Embedded Value: What LIC’s IPO Means for Investors

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The books of accounts of a life insurance company are necessarily moderated by the data provided by the actuary.

LIC’s Initial Public Offering (IPO) is going to be a major event in the history and growth of the Indian securities market. LIC is not only an institution of systemic value for the nation, but one of the largest investors in the stock market.

Stocks are valued on the basis of a company’s net worth, its potential for growth and profit generation. They depend on the sustainability of the company, the ability to ride the technological wave and the skill of management to deal with the disruptions in its wake and continue to generate profits for shareholders.

Valuation yardsticks
The LIC is a monolith not explored by the market until now. Life insurance companies are subject to very different valuation criteria and their real value cannot be assessed on the basis of recent earnings or business performance. Life insurers are judged on the basis of the intrinsic value (EV) they are able to create over a long period. Simply put, the EV is the present value of all the premiums that the company expects in the future from all the policies on its books on a given date. The calculation is a complex exercise conducted by an actuary who takes into account the probable exits by death, lapse, surrender, maturity and estimates future income based on probable cash flows and the probable rate of return on investments.

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The books of accounts of a life insurance company are necessarily moderated by the data provided by the actuary. The company’s appointed actuary also reports to the company’s board of directors on the financial health of the company because the visible numbers do not necessarily reflect a company’s strengths or weaknesses. The potential investor should have some understanding of these technical aspects of valuing a life insurer before jumping into the fray with a big purse.

Protection and annuity needs
The protection as well as the annuity needs of the people will make insurers grow for a long time. Therefore, a very optimistic scenario is unfolding regarding the profitability of the industry. It would be quite reasonable to expect very decent returns for those investors who would be eligible to buy LIC shares. So far, only policyholders and the government have benefited from wealth creation by the country’s best-known brand.

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In accordance with the LIC Act of 1956, out of the valuation surplus generated each year, an amount equal to 5% is payable to the Indian government and the remainder is allocated to policyholders in the form of reversion premium. Before the IPO, the government is expected to amend the LIC law to allocate 10% of the surplus to shareholders. Currently, private sector insurers are entitled to 10% of the surplus valuation. In all previous years, LIC has declared over-valuation. For the year 2019-2020, the LIC valuation surplus was `53,955 crore. This can give the investing public a fair idea of ​​the earning potential of LIC scripts. LIC has the potential to consistently generate wealth for investors due to its history of steady growth, strong hold over market share for two decades since the industry opened, and an enviable record in settlement. claims. But a smart investor will expect LIC to be more transparent and accountable in all of its activities, including investing its huge fund and awarding policyholders bonuses.

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As the size of LIC’s fund is larger than the total fund with mutual funds in India, investment decisions and returns will be closely watched by the market and will have a huge impact on the value of the share. To impose a high price, LIC will need to ensure that employees and managers disengage from their old work habits and that management is able to make difficult decisions in the interest of policyholders and shareholders only.

The writer is the former Managing Director and CEO of Star Union Dai-ichi Life

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