HDFC Life Insurance Co Ltd

Industry

The life insurance industry has evolved considerably catering to the changing macro economic landscape, customer needs and technological developments. Today, there are 23 private companies and 1 state-owned company operating in the life insurance sector in India. The life insurance industry has undergone several changes which includes introduction of new regulations around protection of policyholders’ interests (2002), licensing of corporate agents (2002), linked products circular (2010), linked and non-linked products (2013), registration of corporate agents (2015), management of expenses (2016) among others. This has led to recalibration of the distribution models along with rebalancing of the product mix. Technology has been a key enabler and has played a key role in improving customer experience in on boarding and service.

During FY 2019, the life insurance industry grew by 11% to garner Rs 2147 billion of new business premium against Rs 1939 billion in the previous financial year. The private insurers posted growth of 12% in individual business while group business saw strong growth of 36%. LIC recorded a growth of 5% in individual business and 10% in group business. However, private insurers continued to further consolidate market share in FY 2019 with the fifth consecutive year of greater than 50% share of the market. Market share of the private insurers has increased from a low of 36.5% in FY 2012 to 58.0% in FY 2019 based on Individual WRP. Key drivers of private sector growth within individual segment include development of distribution channels, product innovation, digital transformation and a focused customer centric approach.

Penetration & Density of Life Insurance
In the global insurance industry, around 55% of premium comes from life insurance and the rest from the non-life segment; in emerging markets, around 54% of premium comes from life insurance. By contrast, the share of life insurance is over 78% for India. Despite this, indicators such as insurance penetration (premium as a percentage of GDP), insurance density (premium per capita) and sum assured to GDP indicate that the Indian market is still significantly underinsured.

India’s life insurance penetration is miniscule. Although overall premiums increased from 2010 to 2018, there was a decline in life insurance penetration between years 2010 to 2018, due to GDP growing at a faster pace compared to growth in premiums. The average penetration for the life insurance industry globally is 3.5% which is 75 bps more than the Indian life insurance industry. This indicates the untapped potential of the Indian life insurance market. Also, the penetration for Indian industry is strictly not comparable to the developed markets, such as US and Australia, as mandatory pension contributions in the US and Australia is not included in the insurance pie. Further, due to higher share of savings than protection in the premium, the actual protection provided by insurance in India would be much lower compared with even other developing markets.

Macro trends
India is amongst the top countries (3rd) when ranked on basis of GDP (PPP) and has been one of the fast growing countries in the world, aided by strong fundamentals like falling inflation, rising disposable income, largest working age population. Innovations in operating architecture based on the e-KYC are expected to improve reach of insurance products and efficiency. With rising income and inflation under control, the household savings rate (household savings as a percentage of GDP) is likely to increase gradually. Though the share of household savings has remained subdued since fiscal 2012, the proportion of financial savings has increased significantly during the period. In the past too, strong real income growth and low inflation had a positive spin-off effect on financial savings.

During fiscals 2017 to 2018, the share of financial savings in household savings decreased from 49% to 40%. Furthermore, benign inflationary pressures would diminish the attractiveness of gold and real estate – which represent physical savings of households – as investment alternatives. The government’s measures to curb black money will also help increase the share of financial savings, which would further aid the life insurance industry. Risks to inflation could emanate from 1) high protein inflation, which has recorded double-digit growth for 12 consecutive months; 2) service inflation, especially in rural areas, which is keeping core inflation high and sticky; 3) unfavourable temporal and spatial distribution of rainfall; and, 4) oil prices.

Valuation

We expect HDFC Life to continue its growth momentum on the back of ongoing product innovation, advancement in its distribution network with multiple channels, and reorganizing processes to provide a flawless experience to the end-customer. The company is in right position for long term growth due to increasing digital adoption by the customers and stable regulatory environment. Further, we also expect its technology platform should help in improvement of product offerings. The company’s wide range of products in its portfolio along with strong financial performance will help in preserving its position in the market. At CMP, the stock is trading at 5.3x times FY20E Embedded value. We initiate BUY on HDFC Life Insurance Company Ltd with a target market cap of Rs 13.45 lakhs crore in 10 years.

Terminology

First Year Premium (FYP) : FYP is the premium collected by the insurance company during the first year of the policy (for regular policies or limited premium paying policies). It doesn’t apply to single premium policies.

Renewal Premium (RP) : RP is the premium collected by the insurance company from the second policy year onwards (for regular policies or limited premium paying policies). It is the amount paid for renewal of the contract as per the terms.

New Business Premium (NBP) : NBP is the premium collected by the insurance company from all the new policies sold in that year (or given period). All the policies are considered (regular, limited premium and single premium). Hence,

NBP = FYP + SP

Annual premium equivalent (APE) : This is one of the most commonly used terms. In insurance, new business is not entirely comparable across all types of policies. New Business Premium (NBP) comprises of single as well as regular premium policies. In case of single premium policies, the entire premium is collected upfront while in regular premium policies, the premium amount is smaller since it’s collected over a longer term. Thus business garnered through these two policies is not directly comparable. It has to be brought on a common ground before comparison.

Traditionally, a 10-20 year term is very common in insurance and hence, single premium is multiplied by 10% to arrive at the equivalent regular premium. In other words, 10% of the single premium collected is taken as comparison with regular premium. Hence, a weight of 10% brings single and regular premium policies on common ground.

APE = FYP + 10%*SP

Total Premium (TP): As the name suggests, it is the premium collected from all policies during the given period.

TP = NBP + RP = FYP + SP+ RP

Embedded value (EV): It represents the sum of present value of all future profits from the existing business and shareholders’ net worth. Embedded value simply represents the value generated from the business sold by the company, if it were to stop writing anymore business. The more business a company generates, the larger will be the embedded value assuming all other metrics like persistency ratio and costs remain the same.

Value of new business (VNB): It represents value of an insurer on the basis of the new business it wrote in the last year. VNB is also termed as embedded value of new business measured at point of sale.

VNB margin: It is calculated by dividing the value of new business by 1 year’s annualised premium and it indicates the profit margins of a company. It also indicates the product mix of a company. Traditional investment products have similar margins, so a company that wants to improve its margins will start focusing on the protection business more.

Operating expense ratio: This ratio is computed by dividing expenses incurred for business operations by the gross premiums. Expense ratios depend on the type of business sold by a company. For a company that largely has single-premium business, the expense ratio will be much lower since single premiums collected are usually large amounts.

Persistency Ratio: The proportion of business retained from the business underwritten. In other words, the policies that remain live with policyholders paying premiums regularly (and not cancelling their policy).This is an important metric to track as persistency is a key driver of profitability for an insurer. A persistent book—where customers pay renewal premiums every year—also helps insurers reduce costs through economies of scale.

Assets under management (AUM): Premiums collected by an insurance company are invested over the term of the policy. This entire accumulated premium amount from all policies sold by the insurance company is called as AUM. It is one of the most important measures of the company’s health and growth. Total AUM can be broadly classified as follows:

Shareholder AUM: This is the fund value lying in the insurance company’s shareholders account. Shareholders have to maintain a certain solvency margin. Shareholders infuse money into the business from time to time. A part of the money gets used in funding the expense overrun and new business strain. The balance remaining after meeting these expenses is called shareholder AUM.

Policyholder AUM: As the name suggests, this is the fund set aside to meet the benefits promised to policyholders (liabilities). Actuarial department calculates the amount to be set aside by the insurance company to meet the benefits promised, based on the future expected cash flows. This amount is calculated on a conservative basis and is called as reserves. The accumulated reserve is effectively the policyholder AUM. (There could be differences as reserve is prospective calculation whereas AUM is retrospective aggregation but conceptually it is similar). Policyholder AUM can further be classified as:

Assets held to cover linked liabilities: It is the AUM from unit linked policies. This amount is the aggregate fund value in all the ULIP funds.

Policyholder investments: This amount refers to the fund garnered under non-linked policies.