"COMPARING AN AGE OLD SANDAL TREE WITH ELEPHANT GRASS IS A GREAT FOLLY "
FIRST PART ( BEATING THE BUSH)
At the time of SBIL & HDFCL IPO, I took detailed appraisal of life insurance (LI) business to its nook and corner and came to the conclusion that investment in such business model is a great folly and I have an everlasting nonconformity to this business model, so to say nothing is there for any shareholder.But for LIC , I have a different view got from study of it.
Before understanding any LI business, you are to understand the followings:
1. A business is nothing but ' creation and retention ' of customer .
2. In Li, a business procured will run for 20 -25 yrs , so retention is all the more important . Unlike other business, if a holder leave after one/ two premium payment, it will force the company to suffer loss in this count.
3. People are talking about tepid growth of LIC. Check the constant currency growth rate of TCS, Infy. A big company's growth rate is always tepid. Moreover, LI IS THE ONLY BUSINESS WHO DOES NOT SELL TO ANYBODY OR EVERYBODY. Disproportionate growth in LI business is toxic as it can cause ' Adverse selection' i.e substandard life pouring in more number causing extra death claim. Moreover , as in the initial years expenditure is more to be covered subsequently with the continuation (if at all) , the company has to arrange for fund. This is the logic why foreign funds are allowed in this segment.
4.Though limit of FII has been increased to 74%, response is tepid. In HDFCL 26%, SBIl 24%, ICICIPRUL 16%.
ROLE OF AGENTS
1.Life insurance policies are most often sold and seldom bought.This is because of the nature of the business. So the agents have a great role.
2. In our mind there are two parts A) conscious or Active mind B ) subconscious mind. Conscious mind is engaged with immediate needs while postponed/ deferred needs are in subconscious mind. Taking a LI policy is in subconscious mind and the function of the agent is to take it in our conscious mind by constant follow up. By this time many mishap happen and people repent.
3.LIC has 13.5 lac whole time agents with decades / generation-wise attachment.And it is the strength of the company as much as they are engaged in keeping the policy alive by constant touch with the holders. Only problem they are very commission prone and unwilling to sell ULIP and Short term policy for lower commission rates which adds to the business of the private companies.
4.People claim that 90% of LIC policy sold through agents while 30% by pvts.The data does not support this contention. The commission to prem ratio of LIC is 5.3% and that for pvts 4.3% (inspite of more operating with lower term policy and low commission ULIP) .That means online pols sold by different bodys enjoy the applicable commission.
5.The efficiency of an LI company is judged by its overall expense ratio. For LIC it is14.2 vs 16.9 for the pvts( IRDAI guideline 15%). How can you explain it ? Keep in mind that LIC has to bear the brunt of 5000 cr yly pension to employees and 4000 cr extra commission for for 1% extra than the pvt. This extra 9000 cr is more than 2.2times of total commission paid by the pvts.
6. Per agent production for 6m upto 30/9/21 LIC 5.3 (13.5 lac agent), SBIL 1.7 (1.4 lac ag), HDFCL 0.6 (1.05lac ag). Keep in mind only 20% of yly business of LIC comes during these first two quarters.
7.S uccess of a LI business is reflected in the" conservation ratio" (not Nb market share.). Conservation ratio is defined as Renewal premium of current yr divided by total premium (less current yr exit) of the previou yr.In terms of conservation ratio pvt. companies are nowhere near LIC for more number of lapsation and misselling and inadequate follow up .Lic agents play a vital role here.
8.LIc still enjoy 66% nb market share in terms of premium (inspite of selling long term pols including rural area) and 74.5% on policy number count.
There is no LI company in the world which enjoy more than 22% share except the national insurance company in china where the matter is dicey as you know.
Standard of business :
1.LIC's 98% operation is in conventional type of policies i.e not market linked whereas pvt. mainly operate in ULIP (which is predominantly a MF business with higer operating expeness and sometimes moderate to low insurance cover) along with short term policy which does not give any sense as to taking a LI.
2.ULIP pols are boom when the market is boom. 2005 to 2007 observed Ulip boom followed by 2008 -2010 bust .LIC also took part in it.Consequently LIC agents has to suffer heavy credibility loss along with compensation to pol holders in some cases for regaining their credibility / business operations. PH suffered heavy loss.whatever return Lic could for their prudent approach, the pvt could not. As pvts run on hire and fire , it is no difference to them.
3. In 2010 Irdai comes with more stringent norm to reign the crazy horse.
But the Lic agents got a phobia and refrain from such selling and stick to more stable non linked conventional policis. In the 2008 around Ulip business decimated and pvt. were in the lurch. Now the same boom period is prevailing. History gives a caution may it be taken or not.
Credibility :
1.As the principle of Caveat emptor or caveat vendeta is not applicable and principle of Good faith is applicable to LI business, it is a litigation stricken business cosequent upon non disclosure of material fact at the time of taking the policy or subsequently resulting into court cases at different level forcing the companies booking huge contingent liability which will directly add to the profit in case of wining the verdict.
Inspite of this LIC is a generally acclaimed company with huge trust of the people of the country. It is a big brand with no corporate irregularities except one small case in LICHFL some years ago.
Thus it makes a sense to invest in such a company.
PART II VALUATION AND OTHER MATTERS :
This is for those who has interest and try to understand LI business. It should be gone through patiently as the matter is complicated and I share what I have found during my study in this subject.
Now understanding a LI business, study of embedded value (ev) is indispensable.
People are saying bv =13 , eps =4, p/e = 191 . My question is then how price can be 2100 subsequently dropped to 949. What LIC has done in this long 67 years ?
First we are to understand two independent evaluations :
A) Embedded Value (EV) B ) Valuation for generation of surplus / deficit and providing for life fund.
A) Embedded value has three components
EV =A) NAV (belongs to share holder)+ B) present value of the future profits from the existing business(90% belongs to PH, 10% to SH) + C) Present market value of all assets in hand ( belongs to SH)
But LIC has taken the valuation of A ) & B) only leaving the C.
So you can't say it EV , You may better call it EV without AV.
Everybody knows that EV of Lic is 5.39 lac cr as at 30/ 9/2021 ( which will be about 5.67 lac cr as at 31/3/22. )
Some silly comparison may be done with that of pvts which is in the range of 0.30 to 0.35.
Before understanding EV you are to understand the following things:
1.No policyholder (even the participating ones) has any right in the profit of the company.
2. Policyholders have right to surplus generated in the scheme of the policy he has taken which depends on the plan and term of the policy. Thus for the same plan higher term policies enjoy higher rate of bonus(portion of supluus).
3. As per IRDAI guidelines 90% of surplus to be distributed among policyholers, rest 10% to SH . Here 5% GOVT , 5% PH (from next year.)
4. As total business surplus is distributed nothing to add to NAV.So the NAV belongs to SH.
5. Then where does NAV come from shown as Rs13?
It is from other than core business where p&l a/c is possible. Thus not related to this LI business and specifically belongs to SH.
6. Valuation is a process based on assumtions as per experience of the insurer as to interest rate, motality , expenditure, exit gains etc to find out the policyholder's liability on the date of valuation. As
LI are conservative in nature they try to take favourable assumptions in respect of the variables which along with loading for bonus in premium generates surplus 90 % of which is distributed to PH but payable at the time of exit if condition laid out is fulfilled. Thus at the end of valuation process , entire policy holders liability is credited to 'Life Fund' specifically meant for policy holders.
7.As on 30/6/2021 life fund was 36 lac cr. and Lic's total property is 40 lac crore. So this difference of 4 lac crore belongs LIC alone means Shareholders. As on 31/3/2022 this figure will be about 42.3 - 37.8 =4.5 lac crore.
8.Present Value of future profits from existing business as shown in B) is a less important subject which raised hue and cry . How?
Yearly surplus generation of LIC is in the order of 56000cr. An existing policy may run for say 1 to 20 yrs (increasing volume) , so average span may be taken as 10 yrs .So if we take simple calculation, present value of future profits stands more or less at 56000×10 = 5.6 lac crore as I understood for the sake of simplicity and it matches with LIC' s appraisal.
9.Now out of this 5.6 lac crore only 10% i.e 56000cr belongs to the policyholder.Hence per share works at Rs 88.
10.People are so much speaking of growth of pvts etc, In this count value of HDFCL comes at Rs 14. Interestingly if you take NB growth rate of lic 6%,its effect will be 0.6% , and 88 changes to 88.53.
For HDFCL with gwowth rate 18% this value changes from 14 to 14.26
So EV of 5.39 lac in not that much a great factor. Pvts are much lower at 30000 to 35000 range are insignificant.
Now come to the all important last point C) Market value of assets in hand:
1.For pvt. companies this point is insignificant as they are asset light.
So there EV as shown 30- 35000 , it is orthodox EV considering all counts.
2.In the year 2021 , we have heard many new terms like cash burn , asset light, growth business, new age business , futuristic model ctc.Some may ask what is the need of asset in the business, it blocks capital. But in fact asset gives a stability at the adverse circumstances, it may work as a collateral and above all it creats a sinking fund in disguise. In a risky business like LI assets have great significance. Such are KHANDANI companies.
3.Everybody knows that LIC has huge land and building properties through the length and breadth of the country mostly in prime places. A large section of it inherited from the erstwhile 245 companies who were in operation before nationalisation in 1956. These companies were hugely invested in land and buildings properties as at that time there were not much avenue for investment . LIC too in the time of monopoly has amassed huge fortune in this arena.
Now take glimpses of three LIC property acquired at different point of time :
1. At Anna Salai road Chennai LIC has a fifteen storied skyscraper (southern zonal office) which was completed in the year 1959 at a total cost of 90 lakh.Uptil mid ninety it was the highest and most prestigious building in south india region extending upto Mumbai area.It was the first building in this area with a unique form of structure first adopted.
In 2016 the building was valuated at 447 cr. Now its market price will be not less than 750 cr but still kept at a book value of 90 lakh.
So you see 800 times appreciation .
2) Now take example of Queen's mansion kolkata .LIC inherited this building from erstwhile insurer.Rather than a building it is a mahalla in the heart of Kolkata. In the year 1920 it was built at Rs 6.5 lac .Now its market value is not less than 2000 cr may be even much more higher.
Appreciation here is 30000 times at least. Kept in book value.
3) In the year 1988 , LIC bought 25 kathas of land in a prime place of a subdivision town @ 25000 / katha . Now its price is 15 lac / katha.
60 times appreciation. Kept in book value.
Now on the basis of above discussion , as large portion of properties are inherited from erstwhile insures , we can easily assume that market price of this properties on the average will be at least 150 times of book value.
Book value of LIC properties is in the range of 3800 cr (while rent income is more than 5 times of it after using spaces for its own use) .So market value as per calulatiin will be at least
in the range of 5.7 lac cr. Which belongs to the SH.
So market value of LIC own assets as at 31/3/22 meant for SH is
4.5lac cr+5.7 lac cr =10.2 lac cr
So as per norm Embedded value ofLIC should be 10.74 lac cr
Now notional book value of a LiC share = 13 (NAV) + 88 (EV as lic has taken ) +1613 (asset) = 1714 (if people assume higher/ lower multiple it may change but it gives a direction)
I have already shown that LIC has its own cash of 4.5 lac as on 31/ 3/22
Now people are speaking of market cap which is a temporary value relevant to the time and depends on the perception of the market at that time which is a very fragile conception and may change in a few minute as we saw 22.5% fall of facebook and also many other Indian companies, recently m cap of Hdfc bank fall 24% within some days.Others falling every day. What is Mcap see chhota Amban But BV stands on solid base can't be shattered that way.
Take companies on the basis of asset of promoter /company in hand.:
Company............promoter.......... company
Reliance ..............2.4 lac cr............5.1 lac cr
Tcs.......................0.62 lac cr..........0.84 lac cr
Sbin......................1.5 lac cr............2.7 lac cr
Hdfc bk.................0.46 lac cr..........2.2 lac cr
For LIC See above
For SBIL, HDFCL, Iciciprul etc nothing mentionable.
Total of three companies about 0.6 lac cr
INVESTMENT RETURN FOR LIC IN 20-21 IS 7.6%
which I think satisfactory in low interest scenario.
Per share Profit generating power :
Expected : 210+65 (property appreciation )
Now we understand what a value stock is it ! An age old sandal tree ! Not to be compared with elephant grass.
Thus I was FF
At this price point Enterprise value of LIC stands negative. (Point to note)
CRITICAL ANALYSIS of developed scenario along with listing gain and price behaviour may be dealt subsequently in PART III
Disc : I should have posted it earlier. But didn't seeing the environ. I didn't like to influence individual' s opinion.