#Actuaries words: Need more transparency in participating insurance plans

With the Insurance Laws (Amendment) Act, 2015, in place, foreign insurance companies have started to increase their stake in India. This puts focus on valuations and factors that drive valuations. Richard Holloway, managing director, South East Asia and India, life, Milliman Inc., and Sanket Kawatkar, principal and consulting actuary, life insurance (India), at Milliman India Pvt. Ltd, an actuarial services company, speak of aspects that they see as important for valuation, and about the need to improve the participating business in India.

To assess valuations, purchase price as a multiple of the embedded value is looked at. For certain insurers, this multiple is quite high, up to three times their embedded value. (Embedded value represents the present value of all future profits plus adjusted net asset value). Does this mean these insurers have high valuations? What would be the right way to gauge valuations?

Richard Holloway: Valuation is a complex subject and many factors contribute to the valuation of a company. In India I see this obsession with looking at valuation as a multiple of embedded value. That’s just one of the many parameters. A younger company, for instance, will have a lower embedded value and so its valuation calculated this way may look very high. India is a young and growing economy and so the valuation may command a higher multiple of embedded value compared to developed economies where the multiple can often be much closer to 1.

Sanket Kawatkar: One should also look at valuations as an implied multiple of value of new business (VNB) of the previous year. VNB measures the value to the shareholders of new business written in the last one year. The implied multiple indicates the number of future years the insurer has to underwrite at least the same amount of business as last year and with the same level of profitability as last year’s new business, to justify the valuation. If insurers disclose the embedded value and the value of last year’s new business, the implied VNB multiple can be derived based on the disclosed purchase price—(purchase price minus embedded value) divided by the VNB.

Having said that, we have also seen other non-quantifiable, rather subjective, aspects that have influenced valuation. For instance, foreign partners may like the Indian market or value their relationship with the domestic partners and may be prepared to pay a premium on such aspects.

Is distribution the key driver of valuation in India?

Holloway: In insurance, distribution is definitely important as it measures the ability of a company to get future business. Insurers that own their agency will be better positioned than those dependent on bancassurance channel, which they don’t own, especially if such a relationship has a defined tenure.

Kawatkar: Distribution is one of the important factors. Product mix is another. For instance, unit-linked insurance plans (Ulips) have lower profit margins now compared to participating plans. So, even if two companies have the same volume of business and are expected to write the same volume of business in the future, the company that focuses on participating business may be able to command a higher valuation.

Open architecture in distribution is now allowed. Does that mean that agency-led insurers are better placed?

Kawatkar: Banks that have floated insurance companies would have entered the business with a long-term understanding of a tied bancassurance model. It’s unlikely they will open up.

However, yes, if compulsory open architecture was to be introduced, it would impact the valuation of non-bank promoted insurance companies that are focusing on bancassurance channel.

Agency channel is underperforming and is more expensive compared to bancassurance, so it may not be correct to say that agency-led insurers are valued higher on the basis of distribution channel alone.

Are the new regulations formulated after the Insurance Laws (Amendment) Act, 2015, focussing adequately on governance?

Kawatkar: In general, I haven’t seen many changes. One area that needs improved governance is participating business. Disclosures and transparency around bonus declarations are almost non-existent. There is no disclosure on how ‘asset shares’ are calculated. So, even if rules mandate that 90% of the asset share has to go to policyholders in the form of benefits, it doesn’t really mean anything given there is no standardised approach or disclosure on calculating the ‘asset shares’.

Then there needs to be greater clarity on how surrender values are calculated. The with-profits committee (dealing with participating plans) needs to be more involved with how participating funds work and should be completely in charge. And this is easier to implement now because the pool of participating funds is not huge, barring, of course, a few companies.

Holloway: Participating plans are important insurance products. They are also popular in markets such as China, Malaysia and Singapore, but there is greater transparency in these markets.

From a consumer’s perspective, insurers can try and explain how participating products work. For instance, in Europe, every insurance company has on its website a document called Principles and Practices of Financial Management, which explains to the customers what participating funds consist of and how bonuses are calculated. Although this may still be difficult for a layman to understand, at least such documents exist for those who are interested.

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Persistency ratios continue to be low in India. How important is persistency of policies while valuing the business of an insurance company?

Holloway: Yes, persistency levels are low in India and this is something that insurers are aware of. There is a distinct link between persistency and profitability, and improving persistency is hard to achieve over a short period of time. In India, poor persistency could be due to customers buying or being sold products they don’t need. Hence, there could be a need to put in place more checks and balances around the sales process. Any valuation should reflect the persistency track record of an insurer, with less emphasis placed on an insurer’s ability to improve its persistency in the future, which is hard to achieve in practice.

Kawatkar: India is also operating on very low margins. The pre-cost overruns margin in India is in the range of 18-20% whereas in developed markets the post-cost overrun margin is in the range of 30-40%. So, insurers in India have a long way to go and need to take very serious steps to improve persistency and costs.

From: Deepti Bhaskaran @livemint

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About the Author

Mayank Goyal

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Redmond Lover(Microsoft), London Dreamer(Actuary), California Thinker(Entrepreneur). Actuarial Science, Blogger, Web Developing, Winphan India, App development, Social Media Managing, Event Managing & bla bla bla.