Savvy investors won’t be swayed by 1,000% jump in LIC’s net profit

LIC lags behind its private sector peers in terms of profits and returns on its portfolio. This is also one of the reasons for the low valuation. Savvy investors won’t be swayed by an apparently astonishing 1,000 percent increase in net profit. Rs 1,433.71 crore a year ago 15,950 crores. This is thanks to an accounting adjustment.

Government control (96.5 percent is government-held) remains a factor, which slows down growth. The IPO prospectus cited government influence on management decisions as a key risk. LIC has been forced to invest in other PSUs to support the disinvestment programme. This has given bad returns.

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But there are some good signs too. LIC has gained market share. This is creating a more profitable policy mix, and promises to generate higher profits in the future. The market share of LIC’s new policies (“First Year Premium”) increased from 63 per cent in FY 2021-22 to 68.3 per cent in the first half (April-September 2022). This is a serious advantage in a very competitive segment. ,

Total sales growth was strong. Value of New Business (VNB) grew by 64% QoQ 2,290 crore in Q2 as compared to Q1, and VNB margin increased from 13.6 per cent in Q1 to 15.25 per cent in Q2. A higher VNB margin indicates higher future profits.

Life insurers offer non-participating (“non-equal”) and participating (“equal”) policies. Par policies give a share of the profits to policyholders, non-par do not. Non-equivalent policies provide better returns for the insurer. LIC has a mix of 9 percent non-equal (high-margin policies for the insurer) to 91 percent at par (low-margin policies for the insurer). It is trying to increase the ratio of non-equal by launching new non-equal schemes.

The jump in PAT is linked to the change in payout. LIC has reduced the payment at par paid to policyholders to 95 per cent from 95 per cent paid in the last three quarters. It intends to cut the amount paid to policyholders in future by up to 90 per cent. LIC added three-fourth of the surplus income generated by this change in payout ratio and declared it as PAT in the second quarter.

Insurance works by collecting premiums that are surplus to payments on claims. That “float”, as it is known, is invested. It is important for an insurer to generate good returns on this portfolio.

Rising rates generally reduce returns on financial portfolios, and interest rates have been rising since May. LIC has Assets Under Management (AUM) 42,93,778 crore, (an increase of 9.7 per cent as compared to 39,50,633 crore a year ago). The return on investment made using policyholders’ money is 8.32 per cent for H1 2022-23, while it is 8.62 per cent for H1 2021-22. This seems appropriate given the volatility of the stock market and rising interest rates. But private insurers have much higher yields.

An insurance company is valued through the concept of Embedded Value (EV) which is also affected by interest rate fluctuations. The higher the EV, the better.

Here’s how it works. Suppose, government debt offers 5 percent return – this is the “risk-free return”. if you have invested 5 percent at 95.24, you will get 100 after one year. Hence, The present value of 95.24 is considered 100. If the risk free rate rises to 6 per cent, the present value of falls to 100 94.34.

The EV calculation estimates future returns to the insurer and calculates the present value. In fact, it compares the returns with the returns available with zero risk. Looking at the arithmetic, if rates are rising then the EV falls.

But despite rise in risk-free rates, LIC gains little in EVs 5,44,291 crore (September 2022) against the EV of K. 5,41,492 crore (March 2022) and5,39,686 crore (September 2021).

Insurers are valued by comparing them to EV per share rather than to earnings per share, as is commonly done for other businesses. LIC went public at an estimated price/EV ratio of 1.1. It is currently trading at a P/EV of below 1. Rivals like HDFC Life, SBI Life and ICICI Prudential have P/EV valuations of 2.5 or more. LIC investors would be hoping for a positive revaluation based on the encouraging results.

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