Why LIC's present governance culture makes it a poor investment bet

IPO plans for the state-owned insurer will reveal weaknesses in its business model

India does not have a sovereign wealth fund but if it did, it could look like the Life Insurance Corporation (LIC). This did not happen by design, but the combination of a government-run life insurance business operating in a monopoly market until 2000 has made LIC a de facto one. The institution still does not fully report to the insurance sector regulator, being governed by a separate Act. It is also one of India’s largest employment generators, its total agency force being just shy of 1.2 million. It is also suspected of having destroyed wealth because successive governments have used it to bolster the stock market and, of late, add to disinvestment receipts.

These are the worries gnawing at the commentators from February 1, when Finance Minister Nirmala Sitharaman announced plans to sell some shares of the company to the public in her Budget speech. Despite these misgivings, subjecting it to market discipline would be salutary, as Coal India, another large state monopoly, discovered in 2010 when it was listed. Foreign investors asked searching questions about its pricing policies that pushed the latter to adopt transparent practices eventually.

Yet LIC is no Aramco, with which some commentators have drawn comparisons. Sure, its turnover is larger than the Government of India’s expenditure at Rs 33.73 trillion (as on March 2019). But that does not tell you much about LIC’s relationship with the Indian government. No LIC chief, for instance, has ever seen his position as comparable to that of the Indian finance minister. No politician, too, has thought to occupy the LIC corner room to improve his political prospects, unlike the infinitely more powerful roles that, say, Singapore’s Temasek or Aramco chiefs have played in their respective political economies (that they are related to the ruling families in both countries also reflects their power). This is despite  LIC earning Rs 22.16 trillion from its investment in the capital markets (including government papers).

One of the reasons for this divergence between LIC and the others is that the Indian government does not draw a corresponding share of its revenue from LIC as, say, the Saudi Arabian government does from Aramco. Including taxes and 5 per cent of its surplus, LIC paid just Rs 17,513.85 crore to the finance ministry in 2018-19, a 6.6 per cent rise year-on-year.

The problems with LIC is that it provides sub-optimal returns to the government, its shareholders, and to policyholders. To be sure, LIC will remain India’s largest life insurance company for at least this decade. It has a market share 66.24 per cent in total first-year premiums and 74.71 per cent in new policies. It has an investment corpus of Rs 31.9 trillion as of March 2018, an 11.74 per cent rise year on year. But it rarely invests this money well.

In the life insurance business, a useful metric to judge a company is what percentage of the money it earns as premium is used by the company as its risk margin. The more risk a company shares with its policyholders, the better its financial profile. This is known as participating premium. For instance, investment-linked policies are not part of participating premium.

LIC’s balance sheet shows, just about half its premium is used for building up its profit. This could be good news for policyholders, because it means they get better returns, but equally bad news for shareholders, since their returns are lower. So why, then, is LIC not good news for policyholders too?

Life insurance is a long-tail business, which means that the insured should hold their policies for a long time for the company to show profits. But data shows that only 51 per cent of LIC’s policies last beyond five years, which means about half of LIC’s policyholders drop out early leaving the company richer by the amount of insurance that the policyholders do not claim back. Therefore, LIC is profitable for the “wrong” reasons. More LIC customers use its policies as an investment (essentially tax-saving) avenue than as a life insurance product. To keep them interested, the company sells more investment-linked products than long-term policies.

This is the reason the persistency ratio of premiums used by LIC to build its book is lower than what global insurers will recommend. In mature insurance markets, the acceptable persistency ratio is close to 90 per cent at the end of the first year and above 65 per cent after five years.

Add to this the demands placed on it by successive governments. Participating in disinvestment was the most dramatic of those, but there were other less noticed impositions. Former Finance Minister P Chidambaram asked the company to set up 1,200 mini-offices in 2013-14 in towns with populations over 10,000. These offices were in addition to LIC’s existing network of branches and agents. Other insurers have to channel their policies through banks. Because of the agent network, LIC has less incentive to use the banks to sell its policies. Of the total 21.4 million new policies it issued in 2018-19, bank channels accounted for just one per cent. This is a cost policyholders bear and now new shareholders will do so too.

The problems with LIC have, thus, more to do with its governance culture. A market listing may well force smart changes all round. That there will be political blowback from established interests is something that the government needs to factor in.