State-owned insurance company LIC filed its Draft Red-Herring Prospectus (DRHP) on Sunday. Noteworthy among the risk factors mentioned by the corporation was the splitting of the single ‘Life Fund’ into participatory and non-participatory funds. This will, however, have a positive impact on LIC’s valuations as it approaches the primary market.
What are participatory and non-participatory funds?
Let us start with participatory and non-participatory policies. Under a participatory policy, a policyholder can get a share of the profits of the company. This is received as a bonus. Examples of such products offered by LIC include Jeevan Labh and Bachat Plus. No such sharing of profits happens under non-participatory products, which under the LIC fold includes policies such as Saral Pension and Nivesh Plus.
As all insurance companies do, LIC also reinvests premium monies that policyholders pay. The profits or surplus that comes about as a result was till September last year held in one single fund. This was the Life Fund. The surplus was divided in the 95:5 ratio between policyholders (in the form of bonuses) and shareholders (which is the Government, in the form of dividends).
But the amendment to Section 24 of the LIC Act has necessitated the segregation of the Life Fund into participatory and non-participatory funds, depending on the nature of the policies they support.
The amendment stipulates terms on how surplus is to be shared with respect to participatory and non-participatory funds. As for non-participating funds, surplus from the non-participating business would be transferred to shareholders. Surplus from participatory business, however, would be shared between policyholders and shareholders.
Is there more to the amendment?
Yes, there is a change to the way the surplus is divided between the policyholders and the shareholders. While the surplus from the Life Fund was historically divided in the 95:5 ratio, as far as the participatory fund is concerned this ratio will change to 90:10, “in a phased manner,” according to the DRHP document. This is in line with how surplus is distributed in the private sector. The surplus in the non-participatory fund, on the other hand, will be fully available for distribution to the shareholders.
How does this change impact the shareholder?
The change, especially the one that has enabled 100% of the surplus in non-participatory funds to flow to the shareholder, has led to a massive jump in the value of a key metric called the Indian Embedded Value, or IEV. A Reuters report calls IEV “a measure of future cash flows in life insurance companies and the key financial gauge for insurers.” It also says, “The embedded value will help establish the market valuation of LIC and determine how much money the government raises in the flotation. That will be crucial for the government to help meet its divestment targets and keep its fiscal deficit in check.”
The IEV figure has jumped more than five-and-a-half times to approximately Rs 5.4 lakh crore on September 30, 2021 from just Rs 95,605 crore as on March 31, 2021. This value was calculated by independent actuary Milliman Advisors, as per a mandate of the regulator, the Insurance Regulatory and Development Authority of India, which requires all life insurance companies heading for an IPO to furnish an IEV report by an independent actuary.
Why is it a risk, then?
LIC has stated the document that a significant portion of its business premiums come from participating and single premium products. It added, should the participating products generate lower than expected returns for policyholders, it could lead to increased surrenders. This could also potentially bother their financial condition, operations and cash flows.
Ratings agency expects competition from private players to lead to greater push for non-participating products (which have high value of new business margins) and credit life products via the bancassurance channel (Bancassurance is the scheme of arrangement between a bank and an insurance company, under which the former’s clients are the latter’s policies). “In addition, as a substantial accounting profit and embedded value for the entity is through its investment portfolio, ICRA expects greater prudence in the investment management with a focus for shareholder return,” states ICRA.
“However, we should note that historically LIC products have been more of a push products by a strong agency force, and they have been able to sell policies which are more expensive compared to other life insurance players, so longer term impact on their participatory product sales would need to be monitored,” states ICRA. According to ICRA, the potential impact could be lower returns and marketability for the participating products (about 62% of the cumulative premium count in September 2021).
As on September 30, 2021, the participating policyholder’s fund aggregated to ₹24,57,995.218 crore (₹24,579,952.18 million) whereas the non-participating policyholders’ fund totalled ₹11,36,966.079 crore (₹11,369,660.79 million).
