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Higher reserves dent EVOP growth; persistency trends stable

COVID claims rise 3–4x the peak levels of first wave

* HDFC Life (HDFCLIFE) saw higher COVID-19 claims and settled gross claims of ~INR16b (over 70k) – as claims during the second COVID wave have been 3–4x the peak claims seen during the first wave. The company made an Excess Mortality Reserve (EMR) of INR7b towards potential COVID claims, which dented earnings and EVOP growth.

* On the APE front, the Individual Protection business declined 4% YoY as the company remains cautious over the near term. On the other hand, strong trends continued in the Non-PAR/Annuity and Credit Life segments. Thus, the share of Non-PAR/Annuity in the total APE increased to 27%/6%.

* Overall, we expect HDFCLIFE to deliver 22% VNB growth over FY21–23E and estimate margins to improve to ~27%. Maintain Neutral.

COVID claims surge; muted trends in Individual Protection business

* In 1QFY22, HDFCLIFE posted net premium growth of 32% YoY, led by new business premium growth of ~44% YoY. Moreover, renewal premiums grew 20% YoY. Persistency trends for individual premiums were stable v/s FY21 levels, with 13th/61st month at 90%/53%. However, on a YoY basis, persistency improved across cohorts (barring 61st month). Overall, shareholders’ PAT declined 33% YoY to INR3.0b (in-line), largely on the back of higher COVID-19 claims settled.

* COVID claims update: HDFCLIFE settled over 70k claims during the quarter, with gross claims of ~INR16b and net claims of ~INR9.6b. Overall, the peak claims during the second wave have been 3–4x the peak claims seen during the first wave. Thus, HDFCLIFE made an EMR of INR7b to absorb potential COVID claims.

* Individual/Group APE: This was up ~22%/~102% YoY, leading to total new business APE growth of 30% YoY. It was largely led by Non-PAR (~41% YoY), Annuity (61% YoY), and Credit life. ULIP growth also recovered to 19% YoY. On the other hand, Individual Protection growth remains muted with 4% YoY decline as the company is seeing higher claims in the segment, and cautiousness is expected over the near term. The share of Retail Protection in Individual APE declined to 8.3% (v/s 10.5% in 1QFY21).

* VNB growth stood at 40% YoY (~7% miss), with VNB margins for the quarter at 26.2% (v/s 26.1% in FY21 and 24.3% in 1QFY21). On a YoY basis, margin improvement was primarily aided by an improved product mix towards the Non-PAR segment.

* On the distribution front, the share of the banca channel in individual APE stood at 56% (v/s 61% in FY21). The share of the direct channel increased to 23% (v/s 19% for FY21) and the agency channel to 15% (v/s 13% in FY21). The agency channel grew 52% YoY.

* Total operating expenses (incl. commissions) grew 38% YoY on account of the low base of last year. Thus, the total expense ratio stood at 16.4% (v/s 16.3% in FY21 and 15.5% in 1QFY21).

* Embedded Value: EVOP growth was impacted on account of EMR of INR5.5b during the quarter; thus, EVOP declined ~38% YoY. However, excluding EMR, reported EVOP growth came in at ~34% YoY. Thus, Embedded Value (EV) growth stood at 21% YoY. Operating RoEV including EMR stood at 14.4%, while excluding EMR, it came in at 16.5%.

Highlights from management commentary

* Group claims have a higher lag effect v/s individual claims. Therefore, claims remain a key monitorable in the near term. HDFCLIFE has created additional EMR to manage potential COVID claims.

* Individual Protection: Deterioration was seen on account of a surge in claims across players, with HDFCLIFE also witnessing similar trends. Hence, growth is expected in a calibrated manner, with a cautious stance over the near term.

* Robust trends were reported in corporate agency channels during the quarter. The company would focus on building a skilled and structurally solid agency channel, along with increasing productivity.

Valuation and view

HDFCLIFE remains focused on maintaining a balanced product mix across the business, with an emphasis on product innovation and superior customer service. However, in the near term, the Non-PAR/Annuity and Credit Life segments are likely to see healthy growth. On the other hand, it remains cautious on the Individual Protection business on claims-related uncertainty due to COVID-19. Overall, Protection remains a long-term structural story, and the company would continue to leverage this opportunity prudently. We estimate VNB margins to reflect stable trends and estimate operating RoEV to sustain at ~18% over FY23E. We value the stock at INR725, corresponding to 4.0x FY23E EV. Maintain Neutral.

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