Healthy cover at a cost: HDFC Standard Life Insurance Company – IPO

While fundamentals are strong and growth is healthy, the asking price for the issue is stiff

Healthy profitability, leading market share, diverse product portfolio, well-balanced distribution network and improving persistency — these factors just about sum up the key arguments in favour of private life insurer, HDFC Standard Life.

The company’s new business premium has grown at a compounded annual growth rate (CAGR) of 17.8 per cent over the past five fiscal years (including FY17), higher than the 9-odd per cent growth witnessed by other leading peers such as SBI Life and ICICI Prudential Life; the outperformance mainly driven by the fact that the business of SBI Life and ICICI Pru Life were relatively more impacted in FY-13 and FY-14 due to regulatory changes. Hence, the right period to assess the growth trend of insurers, would be the past two to three years (since FY-15) when the sector has been emerging out of regulatory uncertainty and turning around. On that count, too, HDFC Life has been delivering strong growth of 25.8 per cent in new business premium between FY-15 and FY-17, steadily improving its market share.

The insurer has delivered a healthy performance on the profitability front too. Between FY-13 and FY-17, its net profit has grown at CAGR of 18.6 per cent, while its return on equity has been a robust 29.4 per cent (average for FY-15-FY-17).

While the business fundamentals remain strong and growth is likely to continue, the asking price for the IPO issue is a dampener of sorts. At the upper end of the price band of ₹275-290, the IPO values HDFC Life at about ₹58,000 crore which is 4.1 times its embedded value as on September 2017. After lukewarm listing, ICICI Pru Life and SBI Life trade at 3.4 and 3.7 times their September 2017 embedded value respectively. While SBI Life is the market leader among private insurers, HDFC Life sports a superior return on equity. Even so, justifying such premium valuations may be difficult.

After its listing recently, SBI Life trades at about 8 per cent below its listing price. For HDFC Life too, given its high valuation, listing gains look unlikely. While strong profitability and sound fundamentals make it a good bet for the long run, with markets perched precariously, investors can wait for a better entry point.

The IPO is an offer-for-sale (OFS) for 29.9 crore equity shares.

On the growth path

The growth of life insurers was impacted by the regulatory changes brought about by Insurance Regulatory and Development Authority of India (IRDAI) in 2010 and 2013. In 2010, the IRDAI introduced regulatory changes to unit-linked insurance products (ULIPs), including a cap on charges, surrender and discontinuance charges, and minimum levels of sum assured. In 2013, IRDAI issued regulations to link commissions to the premium paying term and to discontinue highest net asset value guarantee products, among other tweaks. The 2010 changes impacted the sale of ULIPs, while non-linked products took a knock in 2013.

But life insurers since then have re-structured their product portfolio to comply with the regulatory norms. Private sector players, in particular, have regained significant market share in the last two years, driven by healthy demand for ULIPs.

HDFC Life has remained among the top three among private players, in terms of new business premium over the past several years. In fiscal 2017 and in the half year ending September 2017, the company ranks second among private players. Its new business premium grew a robust 34 per cent y-o-y in FY-17 and 30 per cent in the first half of this fiscal.

A diverse product portfolio has helped deliver a healthy growth in premiums. Life insurance policies are broadly categorised into traditional and ULIP policies. Within traditional policies, life insurers sell participating and non-participating policies. Diversification is important, as dependence on a single product can be risky from a regulatory perspective.

Pursuant to its strategy of building a well-balanced portfolio, HDFC Life’s share of new business premium (individual) from participating policies increased to 29.7 per cent in FY-17 from 18.9 per cent in FY-15. On the other hand, the share of ULIPs fell to 51.7 per cent from 57.5 per cent during the same period.

From focussing on gaining market share through first-year premium growth before 2010, insurers have turned their focus on cost rationalisation and persistency in recent years.

The duration of a life insurance product is important, as most of the expenses are taken upfront and the return is generated over the life of a policy. Hence, persistency in life insurance policies — which measures the number of policies (or amount of premium) retained with an insurer across different time-periods — is a critical factor.

Persistency has been steadily moving up for top private players including HDFC Life over the last two to three years. The improvement in the 61st month persistency ratio by premium (6th year after the policy issue) has been sharper across all insurers. This is because it takes into account policies issued post April 2010, which requires longer lock-in period (from three years earlier to five years). For HDFC Life, 61st month persistency ratio improved to 56.8 per cent in FY-17 from 39.8 per cent in FY-15.

HDFC Life also has a diversified distribution network, comprising bancassurance, individual agents, direct, and brokers and others. Bancassurance, however, remains the insurer’s key distribution channel, generating 50.7 per cent of total new business premiums in FY17. Direct sales contributed 39.8 per cent, while agents accounted for 7.5 per cent (remaining through brokers and others).

Strong profitability

HDFC Life’s strong profitability is a key positive. The insurer is among the top three profitable private life insurers, and has been able to deliver strong return on equity, thanks to cost efficiencies, a balanced portfolio mix and improving persistency ratios. HDFC Life generated an ROE of 25.6 per cent in FY-17. The insurer’s solvency ratio — essentially excess of assets over liabilities — was 192 per cent in FY-17, above the minimum regulatory requirement of 150 per cent.

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