LIC IPO : An Empirical Study
Life Insurance Corporation of India, a government owned insurance company, was established with the passing of LIC Act in 1956, with an objective of spreading life insurances to all insurable persons in the country, providing them adequate financial cover at a reasonable cost.
Today, LIC controls 66% of India?s life insurance market with a whopping total of 290 million policyholders. For years, LIC has been the crown jewel of all the PSUs and has rescued the government several times, being the government's biggest investor and saviour.
The talks of LIC IPO started in the last Union Budget session, when our Finance Minister announced an ambitious disinvestment target of 2.1 lakh crores, by strategic disinvestment of PSUs. Failure to execute the LIC IPO and BPCL strategic disinvestment resulted in the Centre garnering only Rs 32,835 crore or 16% of the budgeted (BE) disinvestment revenue. For FY22, the disinvestment target is set at 1.75 lakh crores, and should the IPO land, it is expected to be the largest in India?s history.
LIC Act and SEBI Rules:
To bring the IPO to life, several amendments needed to be made to the LIC Act of 1956.These changes were passed in the Union Financial Budget of 2021, under the Finance Bill by the Parliament. As many as 27 out of the 49 Sections of LIC Act, 1956 were proposed for amendment. Although questions were raised by the opposition, these were sidestepped. Several members of the Congress were apprehensive of this move and stated that ?Indian economy was being handed over to capitalists?, LIC being the country?s crown jewel in PSU?s and the lender of last resort to the Indian Government. The amendments included the proposal that 75% of stake will be held by the Centre for the next five years and at least 51% post the five year period. A separate bill for these proposals would have possibly invited greater scrutiny, which the government has managed to sidestep.
The Securities and Exchanges Board of India mandated the issuers with a post-issue market capitalization of Rs. 4000 crore or more to offer at least 10% of the post-issue capital to the public in IPO and achieve a minimum public shareholding of 25% within three years from the date of listing.
However, due to the size of LIC, a mere 10% stake in the company is also estimated to be around Rs.1 lakh crore, and it will be difficult for the market to absorb such a big amount. To ease the government selling part of its stake in the company, SEBI has relaxed its norms.
Now, companies with a post-issue market capitalization beyond 1 lakh crore (Rs.1 trillion), need to make an offer of Rs. 10000 crore plus 5% of incremental amount beyond 1 lakh crore. They shall be required to achieve at least 10% public shareholdings in 2 years and at least 25% public shareholdings within 5 years of listing.
Why this article is worth your 10 mins
LIC was created to support the growth and the industrialization of India by raising money through small savings in form of premiums while giving utmost security to the policyholders. LIC is the largest investor in government securities and stock markets, investing anywhere around 55,000 crores to 65,000 crores every year. Be it investing heavily in IPOs and further follow on offers of failed IPOs like ONGC, bailing out companies like IDBI Bank or investing in a lot of debentures and infrastructure projects, a majority of them junked by the credit agencies, LIC has done it all. LIC bidded for more than half of the offer of General Insurance Corporation of India (GIC) that saw just 1.35 times subscription. Same was the story with IPO of state owned New India Assurance. The resources of LIC have been used by the government to bail themselves out whenever the participation of investors has been weak. It has negatively affected the investment portfolio of the company. LIC is one of the few remaining profit making PSUs and arguably the most powerful tool for the success of India?s Atmanirbhar initiative.
Often referred to as India?s crown jewel, LIC?s disinvestment was justified by four reasons listed in the budget. We discuss all 4 of those in detail here.
- Access to its capital needs - The partial stake sale of LIC is expected to bring in about 1 lakh crore, more than half of the disinvestment target for FY22 whose completion is hugely dependent on the success of the IPO. Given the sheer size of LIC, the uncertainty around its true valuation and the negative sentiment that the state owned enterprises often carry with them in the security markets could be tricky.
- Unlock its value benefitting from retail investing - Finance Ministry argued that not only the IPO will raise money but also benefit the retail investors as they will get to tap the huge potential of the company. It has to be understood that only a meagre 2% of the total population of the country invests in the stock market. Until now the benefit was shared by the whole population, since it was used in the ?best? interests of the country by the government, from now onwards it will be partial to a few hundred thousands investors who will get access to the initial listing.
- Discipline the company - The all time high of LIC?s NPAs at around 8% grabbed a lot of eyeballs and it has been argued that post IPO, LIC will be in a better position to tackle it. But, simply listing on the stock market doesn?t guarantee anything, the banks listed in the Indian markets have combined NPAs of more than 8 lakh crores and many listed companies default too. Note that LIC does not enjoy full autonomy over its investment decisions, there is a chunk of failed investments that were directed by the government to save itself, for which LIC cannot be punished alone. Solely an IPO does not guarantee better governance.
- Transparency - LIC along with all other insurance companies comes under the supervision of IRDA and it is ensured that these companies are subject to public disclosure norms. They have to file timely reports on all their activities and are accountable to the parliament too, but LIC?s investment activities are significantly opaque. It has holdings in several unlisted companies, large land holdings and investments in perennially underperforming stocks. Post IPO, LIC?s accountability to the shareholders is expected to result in wiser investment choices.
Why not Privatisation?
The performance of LIC is often criticized. From being an absolute monopoly in the early 2000s, it declined to around a 66% domestic market share in 2020, with customer infographics revealing the true picture. Most belong to the lower and middle classes, while private counterparts of LIC who started pretty late, were still able to capture 80% of the upper middle class and HNIs by making up for the lost time with aggressive marketing and an extremely focused outreach strategy. LIC has a humongous network of about 22.5 lakh agents but the returns have been dismal. While the others capitalized on their banking networks to gain customers, for eg, HDFC Life Insurance pushed its products through HDFC bank, LIC has not yet used the huge PSU bank universe, with only 3% of its customers coming from this channel.
This does pose a question - why not privatise LIC, why just release an IPO when such an opportunity is available. So the reasoning behind privatising LIC can be cost efficiency rather than financial income. It is understood that state owned firms much like LIC are inherently less efficient because of various factors like preference of political factors over economic objectives by supervising politicians and bureaucrats, importance of setting examples for social objectives like job security, health benefits and others, leading to higher costs. It may seem that a change in ownership and privatising LIC will increase the efficiency and improve management, but this is questionable. Privatisation by itself will not change the nature of the market in which the company is operating or the environment which shapes the pricing decisions. LIC is a public monopoly having the majority market share but if it becomes a private monopoly efficiency may not rise. Privatisation yields full benefits only in a competitive market environment as it is the competition which exerts pressure on the management to strive for better performance.
It is also feared that post privatisation, the rationale behind the company?s decision making might change from a macroeconomic benefit to the micro-economic profitability and shareholders? wealth maximization mindset. At present, LIC has special provisions to cover the weaker sections of the society, and for the policy holders in terms of the bonus - 95% of the profits are given to the policy holders. This situation warrants public ownership as it focuses on both macro and micro benefits rather than private who solely focus on micro- economic returns.
So it is clear that privatisation of LIC is not the answer to achieving the disinvestment target and increasing the efficiency of the company. Generally, there are three ways to push managers to become cost efficient. They are : direct monitoring by the shareholders, the threat of takeover of the firm, and monitoring by financial institutions which have an interest in preventing the firm from bankruptcy. So, another solution to the problem of achieving higher efficiency and reaching disinvestment targets is to employ the above mechanism of direct monitoring by shareholders and this can also be achieved with an IPO. With the help of an IPO and stricter transparency regulations for publicly quoted companies, the public shareholders will themselves hold the managers accountable and will lead to better efficiency on the part of the firm.
Valuation of LIC is going to be a mammoth task, given the size of the company. The government has appointed Deloitte as the pre-IPO transaction advisors and Milliman Advisors for reporting the embedded value of the company.
In the budget 2021, the government has proposed to significantly increase the authorized capital of LIC to Rs. 25,000 crores from Rs. 100 crores. Assuming the face value of a share to be Rs. 10 each, this authorized share capital can be divided into 2,500 crore shares, which is one of the major amendments proposed in the LIC Act, 1956 in the recent budget session. The government has also stated that they will still hold a major portion of LIC post IPO and have suggested to sell upto 10% of their stake in LIC. Now, the exact valuation of the insurance giant is going to take some time but rough estimates present a ballpark figure of Rs. 10-12 lakh crores. At the estimated valuation, the price of LIC?s shares can be appraised at Rs. 400-480 per share.
For the year 2021, LIC booked a net profit of Rs. 33,085 crores so far this year compared to the Rs. 18,371 crores in the entire previous fiscal year. This brings the estimated share price to be 30.22- 36.27 times the EPS. Taking note of the distinctly overpriced IPO of New India Assurance, whose initial issue price was 74 times the EPS and its peer ICICI Lombard, whose initial issue price was 48 times the EPS, the valuation?s accuracy is further substantiated. New India Assurance took a pretty bad hit and its share price has fallen from its initial value of Rs. 800 to Rs. 150 per share, whereas the share price of ICICI Lombard has more than doubled from Rs. 651 to Rs. 1451 per share. This indicates the fact that buying a share of LIC is going to be very profitable for the potential investor.
Down the line, whatever the market prices the LIC to be, the actual price of the company which will be much more than that. The market also often prices the PSUs? stocks a bit on the lower side. One of the reasons is that they react almost immediately to any policy change. For eg, in the case of IRCTC, there were a couple of new announcements which zoomed its share price more than 500% in little over 5 months, making it a superstar stock from an undervalued IPO. (IRCTC was issued at around 350 in October 2019 and it was valued at around 2000 in February 2020). LIC resembles IRCTC in many ways, both are a monopoly, have high revenues and are susceptible to government policy decisions. Hence, similar behaviour might be seen in the case of LIC too.
Following are a few ratios that will be considered in carrying out the valuation of LIC:
- Persistency ratio - It is a measure of the total business that the insurance company is able to retain in a financial year without policies being lapsed or premium amount being lost to other insurers. LIC?s 13th month persistency ratio was 66% FY2019 whereas its peers in the private sector were well above 70%. Even though LIC has been in the insurance industry much longer than other private insurers, it still has a long way to go in terms of retaining its clients.
- Solvency ratio - Solvency ratios measure the ability of a company to pay its long-term liabilities, such as debt and the interest on that debt. In FY19, LIC had a solvency ratio of 1.6. Even though LIC is the only public sector life insurance company having a solvency ratio higher than the lower limit of 1.5 set by IRDAI, the industry average is 2.9. This might be because of the fact that LIC has been operating for a long time, but a higher solvency ratio certainly indicates a strong company profile.
- Combined Ratio - The combined ratio measures the money flowing out of an insurance company in the form of dividends, expenses, and losses. The combined ratio is calculated by taking the sum of incurred losses and expenses and then dividing them by the earned premium. The combined ratio for LIC has improved from 95.31% FY 2018-19 to 89.46% FY 2019-20 which shows that that the company?s revenue from premiums is growing faster than the net expenses and that the company is growing financially.
- Incurred Claims ratio - Incurred claim ratio refers to the net claims paid by an insurance company as against the net premiums earned. FY2020-21, LIC has a very healthy claims ratio of 82.8%(generally 75-100% is considered healthy). This indicates that LIC is making an overall profit from its premiums. Moreover, LIC also made Rs. 2.34 lakh crores (38% of its net income) from investments(including capital gains). This can be explained from the fact that LIC holds more than 75% of the market share.
- Commision Expense Ratio - the commission expense ratio tells us what is the outflow towards commissions when compared to the premium during a financial year. LIC?s commission expense ratio has declined from 5.73% FY 2018-19 to 5.39% FY 2019-20. Usually, higher the commission expense ratio, lower the discount on the premium, leading to higher premiums. And higher premiums reduce the persistency ratio, which ultimately leads to reduction of revenue earned from premiums.
- Claim Settlement Ratio - The claim settlement ratio of an insurer is the number of claims settled against the number of claims filed: the higher the ratio, the better the insurer. LIC of India has a claim settlement ratio of 96.69% for the year 2019-20. The industry average was 95.85%. A higher claim settlement ratio means lesser number of repudiations or insurance claim rejection and potential customers always look for a higher value of claim settlement ratio.
Is the timing right?
Several IPOs in the past have failed and led to unreasonably low returns for the company from what was expected from them, even after full-proof planning and perfect valuations, due to wrong timing. Take for instance the SBI Card IPO which was released last year and had a perfect valuation, but failed to reach the expected subscriptions because of the pandemic. The market was sluggish and the investors were jittery due to the uncertainty surrounding the pandemic. A time when the market has the appetite to consume the mammoth LIC IPO will have to be carefully chosen.
LIC IPO was planned to hit the market by the third quarter of fiscal year 2021-22. It was considered perfectly timed, given the huge global liquidity, strength in equity markets, low interest rates coupled with the positive market sentiment. Many big investors, like Keki Mistry from HDFC, and position holders weighed in on LIC IPO being a success, arguing that the economy will come out of the recession by the 3rd quarter, GDP expected to rebound and Sensex witnessing a historic high. The opening of around 10.5 million demat accounts, i.e. an addition of 22% retail investors by the expected LIC date and the increase in the FDI limit from 49% to 74% further strengthened the hopes of success. However, with the second wave of the pandemic hitting the country, the recovery is expected to slow down. Experts at Nomura say that this impact will be significantly visible in the economic output in April-June, but the medium term impact of the second wave on the national economy will not be as severe as the first.
The IPO preparation is expected to take at least six months even after LIC has transitioned into the structure of the Companies Act. Before the release of the IPO, the insurer?s finances will also need to be restated in accordance with the Companies? Act in an investor friendly manner. The government is racing against time to complete this mammoth task by the fourth quarter of FY22. It is highly probable that the IPO will be postponed again and will not be released this year altogether.
How can LIC save the economy?
Finance Minister Nirmala Sitharaman had assured in the Financial Budget for FY21 that the money raised via the disinvestment process will be used to build infrastructure and will not be used to bridge the dreaded fiscal deficit. She argued that this Capital Expenditure will have a multiplier effect on the economy and the infusion of private capital, better technology and the best management practices in the Central Public Sector Enterprises will further support this growth and create more employment.
The fiscal deficit for 2020-21 shot up to 9.5% against the budgeted 3.5% due to the pandemic. It has been aimed to be 6.8% for FY22. While it is being speculated that the government will try to meet part of the growing fiscal deficit with this divestment, there are no recent statements from officials with respect to this. In case the IPO fails, it will be a huge problem for the government as it neither would have the money to spend nor would have the full access to the generated profits. It will become even more difficult to support the future GDP growth.
The motivation of the leadership behind the IPO and its lack of credibility should also be considered in the valuation process. When the motivation is just disinvestment and not a single mention of scaling up the business, it will have to be seen if it is able to attract the bigger investors. Critical thing is this time LIC would not be around to bail LIC out if it struggles to raise interest as was the case with GIC or New India. One of the most important things that the government should do is to take action on the role of LIC as its lender of last resort. One of the most basic things that it can do is to release a buyback scheme, wherein if LIC is used to bail out a company by the will of the government, and moving forward, the shares only lose value, then the government should buy back the shares at their original price. This will help boost the investor confidence.
This article was first published on Medium by the co-authors.