ICICI Lombard - Primary Offer: Unfurling the umbrella

The general insurance sector, which opened up in 2000, has been through many ups and downs, given the slew of regulatory changes. The transition from the tariff regime — when insurance players witnessed high growth — to de-tariffing of most policies in 2007, led to a re-alignment of business models and improved economics in health insurance. But the motor third party pool for risk-sharing played spoilsport, knocking insurers off their stride and impacting profitability.

The wheels of fortune have, however, recently been turning in favour of the sector. The dismantling of the motor pool in FY16 and increase in rates on motor third-party have helped reduce losses and enhance profitability. Notwithstanding the regulatory hitches, the sector has been growing at 17-18 per cent annually (in terms of GDPI — Gross Direct Premium Income) over the past decade or so. With much of the regulatory uncertainty now out of the way, general insurance players can generate healthy returns.

ICICI Lombard, which ranks number one in the general insurance space, among private players, appears well placed to ride the next wave of growth in the sector. It has been growing faster than the industry over the last couple of years. In 2016-17, ICICI Lombard’s market share among private players (in terms of GDPI) stood at 18 per cent.

While the company’s business is on a strong footing, the asking price for the IPO issue is high. Deals in the general insurance space have happened at one to two times companies’ gross written premiums (GWP) or 14-16 times earnings. HDFC’s 23 per cent stake sale in HDFC Ergo in 2015 took place at about 1.5 times its one-year forward GWP.

At the upper end of the price band, ICICI Lombard’s issue is priced at about 2.3 times its one-year forward GWP and around 36-38 times one-year forward earnings. Even going by the past stake sale in ICICI Lombard, the price is high. In 2015, ICICI Bank sold its 9 per cent stake in ICICI Lombard, which pegged the value of the insurance business at ₹17,225 crore. Only recently, in May 2017, Fairfax Financial Holdings, sold its 12 per cent stake in the insurance business, at a consideration that valued the business at ₹20,300 crore.

At the upper band of the IPO, ICICI Lombard is now valued at about ₹30,000 crore. That said, while the near-term upside may be limited on account of the steep valuation, investors with a long time horizon, wanting a piece of the action in the general insurance space, can subscribe to ICICI Lombard’s primary offer. Its diverse product portfolio, sound solvency margins, healthy profitability, lower loss ratio and well-balanced distribution mix are key positives that will help the company retain its leadership position and deliver healthy returns over the long run.

The IPO is an offer for sale of 8.6 crore shares, with a reservation of around 43 lakh shares for ICICI Bank shareholders.

There are currently 18 private multi-product players in the general insurance space, with key products related to motor, health, crop, fire and marine insurance. All products, except third-party motor, are non-tariffed. The premium rates for third-party motor insurance are set by the IRDAI and reviewed every year. For FY18, IRDAI has proposed up to 28 per cent increase in premiums. For ICICI Lombard, motor, health and crop constituted 36.5 per cent, 18.2 per cent and 21.8 per cent respectively of GDPI as of June 2017.

The company has been selective in underwriting within these segments, focusing on more profitable businesses. In motor insurance for instance, the share of GDPI from private cars and two-wheelers has inched up by 5 percentage points since FY15 to 82 per cent as of June 2017; it has been underwriting select segments in commercial vehicles. This mix helps the company mitigate losses from the third-party motor business. ICICI Lombard has seen a 15.3 per cent growth annually in motor GDPI.

Within health, due to aggressive pricing and competition in the corporate health segment, the company has been selective . Instead the focus has been on SME (small medium enterprises) and on indemnity products in the retail segment.

With the launch of the the Pradhan Mantri Fasal Bima Yojana (PMFBY) in April 2016, ICICI Lombard’s GDPI from crop insurance grew from Rs 276 crore in FY15 to Rs 2,151 crore in FY17. While the Centre’s focus should keep growth in good stead, the ongoing claims settlement issues can be a dampener. It’s still early days to gauge how the growth in this segment will pan out.

For now, motor and health should drive growth in the general insurance space on the back of increase in vehicle sales, rising medical costs and increased awareness. ICICI Lombard, given its leadership position in these segments, should continue to deliver steady growth.

A well-balanced distribution and customer mix is another key positive for ICICI Lombard. As of June 2017, direct business constituted 43.3 per cent of ICICI Lombard’s GDPI, broker 32.8 per cent and corporate and individual agents 13.2 per cent and 10.7 per cent respectively.

The economics of a non-life insurance business principally rides on the concept of ‘float’, wherein insurance companies collect premiums upfront and pay claims afterwards. This creates a float, or investable asset base, that can be deployed to generate returns for shareholders. Additionally, if premiums exceed the total expenses and the eventual losses, then the underwriting profit adds to the investment income.

Hence two ratios — loss and combined ratio — are used to measure the profitability of a general insurance business. Loss ratio (ratio of claims incurred to net earned premium) is essentially total incurred losses in relation to the total premiums. The combined ratio measures the incurred losses and expenses in relation to the total premiums.

ICICI Lombard’s combined ratio has been lower than the industry average and has been improving from 104.9 per cent in FY15 to 104.1 per cent in FY17 and 102.4 per cent in the June 2017 quarter.

The loss ratio has fallen from 81.4 per cent in FY15 to 80.6 per cent in FY17 and 78.1 per cent in the June 2017 quarter. It’s important to note that the key reason for ICICI Lombard’s combined ratio being lower is the negative net commission ratio. This is on account of the company ceding a substantial portion of its risk to reinsurers.

Profitability also depends on float management. ICICI Lombard has one the largest investment books among private players (₹16,446 crore as of June 2017). The realised return on this has been steady at around 10 per cent over the past three years.

ICICI Lombard also has one of the fastest claims turnaround times, with claims settled within a month at 94.4 per cent. The solvency ratio is also sound at 210 per cent, above the mandatory 150 per cent level.

The company’s return on equity has been at 16-20 per cent levels over the past three years. ICICI Lombard has also been following conservative reserving (loss reserves are based on estimates as to future claims liabilities).

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