4072020 5 metres to evaluate Ite insurance business
5 metrics to evaluate life insurance business
6 min read . Updated: 18 Dec 2017, 09:26 AM IST
Deepti Bhaskaran
Here are some metrics that are unique to the life insurance business. Evaluate these insurance companies on
at least these parameters before investing in them
Topics
india-wire | listing | life insurance companies | value of new business | embedded value | investing
Till now you have interacted with lifee insurance companies as a customer, and so you needed to
understand the different products they sold, embedded costs, performance record of the insurer
and processes of making a claim, But last year, with ICICI Prudential Life Insurance Co. Ltd
going public, followed by two other insurers this year namely SBI Life Insurance Co. Ltd in
October and HDFC Standard Life Insurance Co. Lid in November, you would also be
interacting with the insurers as a shareholder. Listing brings greater disclosure and as an investor
you will come across financial metrics unique to the life insurance industry. We explain five
such key financial parameters that you need to understand in order to analyse the value of a life
insurance company.
Insurance is a long-term business. This means, you buy a policy today but continue to pay
So the
premiums for several years. It is from this future income that the insurers make profits.
value of a life insurance company is assessed by future profits that the current business is able to
generate. This is captured by the embedded value (EV) that represents the sum of present value
ofall future profits from the existing business and shareholders’ net worth, “Embedded value
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simply represents the value generated from the business sold by the company, if it were to stop
writing anymore business," said Shashwat Sharma, partner and head of insurance, KPMG India.
“The more business a company generates, the larger will be the embedded value assuming all
other metrics like persistency ratio and costs remain the same," he added.
Analysts look at EV to analyse valuations. For example, an insurer X may have market
capitalization of Rs1,000 crore whereas its EV could be Rs250 crore. This would imply that
investors are willing to pay four times the company’s EV, indicating a bullish outlook. And this
has been the case for life insurance companies in India so far. All the three companies that were
listed have been valued at multiple of at least 3 times the EV,
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HOW INSURERS STACK UP ON SOME IMPORTANT PARAMETERS
ICICI Prudential SBI Life HDFC Standard
Life Insurance Insurance Life Insurance
Co.Ltd Co.Ltd Co. Ltd
Embedded value (HI of FY18; Rs cr)
Market cap as on 15 December (Rs cr) , aa (Be,
381
Market cap/EV multiple 316 5.46
VNB margin (Hi of FY18) 170% 15.60% 22.40%
Expense ratio (Hl of FY18) 12.90% 13.28% 18.45%
13th month persistency ratio” 80.90% 72.91% 68.04%
61st month persistency ratio 49.60% 46.11% 49.63%
EV: embedded value. VNB: Valu of new business. “On the basis of number of policies. VNB forthe full FYI snot avaiable. Market cap
data from Bloomberg
Ccranhic: PUL SHARMA /MaNT Source: Mint research
Expand
But zoom out and compare the metrics with regional peers and the valuations could begin to
look a bit stretched. “When compared to Asian markets that have higher growth rates and
operate at far superior profit margins, the valuations of life insurance companies in India seem
out of line. This is because the companies in Asian markets are valued at a multiple in the range
of 0.4 to 2 times the embedded value whereas in India the multiple is upwards of three times the
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EY," said a life insurance business analyst who didn't want to be named for the story. This
implies a bullish outlook for the life insurance sector to grow in the future. “About 80% of the
total value is based on growth and profits from the future rather than current intrinsic factors.
The outlook is that insurance companies are expected to generate great profits on the back of
better product mix, higher margins and customer profile. The valuations, in a sense, are a bet on
the future," added Sharma.
According to K.S. Gopalakrishnan, chief executive officer, Reinsurance Group of America Inc.,
you also need to track the EV year-on-year as that tells a story. “A consistent performance in the
growth of EV indicates stability, Companies that see huge spikes or dips will need to be tracked
closely—as changes in product strategy, distribution model, expense performance, pers
all get reflected in the EV," he added,
stency
IfEV tells you the value of the company on the basis of its historical book, the value of new
business (VNB) tells you the value of an insurer on the basis of the new business it wrote in the
last year. “VNB is also termed as embedded value of new business measured at point of sale,"
explained Gopalakrishnan.
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In fact, looking at valuations as an implied multiple of VNB is also crucial in understanding fair
valuations, “This multiple indicates the number of future years the insurer has to underwrite at
east the same amount of business as last year and with the same level of profitability to justify
the valuation," said the analyst, “This is calculated by subtracting the embedded value from the
valuation of the company and then dividing it by the VNB," he added
The other important metric to track is the VNB margin. VNB margin is calculated by dividing
the value of new business by | year’s annualised premium and it indicates the profit margins of a
company. “Simply put, a VNB margin of 20% would mean that if the insurer underwrote new
business premium for a particular mix of products of Rs100 in a year, the expected profit over
the lifetime of that business is Rs20," said Sharma, Obviously, companies with high VNB
margins are better off from a profitability point of view.
According to Gopalakrishnan, VNB margins tell you the product that mix a company has. “It
indicates the product mix of a company. Protection plans have the highest vnb margins followed
by Ulips (unit-linked insurance plans). traditional investment products have similar margins. So
a company that wants to improve its margins will start focussing on the protection business more
and that is what we see happening currently," he said.
Expense ratio is yet another number that you need to track. The expense ratio of an insurance
company is described as the expense of management divided by the gross premium. Expenses of
management are costs that an insurer can deduct from your money, and which include
commissions, and operational and administrative expenses. As per Sharma, a high expense ratio
can hurt the policyholders as high costs can impact investment returns especially in the case of
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traditional products. In India, expense ratios of life insurance companies are in double digits and
for some companies they are in the range of 35-50%. According to Sanket Kawatkar, principal
and consulting actuary- life insurance, India, Milliman India Pvt. Ltd, companies should aim to
bring their expense ratios to single digits. “Expense ratios depend on the type of business sold by
a company. For a company that largely has single-premium business, the expense ratio will be
much lower. But given the type of business generally sold by insurers in India, companies should
be aiming to achieve a very low double digit or close to single-digit expense ratio in order to
achieve expense efficiencies and eliminate expense overruns," he said.
If you are a reader of Mint Money you would know what persistency means in life insurance.
Simply put, it measures how long customers persist with their policies. This is an important
metric to track as persistency is a key driver of profitability for an insurer. Read here for
more: bit.ly/2ghNFvV. A persistent book—where customers pay renewal premiums every year
—also helps insurers reduce costs through economies of scale, The insurance regulator reports
persistency ratios of all companies by the number of policies and you can benchmark this ratio
against the global average. For instance, global average of 13th month persistency (policies that
renew after a year) is close to 90% whereas the 61st month persistency (policies that renew after
5 years) is about 65%, Persistency is an important metric to consider while buying stocks of a
life insurance company. While evaluating it, compare it with global benchmarks
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Of course, these are not the only metrics you look at as an investor. There are many others that
you need to take into account, including some of the softer parameters such as the brand, which
too determines the valuations.
However, make sure to take a comprehensive view. All the metrics mentioned above should be
an important factor in evaluating the fundamentals of a life insurance company
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