Regulatory action picks up pace
Over the past few years the insurance sector has had to deal with an active regulator and a Government that is keen to plug tax loopholes across asset classes. A few of the draft papers and policy decisions announced over the recent past include –
- Cap on commissions that can be paid by insurers to their distribution channel has now been replaced with a limit on overall expense ratio. The insurance industry has always had guidelines on what commission % can be paid based on the product being distributed, however insurers were free to incentivize distributors and agents through other means from their P&L. Life insurers sponsoring the offsite parties of banks were very common, large agents getting soft incentives were common too. Now under this new cap, the total incentive paid out to channel partners cannot exceed a defined limit
- Insurance premium above INR 5 lakhs p.a. is now fully taxable on proceeds, exemption under section 10D will no longer be possible from April 1, 2023. Many HNI’s were choosing this route to contribute a large sum to insurance policies that give them fixed/variable payouts after a tenure without worrying about taxation. This was a tax loophole compared to fixed income mutual funds and fixed deposits that has now been normalized
- Draft paper on the composite insurance scheme that will allow life insurers to launch health insurance plans too, as of now there is a clear segregation between life insurers and general insurers. This can introduce some volatility and competitive intensity amongst insurers, life insurers have bigger balance sheets and franchises compared to general insurers. ICICI Pru Life has an AUM of 2.5 lakh Cr while ICICI Lombard has an AUM of ~43,000 Cr
- The new tax regime (which is a flat slab based taxation regime) starts this FY, the old tax regime gave taxpayers breaks on investments towards section 80C and HRA. As the new tax regime gains greater acceptance, tax payers may choose not to make investments purely to save tax
Some of these developments can potentially be negative for insurers over the next 1-2 years as the way they sell and position life insurance products to the affluent segment will need to change. The seasonality in business booking in Q4 every year may well normalize going forward. The market rarely likes it when the regulator becomes more active, even if the intention of the regulator is to develop the industry over a period of time.
The > 5 lakh per year premium segment was large for players like HDFC Life and ICICI Pru Life, they were the ones with a higher proportion of business coming in from the affluent segment in metros and tier 1 cities. They are also the businesses with higher expense management ratios compared to an SBI Life. Approx 8-10% of the NBP was coming from this segment, starting from FY24 this segment will see a much muted response from customers.
The market today values life insurers much more reasonably than it did 3 years ago. Both SBI Life and HDFC Life trade below 3x on market cap to IEV basis while ICICI Pru Life trades at less than 2x. In terms of how the business has pivoted towards a better product mix and more broad based distribution, we think ICICI Pru Life has shown tremendous progress compared to the other two life insurers. The over reliance on ULIPs and ICICI Bank distribution channel has been done away with and the business growth should be more predictable and broad based here on. Their tendency to missell policies has also come down drastically and this reflects in the persistency ratio compared to the numbers from 5 years ago. Based on valuation, if we had to pick one life insurer today it would probably be ICICI Pru Life over the others, given that VNB margin and share of protection has shown a drastic improvement since FY19.
ICICI Lombard Q4 results weren’t bad in any way, just that the market got a bit spooked by the degrowth in motor premium and is worried about the impact of life insurers being allowed to offer health indemnity policies soon. This business now trades close to 5x book value and is probably the cheapest it has been on this parameter ever since it listed . One should expect operational efficiency to drive the combined ratio closer to 102% from the current level of 104%, with interest rates set to peak soon, the investment income should show a healthy spike as well. At underwriting losses of ~400 Cr per annum and investment income of < 2,600 Cr per annum, the PAT should conclusively and reliably break beyond the 1,800 Cr p.a. mark starting FY24, if the management continues to execute well.
In a relative attractiveness sense we still see greater value in banks compared to insurance companies, today we have banks getting into a healthy credit cycle where recoveries and upgrades compensate for the fresh slippages and ROA/ROE are improving across the board. Good quality mid sized banks are available at < 2x price to book, we will continue to prioritize allocation there until we sense the credit cycle maturing.
Insurance is a long gestation, regulation heavy business that needs a true long term outlook for investors. Unless the market throws us a full toss in the form of cheap valuation in FY24, we may not add aggressively to our existing positions here. We will continue to evaluate the industry from a relative attractiveness point of view w.r.t lenders and other financialization stories.
