The curious case of jump in LIC’s embedded value – Mint
Life Insurance Corporation of India’s (LIC) draft red herring prospectus (DRHP) has understandably garnered a lot of interest. While the valuations at which the shares are offered to the investors remains to be seen, one factor that clearly stands out is the huge jump in embedded value (EV) in a short span of time.
EV is the present value of future profits plus the market value of net assets. For life insurance companies, one valuation parameter is looking at multiples of EV.
As per the Milliman report in the DRHP, LIC’s EV as on 31 March 2021 stood at Rs95,605 crore. In six months, the EV surged to Rs539,686 crore. The rise is due to shareholders’ interest in the non-participating funds increasing to 100%.
Earlier, the insurer had only one fund and the valuation surplus from the participating (par) and non-participating (non-par) business was distributed between policyholders and shareholders in a ratio of 95:5. With effect from 30 September 2021, LIC has a participating fund and non-participating fund as a result of amendment in the Life Insurance Corporation Act by the Finance Act, 2021. The entire surplus from non-participating fund is allocated to the shareholders and the ratio in par business will eventually reduce to 90:10 in line with the private players.
Nevertheless, the surge of nearly six times in EV ahead of LIC’s initial public offering (IPO) is eye-popping. Besides the change in the manner of distributing profit, what else can explain the sharp increase in the EV?
One answer is the marked-to-market gains of non-par equity book. “As per the disclosures in the DRHP we see that LIC – as on 30 Sep 2021 – has allocated a significant proportion of the equity book to the non-par book which usually isn’t the case, as non-par book doesn’t carry such a large equity proportion” said analysts at Macquarie Capital Securities (India) Pvt. Ltd in a report on 17 February.
The report further added, “What is more interesting to note is that in FY21, the difference between investment income including realised gains and investment income including unrealised gains was a mere about Rs6,200 crore. This difference shoots up to Rs3.3 lakh crore as the equity book allocated to non-par has been marked to market. This implies that LIC has driven a large part of the EV increase of Rs4.1 lakh crore through this equity allocation to non-part and subsequently marking to the market.”
The Rs4.1 lakh crore is the difference between the EV before and after the amendment as on 30 September. Note that the government is looking to sell a 5% stake in the LIC IPO. Press reports have indicated a valuation of Rs10-15 lakh crore.
For perspective, the EV as on 30 September 2021 would have been Rs124,767 crore if not for the amendment change. At this EV, valuation multiple would have been in the range of 8-12x for valuation of Rs10-15 lakh crore. Obviously, these valuation multiples are far higher than other peers which trade in the range of 2.5-4x of September 2021 EV.
Macquarie estimates with the increased EV now, LIC’s multiple works out to 1.9-2.8x at a valuation of Rs10-15 lakh crore. In comparison, HDFC Life Insurance Co. Ltd and SBI Life Insurance Co. Ltd’s multiple is at 4.1x and 2.9x, respectively.
According to an analyst requesting anonymity, “It is common for companies to boost their valuations at the time of listing.”
Meanwhile, the Macquarie report also states that the unrealized gains form part of value in force (VIF) and not net worth. VIF includes the present value of future profits. It remains to be seen when these unrealized gains move to net worth and be distributable to shareholders.
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