Insurance Industry Turns Corner with 15% New Business Growth; Valuations Slightly Exuberant

Private life insurers, especially the bank-led, are clearly turning a corner with not only more than 15% growth in new business but also cost improvements and significant persistency improvements. This is aiding a reduction in cost over- runs and leading to improving profitability. Bank-linked insurers will continue to lead and with improving profitability they will be good long-term value compounders. While we continue to use appraisal method for This is aiding a reduction in cost over- runs and leading to improving profitability. Bank-linked insurers will continue to lead and with improving profitability they will be good long-term value compounders. While we continue to use appraisal method for value we also compare valuations v/s private banks/MFs and conclude that valuations look a bit exuberant which could lead to a correction in the sector. We maintain our neutral rating on Max Financial (trades as HDFC + Max Life combined now) and maintain our Buy rating on Bajaj Finserv (more lending business

We maintain our neutral rating on Max Financial (trades as HDFC + Max Life combined now) and maintain our Buy rating on Bajaj Finserv (more lending business driven).

Bank led insurers—Sector fundamentals improving

New business for bank-led insurers has grown by +20% over FY14-16 and they have gained 20% share in the last six years. With their reach and distribution, we expect their lead to sustain over agency led insurers.

Persistency is improving with top three insurers having more than 40% 61st month persistency and even ICICI’s ULIP 61st month persistency is more than 40%. IRDA forced product changes are materially aiding persistency. There is significant cost optimisation with cost ratios for top four bank insurers at 10-13% of total WRP. With improved persistency cost ratios will improve further, leading to lower overruns, in our view. The above is leading to improvement in post over-run margins. With improved persistency cost ratios will improve further, leading to lower overruns, in our view. Lower insurance penetration (2.6% of GDP today from +4% in FY10) coupled with better profitability makes the sector a good long-term compounder.

We increase insurance valuations by 30%, implying a valuation range of 2.0 2.7x Sep-18 EV for our covered insurers. Even with our new assumptions, we see limited near term upside and hence believe that the sector could see some price consolidation. We back-test our insurance valuations by comparing them with retail banks and mutual funds. Key calls: Neutral maintained on Max Financials. Their 21.5% stake in combined business implies a PT of R500, with limited upside. Maintain buy on Bajaj Finserv, as it is driven more by the lending business. Valuation of ICICI Pru Life at R402 bn. Surprise on SBI Life’s EV disclosure drives a 80% increase in our valuation. Neutral maintained on Max Financials. Their 21.5% stake in combined business implies a PT of R500, with limited upside. Maintain buy on Bajaj Finserv, as it is driven more by the lending business. Between FY10-14 the life insurance industry experienced difficulties due to regulations and capital market sluggishness. While the industry had to go through significant restructuring and cost optimisations, the same changes in regulations is leading to more structural growth in the industry. We are seeing structural 13-15% y-o- y growth for the insurance companies now and we expect that to continue. We are seeing structural 13-15% y-o- y growth for the insurance companies now and we expect that to continue.

Volumes are stabilising

Over the last two years (FY15/16) new business volumes have been growing after five years of contraction or no growth (FY10-14). Private insurers have seen a 14% CAGR in individual new business over the last two years and FY17 has also started on a positive note with 21% y-o- y growth in new business volumes. We believe 15% growth is likely to be sustained, as: new products are more customer friendly and higher persistency indicates that investors are acknowledging this; overall we expect financial savings rate to pick up and that should help insurance flows as well; and we expect capital markets to remain buoyant and that aids investor sentiment especially towards ULIPs. Insurance penetration levels have stabilised around 2.6% over the last three to four years. Without any penetration improvement we expect growth of 13-14% in new business for the industry and with some market share shift, we expect private insurers to deliver +15% CAGR in new business. Insurance penetration levels have stabilised around 2.6% over the last three to four years.