LIC IPO: Volatility In Embedded Value Is Key Concern, Says Macquarie

Any investor who's taking an exposure to Life Insurance Corp. is “indirectly taking an exposure to equity markets and its inherent volatility”, according to Macquarie.

“The issue with LIC is that a large part of the EV (embedded value) as per our calculations is constituted by equity MTM (mark-to-market) gains and hence any fall in equity markets can significantly affect EV,” the financial services provider said in a report dated May 17.

Citing an instance, Macquarie said it estimates that a 10% slide in markets could erode LIC's EV—a key valuation metric—by 7% compared to 1-2% for its private sector peers.

The financial services provider initiated coverage on the nation's biggest insurer with a ‘neutral' rating ahead of its listing on Tuesday. It has set a target price of Rs 1,000 apiece compared with its IPO price of Rs 949.

According to Macquarie, LIC's return on embedded value over the longer term and EV growth is likely to be around 10%, and hence at best the fair value needs to be closer to EV. “Unlike private-sector peers in which 9-10% of accretion to EV comes from VNB (value of new business margin), for LIC the accretion is just a mere 1% (due to the large EV base coming from existing policies in force) and hence the contribution of new business to overall value is much lower.”

Diversify Product Mix

It's important for LIC to diversify the product mix in favour of high-margin non-par products, Macquarie said.

After its recent reorganisation, the company is set to increase the share of non-participating pure protection products, which currently form just 5-6% of its overall product portfolio, the report said. It is essential that LIC scales up this business further to drive margins and value of new business growth.

But there are challenges.

Due to legacy reasons, LIC traditionally has largely sold just one product—participating policies. “The management earlier never looked at profitability ofproducts in terms of VNB margins, ROEV, etc. To change the approach and start selling high-margin non-par savings policies and pure protection products could be difficult,” Macquarie said.

Also, LIC has been losing market share in the individual segment with APE growth of just 6-7% over the past five years versus 14% for the private peers, the report said. “Ticket sizes for LIC is also one-fifth that of the private sector, implying the target segment is different, and selling non-par savings products to smaller ticket-sized segments won't be easy.”

The company's market share in individual business (retail), too, has fallen due to lack of a diversified product portfolio.

The research house expects LIC to deliver 12% annualised premium equivalent CAGR and 30% VNB CAGR over FY22-26E.

Bancassurance Challenge

Macquarie remains sceptical of LIC's ability to scale up its bancassurance business.

Though the insurer has access to more than 50,000 branches of its 70-odd bank partners, the problem is that the four largest banks in the country—HDFC Bank, ICICI Bank, State Bank of India and Bank of Baroda don't sell LIC policies. “These are far more productive than most other bank partners by virtue of their scale, size and technology. LIC's partnership with banks predominantly comes from smaller PSU banks where the scope to leverage heavily on the bancassurance network is limited.”

“Also, in other channels such as direct/online LIC's presence has been insignificant.”

LIC, the report said, recently tied up with Policybazaar channel but web aggregators in general don't contribute much to overall business.

LIC listed at an over 8% discount to its IPO price on debut.