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Valuation belies prospects; VNB levers underappreciated; equity sensitivity concerns overdone

Life Insurance Corporation of India (LIC) is the Indian insurance market leader with 44% share of the total APE market (on a weighted basis) as of FY22. Robust back-book (AUM of Rs41trn as of Q1FY23), high brand value, difficult-to-replicate agency strength of 1.33mn individuals (as of Sep’22) are competitive moats. Increasing non-participating mix (currently ~5% in APE mix as of Q1FY23) and change in surplus distribution policy are significant growth drivers of value of new business (VNB) and in turn embedded value (EV). This, against the strong growth outlook of the Indian life insurance (especially through lens of sum assured), makes LIC a strong investment proposition considering that it is currently trading at 0.73x FY22 price to EV. Concerns on equity sensitivity to EV is overdone and the relative ease of increasing VNB margin through change in mix is under-appreciated.

* Initiate with BUY and target price of Rs917, based on 15x FY24E VNB of Rs98bn and 0.7x FY24E EV of Rs6.2trn. We have factored an impact of ~Rs400bn (FY23+24) to factor 10% correction in equity market while our discounted EV multiple adequately factors any further risk from the high equity market sensitivity of the surplus book. The multiple of 0.7x to EV is equivalent to almost 50% market share correction based on current sensitivity of EV to equity market movements. Even at this multiple, resultant upside at CMP is 48%, implying attractive valuation of the stock.

* Under-penetration (especially through sum assured lens), high entry barriers and favourable regulatory environment make us positive on life insurance prospects in India; LIC is a play on the same. India’s life insurance under-penetration becomes starker from the lens of sum assured and protection gap. Basis reducing protection gap from 85% to 65% over next the 10 years, APE / VNB CAGRs can be 15% / 16%. From the point of view of improvement in sum assured as a % of GDP (from 87% currently to 150% in line with certain Asian peers), APE / VNB CAGRs can be 18% / 20% over next 10 years. These CAGRs will obviously be much higher if achieved within a shorter timeframe. Regulatory support towards increasing the penetration over next 5 years will also aid the prospect.

* VNB growth will be very high for LIC: this is a fairly certain narrative. The VNB multiple should therefore be high for the company. VNB growth for LIC will be driven by increase in: 1) non-par mix, and 2) gradual increase in surplus distribution towards shareholders. We have seen that product-mix-driven increase in VNB margin is a fairly straightforward objective as seen from industry peers. SBI Life / HDFC Life / IPRU Life VNB margins expanded from ~17% / 23.7% / 16.5% in FY18 to 26% / 26.7% / 28% in H1FY22, largely driven by change in mix. Additionally, for VNB, the assumed proportion of future surplus to be distributed to shareholders (by year of surplus emergence) will increase as follows: 5% for FY22, 7.5% for FY23, 7.5% for FY24 and 10% from FY25 onwards in case of the participating book of LIC. The current (trailing) VNB multiple (market cap less EV)/VNB for HDFC Life / SBI Life / IPRU Life is 31x / 22.5x / 17.7x while LIC is quoting below its EV, signaling a significant valuation gap with its peers. We expect LIC to clock VNB margin of 14%/15% and VNB of Rs83bn/98bn in FY23E/FY24E. Accordingly, we value LIC at multiples of 15x FY24E VNB and 0.7x FY24E P/EV. We have factored an impact of ~Rs400bn (FY23+24) to factor 10% correction in equity market while our discounted EV multiple adequately factors any further risk from the high equity market sensitivity of the surplus book. The multiple of 0.7x to EV is equivalent to almost 50% market share correction based on current sensitivity.

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