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ET in the Classroom: How to evaluate life insurance stocks


ET Intelligence Group

The much anticipated inclusion of life insurance companies in the benchmark Nifty 50 index makes it important for investors to understand how to analyse and evaluate insurance stocks. The National Stock Exchange (NSE) will replace Vedanta with HDFC Life effective from July 31. ET presents some of the key factors to consider while valuing and comparing these stocks.

What sets insurance business apart from other businesses?

A major difference is the insurance business model itself wherein a periodic premium is taken from customers with a promise to bear a future liability in the form of sum insured. The profitability depends upon the success of the insurance actuaries in adequately calculating premium amounts that can generate long-term profit after providing for the liabilities as they incur.

What are the variables that capture financial performance of insurance companies?

To begin with, periodic growth in the gross written premium (GWP) tells how fast the business is growing. GWP consists of new business premium (NBP) and renewal premium (RP). A higher NBP growth indicates rapid business momentum.

But, won’t a greater proportion of new, single premium policies skew GWP in favour of insurers that push for such schemes?

Sure, it would. That’s where the annualised premium equivalent (APE) comes into play. It breaks the single premium into the equivalent annual premium (usually 10% of the single premium in a period). APE gives a better view of the sales momentum of an insurer in a period, which is useful in comparative analysis.

What’s value of new business (VoNB) and is it different from NBP?

While NBP indicates premium clocked during a period, VoNB captures the present value of the expected future premiums of the new business in that period. It shows the potential value that can be generated in future for shareholders.

How to compare profitability among insurance companies?

For that, VoNB margin is the tool. It is the ratio of VoNB and new business APE. It reflects the profitability of the new business; a higher margin is better. Another parameter is the total cost ratio, which is obtained by dividing a sum of operating expenses, commission, and provision for doubtful debt with GWP. A lower ratio shows higher operating efficiency.

Are there any parameters to capture customer satisfaction?

Being a customer centric business, it is necessary to know how well an insurer serves clients. The persistency ratio shows the percentage of customers retained for a given period. A higher ratio is desirable. Surrender ratio tells the proportion of surrendered policies in the average assets under management; a lower ratio is better. In addition, a higher claim settlement ratio shows the insurer’s commitment to customers.

What is embedded value (EmV)?

EmV shows the long-term profitability of the existing business. It is the sum of adjusted networth and value of in-force business calculated as the present value of the shareholders’ interest in the earnings. Insurers in India provide Indian EmV. The ratio of the company’s market cap and EmV — the price-EmV ratio (P/EmV) can be used to compare the valuation of life insurance companies.

What about the usual valuation parameters like RoE, P/B? Are they relevant for insurers?

Yes. They help in the comparison across the sectors. Ratios such as return on equity (RoE) and price-book (P/B) multiple help in comparing insurance companies with those in other sectors to arrive at a sound investment decision.


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