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Amid all the noise around the loss of Input Tax Credit (ITC) in individual life and health insurance, listed life insurers have disclosed a minimal impact (<1%) on EV. Insurance companies will not operate on the basis of ceteris paribus over the medium term. There are multiple levers, which will allow life/health insurers to mitigate the impact (from ITC loss) on VNB or Combined Ratio, including: 1) Repricing the product, 2) Negotiating commissions with distributors, and 3) Group life and health businesses which continue to be under the ambit of GST. Beyond the usual noise, it’s important to focus on the bigger picture, which indicates that 1) The government recognizes the importance of life and health insurance and wants it to grow robustly, so that it can provide insurance cover to all by 2047. 2) Amid the fast changing sectoral and direct and indirect taxation-related regulations, private-sector market leaders have delivered strong EV and VNB compounding over the last 3-5-8Y, reaffirming the hypothesis that brand and distribution provide scale and cost-efficiencies, leading to profitable growth.

All individual life and health products are exempt from GST

The GST Council in its 56th meeting, which concluded on 3-Sep, decided that all individual life insurance (term, ULIP, and traditional savings) and individual health insurance (including reinsurance of individual life and health) products will now be exempt from the existing 18% GST rate, along with Input Tax Credit (ITC). However, with these products being in the exempted category, ITC goes away; hence, effectively, the benefits of the GST cut partly reduce, as insurers will continue to pay GST on input services (commissions and non-salary opex). Further, the Finance Minister clarified that GST exemption benefits will be passed on to customers.

Businesses do not operate based on ceteris paribus

While the minimal impact on EV (Exhibit 3) comforted investors, the noise around the impact of ITC loss on VNB margins worried them. However, as the famous Keynes once said, “When the facts change, I change my mind – what do you do, sir?” Great companies respond to a changing environment by dynamically updating their operating models. Indian life insurers very recently demonstrated that during the implementation of the New Surrender Value Regulation in Oct-24. Right now, that’s where their focus will align with the government’s agenda to push growth by passing on GST benefits to its customers. Gradually, though, a host of actions will be taken by the players (not in the next 1-2M, though certainly in 2-4 quarters), as the government, GST authorities, and the sector regulator are cognizant of ITC loss; the government wants a sustainable model in order to have sound companies in the sector. These actions/ levers include: 1) Repricing the product. 2) Negotiating commissions with distributors, and 3) Group credit life and other group businesses which continue to be under the ambit of GST. However, if one attempts to assess VNB margin impact from ITC loss on a ceteris paribus basis, the sensitivity of acquisition and maintenance cost increases to VNB margin could be a good place to start.

It's all about brand and distribution-led scale with cost-efficiencies

Ever since Indian insurers got listed about 8-9Y ago, the sector’s regulatory landscape, including direct and indirect taxation, has been consistently evolving; at times, with certain shocks like the Covid-19 delta wave being the shock of the century. Amid all this, private life insurers have maintained their track record in delivering consistently strong EV, VNB, and AUM compounding (Exhibit 4) over 3-5-8Y. Given the importance of brand and distribution, along with fixed operating costs, these private leaders have a strong advantage, and they have leveraged their brands and distribution to deliver scale with cost-efficiencies, driving profitable growth. Uncertainties over the near-term impact of ITC loss on VNB margin and possibly softer new business growth for 1-2M could result in weakness in life insurers’ share prices, providing an entry point for the long term, as beyond the labyrinth of regulatory changes are these solid franchises with an established track record of value creation. We prefer SBILIFE (BUY), HDFCLIFE (BUY), and MAXF (ADD). Despite near-term challenges in growth, valuations for IPRU (ADD) and LICI (ADD) have become very favorable.

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