Thursday, 19 January 2017

General Insurance sector-2nd Part: Nothing General about it. Stocks Covered: Tube Investments of India, Sundaram Finance, Bajaj Finserv, Max India, Future Enterprises

In my earlier post about general insurance (Click here), I mentioned about the rerating prospectus of general insurance companies once the IPO’s of these would come. SEBI was also pressing General Insurance companies for IPO. So today Govt has approved plans for divesting 25% in 5 public sector General insurance companies. This is as per my expectation and will surely make our Stock market better understand the valuation of General Insurance companies. General insurance sector is way underpenetrated in India with around 28 players fighting for small scale of business available. Everybody is fighting with low prices to lure customers making us think that General insurance is useless low cost phenomenon mostly forced upon us. However it is ,in fact, a specialized service which can save us from unforeseeable costly accidents. So quality of service is very important. But as most of the players are busy in the price war so nowhere focus is on to improve the customer experience and service quality. They need to make themselves more relevant so that more people understand the value of insurance. But I find it hard to understand what growth they can achieve with low prices and with even low quality services.


IPO is all about getting the most for your equity stake. For this, we need better business model with quality balance sheet. But at present, PSU General insurance companies have dismal balance sheets and operating model. Four public-sector giants had massive underwriting losses for the half year — New India's underwriting loss was Rs 1,803 crore, followed by United at Rs 1,533 crore, Oriental at Rs 1,465 crore and National at Rs 991 crore.

But Insurance business is very different from other businesses where incremental revenue brings more profits. But in Insurance, in quest for growth, one can underwrite riskier insurance case which can destruct even the profitability of 10-20 earlier cases. So growth is never a blind game for Insurance sector.

IPO will make these General insurers to put profits into perspective and to focus on repairing their dismal balance sheets. So I see an end to price war and more focus on profits with high levels of service with more innovative plans.

Second; as explained in my previous post that in spite of making underwriting losses General Insurance companies are still profitable due to Investment income. Insurance companies receive premiums and pay the claims against premiums received. But there is a time Gap between these two events…they are not paying claims immediately…there is always a time gap between premium period and claim period during which Insurance companies can use this float to earn investment income from the premium amount. Float is the money that doesn’t belong to Insurance companies but which they temporarily hold. So Insurance companies invest this float money into so many investment options like Bonds etc. and earn investment income. Indian general Insurance companies are profitable only due to this investment income.

But this investment income will fall due to falling interest rates. Interest rates are falling due to low inflation (RBI cutting Repo rates) but the rates will fall even more due to high bank deposits courtesy Demonetization. So this falling investment income will put more pressure on General Insurers to focus on profits at underwriting levels. Although I think they will post high profits this quarter due to rise in Bond prices (Bonds they are holding in their portfolio) pursuant to fall in interest rates (Bond prices are inverse to Interest rates).

I have mentioned many times that Banks, in their quest for growth, aren’t constrained by deposits or reserves (as is commonly thought) but by Capital. Banks are always short of capital. They need to maintain minimum Capital adequacy ratio; a capital base adequate to absorb any unpredictable losses in the future. The current NPA issues of our PSU Banks have the potential to destroy any chance of future growth as in the absence of adequate capital they can’t offer more credit.


In the same way, Insurance companies are also constrained by capital. The adequacy in case of General Insurance companies is a function of Solvency ratio. Insurance is a very risky business (riskier than banks) where one calamity like Chennai floods or an earthquake can create havoc on their business. So these companies need to have enough capital to absorb any such shocks on our behalf….which is their business. We are paying them only for this. It is not like equity money invested into current retail startups like Flipkart (Startup!!) which can burn this cheaply for acquiring more customers. Insurance is big responsibility…requiring careful business mind. They are supposed to get fatty in order to bear the pain during starvation. But our General insurance companies at present are devoid of any such fat…they are way too lean.

PSU General Insurance giant National Insurance’s solvency ratio (1.2) is well below the mandatory ratio as prescribed by IRDA (1.5). Oriental Insurance has solvency ratio of 1.14….and they are planning for IPO?? What special valuation will Govt get from these general balance sheets?

Solvency Ratio is a measure of total assets of an Insurance company relative to its total liabilities. As per current IRDA rules, assets must be 150% of total liabilities. The process involves valuation of the assets and determination of the liabilities. The value is assigned to assets as per the provisions laid down in IRDA Rules. For instance, advances of unrealizable character, deferred expenses, preliminary expenses in the formation of the company, etc are to be assigned zero value. Assets also include the insurance company’s investment in approved securities, non-man-dated investments; etc. The determination of liabilities is more complicated. IRDA Rules have prescribed a detailed method for the determination of liability by both life insurance as well as general insurance companies. I’ll try to post another study on this when time permits.

We live in a dangerous world now. Our capacity to create destruction has only grown multifold. Events such as the terrorist attack on the World Trade Centre in New York can create unexpected liabilities of a magnitude difficult to anticipate and cover. A giant earthquake and terrorist attack can impose unbearable burden on the Insurer and it can go insolvent. That’s why Solvency ratio is very important.

In my post related to GDP (Click here), I have mentioned that being resilient is one of the factors of growth. Solvency ratio is just that…it demonstrates the resilience of an Insurance company. It needs to have extra cushion. Imagine a situation when a Life Insurance company with inadequate solvency ratio is required to pay for claims due to some big natural calamity and in the process it goes insolvent…we’ll lose all our money…our investment.

Insurance is not about Cheap and Low Cost Products

That’s why I feel that Insurance is a specialized service requiring high business acumen. I always tell that cheap policy or High promised returns are not the prime metrics in choosing an Insurance company. We are misled here as Solvency ratio is the biggest relevant figure to look out while choosing an insurer. Higher the ratio higher the chance that you insurer can meet any calamity. And calamities are inevitable…once in a while they are coming always. So Insurance companies can’t relax in wasting money in acquiring cheap customers by offering low priced insurance policies. Just for putting things into perspective, among Life Insurers Bajaj Allianz was having Solvency ratio of around 7 and also it was the only company in General Insurance earning underwriting profits (Bajaj Finserv is the holding company, I always like Bajaj for their great Business insights).

So these General Insurers can’t think of getting high valuations with low valued balance sheets and business models. PSU General Insurers can’t always look towards Govt for their capital needs; they need to have self-sufficient model. Sometimes I think that this reckless behavior from PSU business houses like Banks and Airliners should have been penalized by competition watch dog. These PSU’s do bad business…bad management…terrible choice of customers (Mallaya/Jaypee)….they compete on cheaper prices. But when they are into losses due to their terrible business models, they beg to Govt for capital which our Govt does with public money. This is pure looting and should be stopped.

So I think good time for General Insurance industry will come shortly. We may witness some consolidation. We’ll see players with more specialized set of services. Like Max Bupa is catering to Health Insurance and due to synergy of Max hospital can become a force in health insurance.

Some time back I have shared about the potential of Internet of things (IOT) in business. IOT can provide big benefits to General Insurance sector. Sensors in Cars can detect the driving pattern of a person and on the basis of the same premiums will be charged (High premiums for bad driving, Salman khan!!). Health Insurance companies can use wearable devices to monitor the health of its customers and can take advance decisions/steps in case of emergency and thus reducing its costs. But these things will become a reality when they have profits to back up these specialized set of services. That’s why I feel quality of services and innovative products are the key.

General insurance penetration is extremely low in India...around 30% for 2 wheeler, 40% for commercial 4 wheeler (private is good at 70%), health insurance is just at 20%. Crop insurance is the new high growth segment.

So as explained in earlier post also, General Insurance stocks like Tube Investments of India (CMP 570), Sundaram Finance (CMP 1230) , Bajaj Finserv (CMP 3011), Max India (CMP 140) are a great fit for investing. Even Future enterprises, CMP 18.30 (Holding 30% share in Future Generali Life Insurance and 50% in Future Genereli General Insurance) can be worthy...and this can surprise as it is focusing big on health insurance. Its Gross written premium was 1600 cr in 2016. I am never a follower of Reliance (Reliance Capital) and Religare…so I am leaving these from my study....because we are looking for Special companies in General.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post)

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