The private sector insurance industry received a capital infusion of almost Rs 21,000 crore in its first seven years, possibly the highest such infusion during any industry’s infancy. And since most of this has come from Indian joint venture partners listed on the bourses, the insurance companies have an obligation to deliver a good return on capital.
As the sector grew, most analysts were saying that the insurance companies, especially the life insurance ones, have created value. Unfortunately, shareholders and not analysts will have to pay for these misconceptions.
One myth is that the more you grow, the more will be your losses. Another is that every insurance company has created shareholder value and since India is a highly under-penetrated insurance market, there is scope for more players. These myths were shaken a bit since the January 2008 crash of the equity markets and the global economic meltdown. Most of the players faced de-growth but still required capital infusion.
Let’s look at the myths in some more detail. In most cases, the capital infusion has been four to five times the solvency requirement in the life insurance industry. Ergo, capital has been brought in to fund losses. And the losses happen because of the strains of new business. For every Rs 100 secured as new premium, an insurer has to set aside a certain percentage to fund the first-year losses. This percentage depends on the way the products have been designed.
Some products have a very high new-business strain and some have low strain: the range is 0-70 per cent. The premium-to-capital ratio varies widely for various companies. But, even today, when capital is scarce, shareholders are not questioning the correlation between premium and capital.
Meanwhile, analysts seem to associate valuation with new business growth, without factoring in persistency level, expense management and other items adequately enough. (Insurance companies don’t disclose this information.)
Calculations of embedded value or NBAP (new business achieved profit) are based on shaky presumptions. Many high-flying companies have close to nothing as embedded value because of their very high expense overrun.
Currently, every life insurance company is valued at three to four times the capital invested. Some have been making losses from Day 1, with no profitability in sight. So, how will all life insurance companies create shareholder value?
There are two main areas of concern in general insurance—group health cover and commercial vehicles’ third-party insurance— as these are eating into profits. For instance, in the estimated group health insurance portfolio of Rs 3,500 crore, the losses are Rs 750-1,000 crore a year. In motor TP claims, losses add up to Rs 700-750 crore a year in a Rs 3,000 crore industry. So these two lines, which fetch 25 per cent of the overall business, account for 75 per cent of the losses.
If this wasn’t enough, general insurance companies have found a new way to generate more losses! The radical and baseless reduction in premium rates by 25-80 per cent in other business lines since 2007 is threatening the industry’s survival. It is no surprise that most companies (including the government-owned ones) reported a significant dip in profits in 2008-09. Capitalefficiency has taken a hit as a result.
Against this backdrop, why shouldn’t valuation be correlated to profits? Some analysts have started doing so with general insurance companies, and one can only hope that this scrutiny extends to life insurance as well. The situation can only get worse as more players are entering the fray, adding to the pressure in what is already a highly-competitive field.
Kamesh Goyal is Country Manager (Allianz) & CEO , Bajaj Allianz Life.