• HDFC securities
• 06 Feb 2018
• Blog Articles

Markets are decidedly weak and volatile post Budget, driven by negative global cues too. The US, after posting persistently strong macros, is on the cusp of a series of rate hikes, which should bring strength back to the dollar. The biggest concern is around the direction of fiscal consolidation, and whether the Government can achieve its stated 3.3% fiscal deficit target for FY19BE. No wonder 10-year GoI bond yields in India have spiked above 7.5%. The Budget's announcements of rising infra and rural/agri spends was well known in advance. Indian macros now depend critically on whether GST and income tax collections will suffice for these grandiose plans, whether crude prices will spiral out of control (driving up CAD, FISC and imported inflation risks in India) and whether government spending will suffice to keep the economic momentum going.

 

Meanwhile, the Life Insurance industry has turned out to be a direct beneficiary of the Union Budget 2018-19. Not only was the income tax rate left unchanged at the concessional 12.5%, the imposition of Long Term Capital Gains on equity investments (direct or MF) is not applicable to redemptions or claims on Insurance policies. Hence ULIP investments are unscathed by LTCG. This provides regulatory arbitrage to ULIPs over Mutual Funds. We think these two pluses have landed at just the right time into the laps of Insurance company investors in India!

 

Some time ago, we wrote a sector report on Life Insurance in which we highlighted some key reasons to be long-term investors in the sector.

 

Firstly, Life Insurance is under-penetrated in India compared to not only the advanced, high-income OECD nations but also comparable countries like Indonesia, Thailand, etc. It is not only a question of whether large numbers of people are insured or not. It is important that the real insurable value of their lives (as reflected in their income and age profiles) is sufficiently protected. Our life insurance premiums add up to 2.7% of GDP vs. 4% for Thailand and 7% for the UK.

 

Secondly, India is undergoing a massive financialization shift in citizens' savings, as more and more incomes (and wealth) get formalized. This has been partly driven by demonetization, of course, but the longer term trends are unmistakable. Formalization of employment and incomes also makes people more aware of life and income risk. Investing habits also grow beyond gold and real estate (interestingly, these two asset classes have underperformed for quite some time now). We believe the Life Insurance industry is set for decades of growth, just like home finance was in the 1990s.

 

Thirdly, all the current news flow around the business performance of life insurance companies is encouraging. ICICI Prudential Life sprang a margin surprise, not only did the mix move towards the more lucrative protection business (4% in the mix), the new ULIP products also carried better margins. Growth is driving cost efficiencies, as a result of which management 9mFY18 VNB margin to 13.7%. SBI Life, our top pick in the Life Insurance space, also reported a very good quarter. The co's VNB margin for 9mFY18 was higher at 16% with individual premiums rising as much as 38%. Protection in the mix improved to as much as 5.1%. SBI Life has a terrific advantage of SBI's distribution bancassurance footprint, in excess of 25,000 branches.

 

Our Target Prices for ICICI Prudential Life and SBI Life may indicate 13 and 21% upside, but remember these are 1-year TPs, at what we think are fair multiples assigned to their VNB (value of the new business) plus 1x EV (embedded value). Both companies should comfortably continue to grow and compound shareholder value over the next many years. Management quality, business franchise and strategic moats are durable. These are businesses that will look very different in a decade from now.