policy sold by an agent seems to be more profitable than the banc assurance channel.
Commission as a % on Premium HDFC - 4.1% , ICICI - 3.4% , SBI - 3.8%

Operating Expenses as a % on Premium HDFC - 12.4%, ICICI - 10.6% , SBI - 7.9%

Claims as a % on Premiums - HDFC - 51.1%, ICICI - 67.5% , SBI - 45.7%

Non - Claim Expenses as a % on Prem HDFC - 18.6% , ICICI - 16% , SBI - 13.6%

The above cover some of the most important parameters in expenses. We could clearly see SBI scores
on the important variables. Now this depends upon the product mix and the Distribution channels these
companies have.

Product Mix : The most important factor to take note in a Competitive business and a highly sensitive
business which is dependent on the capital markets and Risk . The most profitable area of the Insurance
is the Term insurance (Protection business) . In a falling Interest rate environment if you’re
guaranteeing a rotund than it could be a risk for the company. The higher the ULIP portion the balance
sheet will be more volatile as it depends on the Capital markets. If the markets are not performing than
people may start moving out leading to a higher surrenders (Another ratio to watch)

Surrender ratio - Surrenders / Total Premium

Highest ICICI - 53% in FY 17

Lowest HDFC - 27.5%

Margin analysis of Product Mix: 1. Protection plans have higher margins 2. Individual business has a
higher margin than group business we can choose companies based on which area they are catering to.

How are Premiums fixed? Premiums on Life insurance policies are based on Mortality rates , The
mortality assumptions are taken into account when calculating the premiums . Ex : A person in age 25
will be covered with a lesser premium than a person at age 40. These assumptions are based on the
Actuary who calculates the premiums. The Cost of the coverage that is the Premiums can vary to a great
extent when entering the policies.

Return on Equity: The standard measure on how much the company is making in terms of Equity
holders net worth.

Asset Under management: AUM can be with growth of Linked portion which poses a risk in times of
bad markets. The Insurance Company does not depend on revenues from AUM its business model is
from premiums, the measure is used to evaluate peers in terms of funds managed.
Other variables to see:

1. Renewal premiums growth

2. Individual business vis a vis group business
3. Product Mix
4. Asset Under management
5. Customer complaints & Settlement ratio

The Excess float part: The portion of funds that is available to investment, which can be defined by

Shareholders’ Investment + Non-Linked Policy Holders investments

This would be a parameter I would watch in terms of how insurance companies get funds

1. Returns generated on the Excess cash would be = (Investment income from Shareholders +
Investment income from Policy holders / total Investments of Shareholders + Non-linked policy holders

2. The Cost of Non-Linked Portfolio / Excess cash would be the cost to acquire the funds

Spread would be the difference b/w (1-2 )

(Note : More thoughts needed on this portion)

Actuarial Assumptions: This portion I believe is a very important area In the Insurance company.
Actuarial assumptions are Changes in Valuation Reserves as mentioned by the Actuary. The company
makes assumptions on the future experiences of the policies. There are 4 main assumptions

1. Interest rate assumptions

2. Expenses
3. Mortality
4. Morbidity
5. Persistency

Interest rate Assumptions : It is a very important parameter to note this shows if the management is
being conservative in its earnings on Valuation reserve. It’s the Present value of the funds that the
company should have in order to meet the future obligations at a given Interest rate assumed. In case of
HDFC the Interest rate assumption is 5.20 to 7.35% which means that at a future date the company now
having Actuarial liability is expecting a return of 5.2 - 7.35% on its funds.

Thus higher the Interest rate assumption the lower the company needs to maintain as a Valuation
Reserve. The more conservative this numbers the better.
Ex: If I am Expecting a 20% interest rate or return on my investment ( The amount to be given to Policy
holders at a future date ) then I will keep lower funds to meet the obligation as I am positive on 20%
returns , Whereas if I’m a conservative person I would assume a 10% Interest rate on funds so I will set
aside more funds for future appropriation .

Expense analysis: Based on the expenses in the future based on renewal and investment expenses
charged as a % on the funds.

Provision for Free-Look : A policy that is In-Force or current is cancelled in a Free-look period ( The New
policy holder can terminate or cancel the policy in initial 10 days or time given without any charges) So a
sum is set aside to this based on the strain the company Expects.

Bonus rates : Bonus that should be given to the Participating funds of the business is assumed on the
basis of the Interest rates.

Risks :

The Insurance business consists of major risks, the underwriting and the investment risk.

Underwriting should be sound and prudent in order to avoid writing down policies with bad odds based
on the Mortality.

Investment risks: The Excess cash derived from the insurance business should be put to use in a prudent
way in order to create a proper amount of wealth to Shareholders and Policy holders. The invested
funds are based on the instruments invested and capital markets. SO investment yield as mentioned can
vary according to Interest rate changes in the economy.

When a Mortality assumption goes wrong for Ex : When a policy that is written based with assumption
of 70 years if carries for 10 more years can cause a strain on the balance sheet of the Insurer who bores
the risk

Regulatory Risks: The regulator imposes guidelines which can reduce Premiums received by the insurer.
Structural changes.

Competition: Number of insurers has steadily increased over the years from single digit to over 20 in a
short span of time. So each insurer designs a product to attract customers, It is like watching a parade
as everyone stands on the toe to watch the parade then no one gets the chance to watch . The attractive
gap in india and FDI regulations can alter and competition can intensify only to be consolidated in
Mutual Funds in Insurance: There are no Thematic funds based on Insurance currently , but given the
number of funds serving the Financials and banks there can be thematic funds on Insurance which can
give the option of basket buying. In all the Life insurance companies there are big ticket Mutual funds
holdings as of Feb 2018. Most fund houses have opted to follow Insurance companies given the gap .
Hence for a retail investor only if valuation is in place can we realize some gains. As opposed to buying
below PV we pay 2 - 4x more than PV to capture the future opportunity. So ideally what it shows is the
PV or the EV still is cheap as per the growth that the insurance companies can have in future which is
debatable to.

Conclusion: At this stage India is having a huge potential in the Insurance sector, Compared to other
peer countries and SEA we are under penetrated and Protection gap exists this would be the
addressable market to the insurance companies. Insurance still is at a very early and a nascent stage in
India. Current valuations may not invite but definitely if you throw your view on India’s To-Be insured
then this is a definite opportunity set at a low stage with high value.

After the budget 2018 and imposing of taxes on equity of 10% where gains are more than 1 lakh, the
ULIPS are tax free (Many single -premium ULIPS may not qualify for the tax-free returns) and If the death
sum assured is note more than 10 times more than premium the maturity amount is not Tax- Free. ULIP
has its own disadvantages too it has a 5 year lock-in irrespective of the fund performance. SO would be
not advisable to choose ULIPS on tax basis alone.

This report is prepared by

K. Ragavendhra Perumall

I am not a SEBI -Registered analyst, I am NISM certified. I am not recommending any companies
mentioned in the report. This report is only for educational purpose. Wherever I have put assumptions
those are Gray areas I would like to study more and get a more pragmatic view for experimental

You can reach me @

twitter - ragavqualtrus

Sources: IRDAI Website, HDFC Standard Life Annual Report & RHP, ICICI AR, SBI AR, Value Pickr, Outlook
Business, Industry experts, MOSL report , PPFAS Valuation of Insurance companies(Youtube)