(Illustration: BloombergQuint)

An Investor’s Guide To The Insurance Sector: Parameters To Watch

The imminent listing of ICICI Prudential Life Insurance Company Ltd. has put a spotlight on the sector. And with other insurance companies likely to take the plunge into the capital markets as well, investors will be keen to understand the factors that drive their performance.

The insurance regulator is considering making it compulsory for large life insurance companies to list and had issued a consultation paper on the topic earlier this year.

The insurance sector is not the easiest to understand and functions differently from others. Take for example a standard measure of performance: profit. For many manufacturing companies, a sharp increase in sales, and thereby revenue, would lead to higher profits. For the life insurance sector, though, a spike in sales would also lead to a big increase in costs. It is costly to acquire a new customer.

To make sense of it all, BloombergQuint spoke to Joydeep Roy, the leader of the insurance practice at PwC India.

Below is the edited transcript of that interview.

Is the industry mature enough to see publicly-listed companies?

Let’s not look at the industry as a whole. There are different cohorts. So Life Insurance Corporation of India has been there for long. Then the first wave of 10-12 companies came in 2001.

Normally one would expect a life insurance company to break even in a span of 7-10 year and thereafter be profitable and have enough assets under management and enough policies so that the customer base increases. So that was the intention when the sector was opened up – to increase penetration.

If you look at the global scenario, there are some markets where insurance industries have gone for IPOs much, much later, when companies were 50-100 years old. Similarly, there are some markets where companies have been asked to list early.

This is something similar to what has happened with the banks here. Because that brings in transparency, and it also brings in a lot of governance along with it, which does not need to be separately imposed.

The first cohort in the insurance industry, which has completed 15 years, which is a large number of companies, controls a large part of the market. So therefore I think it is a good time to look at listing of these companies so that the share price becomes the combined measure of growth, risk management, customer service, and cost efficiency.

What are the parameters that an investor should look at when deciding to invest in an insurance company?

When an insurance company gets listed, beyond a point, the parameters are not very different. Once it is listed, what do you look at? You look at the growth potential, you look at the profitability, because that shows you how well it will sustain in future, whether growth can be sustained.

You also look at the risk management, so you know how the company will manage its different challenges. And finally, you look at the whole landscape and figure out if the company will do better than its peers. So these are the three-four things that you look at. Those things don’t change. And that’s why I’m saying that listing is probably good to bring everything to a normal which people understand.

Then consider the fundamentals of a company to find out how a particular company is performing compared to its peers.

1. You look at growth because life insurance and retail must have scale. In a country like India, without scale, you can’t have world class customer service and world class delivery because all of that costs money and will keep on costing money, so while the company will keep investing from its profits, its growth potential is an important aspect. This growth is in terms of both new business growth and renewal payments.

Unlike almost all other businesses and unlike general insurance, life insurance thrives on renewal payments. New business always adds strain, because it’s costlier to go and acquire a new customer, but easier to continue to service a customer and keep getting premiums from older customers, which comes at a far lower cost.

2. You should look at persistency ratios. This is very important. Now of course persistency in a country like India has been very difficult. So what’s the persistency ratio? It’s the stickiness of the customer, but it is the stickiness in terms of payment of the renewal premium. Stickiness, per se, if you look at in the general insurance industry is a different thing. That is like when you do a motor insurance. You stick with the same insurer each year because you have a choice. Here, as a customer, you really don’t have a choice. You can stop your policy, and lose your benefits if you do. But, ideally the company would like you to keep on paying your premiums till the end of the policy, which might be 15-30 years. And that builds the life insurance company’s size. That builds the company’s assets. So that’s a very important measure, which shows the company’s resilience and ability to grow without looking over its shoulder every time.

3. Another issue is the customer service architecture. If the company has to keep on growing branches, people, infrastructure to keep pace with the number of policies or policy holders, then it is not a great idea. Then its cost efficiencies will not come through. So you have to see what the measures of the customer service are. How much is being tackled automatically, how much is self-service, how much is technologically enabled to get an idea of the kind of leverage that people have. It should not be that if I double my customers I’ll have to double my customer service people or infrastructure. So the cost efficiencies will be seen from largely the customer service point of view.

4. The last element is overall cost ratio. Because that’s something that’ll give you an idea of all the costs – management cost, acquisition cost, and maintenance cost. Customer service, the previous point, is a factor of the maintenance cost. It tends to balloon up and that’s why I told you to look at that, but overall cost ratio is another very important aspect.

What is embedded value and why is it important for an insurance company?

Embedded value is an outcome. It will mean very little for a lay investor. It is a function of all that we talked about. If your persistence is high, it means your customer will remain with you and keep on paying renewal premium without much hassle.

So it’s essentially the lifetime value of the customer multiplied by the whole portfolio. So embedded value will basically tell you how much value you can derive from the same customer base. Let’s say Company “A” has 100,000 policies, and Company “B” has the same number. Both are growing at 20 percent. But the one that will have larger renewal premiums coming in will have better leverage and better embedded value because it has got many more customers staying with it.

So its ability to cross-sell, up-sell more policies in the same base is far higher. So embedded value is something that you can’t go and see. On the other hand, you can see persistency ratio.

Is the solvency ratio an important indicator?

This ratio basically indicates the company’s ability to settle claims. But in a highly regulated market like ours, it isn’t really important for an investor to look at. Perhaps in an unregulated market it would be important, because a low solvency market could spell doom for a company. But in India, the requirement is 150 percent, which is 50 percent higher than what is normally required.

Should an investor look closely at the market share of an insurance company?

If the market share is large enough, and the life insurance market is not small, the exact market share is not important. The rate of growth in market share is more important than the absolute number.

You have to clearly differentiate the fundamental factors from the outcomes. If you just look at the outcomes like the embedded value and the market share, that’s irrelevant. You have to look at what is creating this. For example, new business growth and lower cost ratios create higher profitability. Similarly, high persistency will also lead to lower costs, because your cost of acquiring new customers will keep on going down.