The Curious Case of LIC’s Embedded Price Jump

EV is the present value of future profits plus the market value of net assets. For life insurance companies, one valuation parameter is looking at multiples of EV.

As per Milliman’s report in DRHP, the EV of LIC as on March 31, 2021 was Rs 95,605 crore. In six months, the EV grew to Rs 539,686 crore. The growth is driven by shareholder interest in non-participating funds rising to 100%.

Earlier, the insurer had only one fund and the valuation surplus from participating (para) and non-participating (non-para) business was distributed among the policyholders and shareholders in the ratio of 95:5. With effect from 30 September 2021, LIC has a participating fund and a non-participating fund as a result of the amendment to the Life Insurance Corporation Act by the Finance Act, 2021. The entire surplus from the non-participating fund is allocated to the shareholders and the ratio will eventually decrease to 90:10 in line with the private players in like business.

Nevertheless, the nearly six-fold growth in EVs ahead of LIC’s initial public offering (IPO) is eye-opening. Apart from the change in the way profits are distributed, what else could explain the sharp increase in EVs?

One answer is the mark-to-market gain of a non-par equity book. “As per the disclosures in DRHP, we observe that LIC – as on 30 September 2021 – has allocated a significant proportion of the equity book to the non-par book, which is generally not the case, as there is no non-par book. “Such a huge equity ratio,” said analysts at Macquarie Capital Securities (India) Pvt Ltd in a report on February 17.

The report further said, “It is pertinent to note that in FY2011, the gap between investment income, which includes investment income including real gains and unrealized gains, was only Rs 6,200 crore. This gap widens to Rs 3.3 lakh crore as the equity book allocated to the non-par is marked for the market. This implies that LIC has marked a major part of the EV growth of Rs 4.1 lakh crore as non-part and post-market through this equity allocation.

The difference between EVs before and after revision on September 30 is Rs 4.1 lakh crore. Note that the government is looking to sell 5% stake in LIC IPO. Press reports have indicated a valuation of Rs 10-15 lakh crore.

For perspective, the EV modification by 30 September 2021 would have been Rs 124,767 crore if not for the change. On this EV, the valuation multiple would have been in the range of 8-12x for a valuation of Rs 10 to 15 lakh crore. Obviously, these valuation multiples are far higher than other counterparts which trade in the range of 2.5-4x that of September 2021 EV.

Macquarie estimates that now with increased EVs, LIC’s multiple is 1.9-2.8x, with a valuation of Rs 10-15 lakh crore. In comparison, HDFC Life Insurance Company Limited and SBI Life Insurance Company Limited have a multiplier of 4.1x and 2.9x respectively.

According to one analyst who requested anonymity, “it is common for companies to boost their valuations at the time of listing.”

Meanwhile, the Macquarie report also said that unrealized profits are part of the value in force (VIF) and not the net worth. VIF includes the present value of future profits. It remains to be seen when these unrealized profits move into net worth and can be distributed to shareholders.