It has been more than nine years since private sector life insurance companies commenced operations in India. Together, these companies have invested over $5 billion in the sector till date. Despite this, many companies continue to report significant losses in their statutory accounts. Their break-even targets have also been pushed beyond 10-12 years from the date of commencement of operations.
None of the life insurance companies are listed and, as such, there are no market benchmarks of their valuations. Despite the continual need to invest capital, it has not been unusual for analysts to place a value on insurance companies that suggests an overall return on invested capital between approximately 60 per cent to 80 per cent annually.
Considering this, it is important to understand the challenges and issues that arise in valuing life insurance companies in India.
Given the unique nature of the life insurance business, in order to assess the valuation of life insurance companies, one needs to have access to detailed company-specific information, which is currently not published by insurers.
As a result, one may question the credibility of any valuation that is arrived at by analysts looking at the sector. It is important to note that such valuations inevitably have several limitations. At present, the valuations are driven more by the distribution infrastructure established by the companies and less by the profitability of the business already sold. This feature makes the valuations rather ‘subjective’.
Also, the valuations are developed based on very limited, if any, company-specific data. The discounted cash-flow techniques used in the valuations also do not seem to be taking into account the unique characteristics of the products sold by different insurance companies. In many cases, the ‘profitability’ assumptions seem to be based on the industry’s assumptions as opposed to those based on the specific company being valued.
The impact of any expense overruns (that is, the gap between the actual operating expenses of the companies and the expense contributions that a company is receiving from its premium income) on the valuation should also be reflected. There are many other factors – such as allowance for tax, cost of capital, cost of financial options and guarantees, etc – that also need to be reflected appropriately in the valuations.
For the valuations to become more meaningful, there are several aspects that need to change, like the need for increased level of disclosures. Until the level of disclosures in the industry improve, analysts may also need to carefully consider such key aspects as usage of company/product-specific profitability assumptions, allowance for expense overruns, justification for the multipliers used, different approaches in allowing for taxation, etc. Still, as the industry matures, and as further disclosures are mandated along with a growing stabilisation of companies’ operating experience, valuations may become easier and more credible.
Until then, it is important to be aware of the challenges in carrying out valuations and to understand the many factors that impact any valuation that is published.
