Life Insurance | Sector Report

2 January 2018 India | Life Insurance | Sector Report Life Insurance Banca vs. Non-banca insurers – Gap continues to widen We continue to believe that insurers with strong bancassurance channel present a compelling Karan Singh, CFA, FRM [email protected] | Tel: (91 22) 66303082 investment opportunity in the Indian Life Insurance sector. Banca insurers have consistently Nikhil Walecha seen an improvement in all key metrics such as persistency, opex, post-overrun margins, [email protected] | Tel: (91 22) 66303027 operating ROEVs and have gained market share in the past 3 years; we believe such Bunny Babjee outperformance will continue. We expect insurers with strong bancassurance channel to [email protected] | (+91 22) 6630 3263 report superior operating ROEVs of c.19.0% over FY17-20E vs. 10.1% for insurers driven by Sameer Bhise the agency channel. We expect a healthy 19% CAGR in APE over FY17-20E for the life [email protected] | Tel: (+91 22) 66303489 insurance industry, driven by 1) strong long-term growth drivers such as a) robust double- Jayant Kharote [email protected] | Tel: (91 22) 66303099 digit nominal GDP growth, b) favourable demographic profile, c) high financial savings, d) S Parameswaran rising income levels and e) increasing urbanisation; 2) increasing life insurance penetration to [email protected] | +91 22 66303075 2.8% in FY20E from 2.7% in FY16; 3) strong equity markets which augurs well for the sale of unit-linked products. In this report, we initiate coverage on SBI Life (TP: INR 890) with BUY Valuation summary rating and HDFC Life with HOLD rating (TP: INR 410). Key risk for the sector – increase in tax Value Target P/EV rate to 34.6% from current level of 14.2% which could impact EV by 13%-20%. Insurer INR bn USDbn FY19E FY20E HDFC Life 819 12.8 4.7 4.0 Forecast strong 19% APE growth over FY17-20E with private player APE CAGR of 22%: SBI Life 890 14.0 3.6 3.0 We forecast strong 19% APE CAGR for the Indian life insurance industry driven by strong ICICI Pru 667 10.4 3.3 2.9 long term structural growth drivers such as a) robust double digit nominal GDP growth, b) Max Life 255 4.0 3.0 2.6 favourable demographic profile c) high household savings, d) rising income levels, and e) Bajaj Allianz 322 5.0 2.3 2.0 increasing urbanization. This growth would imply increase in life insurance penetration Birla Sun Life 98 1.5 2.2 2.0 Source: Company data, JM Financial from 2.7% in FY16 to 2.8% in FY20E. We forecast private players to report APE CAGR of 22% over FY17-20E implying market share gain of 420 bps to 53% while we expect LIC Target valuation - per share contribution to parent to grow at 16% CAGR over FY17-20E. % of per share Insurer Parent Shareholding parent for parent Banca insurers to gain market share: Over the past 3 years, insurers with strong Mcap bancassurance channels have significantly outperformed industry growth and gained HDFC Life HDFC Ltd 52% 16% 266 market share. Within our coverage universe, banca players’ market share rose from 58% SBI Life SBI Bank 62% 21% 74 in FY14 to 66% in 1HFY18, while agency-led insurers have lost market share (declined ICICI Pru ICICI Bank 55% 18% 57 from 11.3% in FY14 to 7.6% in 1HFY18). We believe this trend will continue and insurers Max Life Max India 70% 111% 667 with strong bancassurance channels will continue to outperform as we expect 24% APE Bajaj Allianz BJFIN 74% 29% 1,496 Birla Sun Life ABNL 51% 12% 23 CAGR for banca players and 20% APE CAGR for agency-led insurers. Source: Company data, JM Financial Increasing focus on pure protection to drive profitable profit growth for banca players: Operating RoEV FY17 FY18E FY19E Life insurers have been the largest beneficiaries of strong capital market growth, as the Strong banca channel contribution of ULIPs in the APE mix increased to 66% in FY17 (FY14: 45%) for large HDFC Life 21.7% 20.6% 20.4% banca players. For agency-led insurers, ULIP contribution increased to 41% in FY17 (vs. SBI Life 18.3% 18.8% 19.8% 20% in FY14), largely led by BALIC. Additionally, banca players have started focusing on ICICI Pru 15.6% 16.4% 17.1% Max Life 19.9% 19.1% 19.3% pure-protection products to improve their profitability. We expect banca players to Wtd. Avg. 18.5% 18.5% 19.1% maintain a dominant share in ULIPs, however rising share of protection products will Agency channel driven support margins. Bajaj Allianz 7.5% 8.6% 9.4% Birla Sun Life 8.0% 8.3% 8.5% Significant divergence in operating metrics between banca and agency led insurers: Opex Wtd. Avg. 7.7% 8.6% 9.2% ratios (ex-commissions) for banca players has remained lower at 11-12% over FY14-17 Source: Company data, JM Financial driven by low cost banca channel and strong premiums growth while agency led insurers continue to be burdened by high opex (ex-commissions) ratios averaging c.20% over FY14-17. Moreover, banca insurers have superior conservation ratio averaging 84% over FY15-17 vs 65% for agency led insurers over the same period. Similarly 13th-mth persistency is superior for banca insurers at 75-85% vs 60-70% for agency led insurers. JM Financial Research is also available on: Such divergence is expected to continue with banca insurers expected to have opex (ex- Bloomberg - JMFR <GO>, commissions) ratios of 10% vs 15% for agency led insurers over FY17-20E. Thomson Publisher & Reuters S&P Capital IQ and FactSet Post-overrun margins improving for banca, but remained subdued for agency-led insurers: We expect post-cost overrun margins for banca players to improve by upto Please see Appendix I at the end of this 290bps over FY17-20E due to strong growth, operating leverage, better cost controls and report for Important Disclosures and higher persistency ratios. Post-overrun margins for agency-led insurers have remained Disclaimers and Research Analyst Certification. negative (due to the absence of strong banca channels, and lower growth). We expect JM Financial Institutional Securities Limited Life Insurance banca insurers to report post cost overrun margins of 13-22% while we expect agency insurers to report subdued post cost overrun margins in the range of 2-9%. However, increase in corporate tax rate to 34.6% could negatively impact margins by 290-560 bps. Insurers with strong bancassurance channel should continue to deliver superior profitability: Insurers with strong bancassurance channel have significantly outperformed others in key operating metrics such as growth, cost, persistency, post-overrun margins and operating ROEVs. We believe such banca insurers should grow faster and contain costs, which will lead to better ROEVs. We expect these companies to generate weighted average operating ROEV of 19.2% by FY20E (vs. 18.5% in FY17) compared with 10.1% (vs. 7.7% in FY17) for agency-led companies. This would be driven by i) persistency improvement ii) a decrease in cost overruns and iii) an increase in NBAP margins as insurers focus more on direct channel and pure-protection products. Prefer insurers with strong bancassurance channel; Initiate HDFC Life and SBI Life with TPs of INR 410 and INR 890, respectively: We use the P/EV methodology to value life insurance companies. We give a higher P/EV multiple to HDFC Life (4.0x FY20E EV), SBI Life (3.0x), ICICI Pru (2.9x), and Max Life (2.6x) as we believe they would generate superior ROEVs vs. BALIC (2.0x FY20E EV) and Birla Sun Life (2.0x) due to superior profitability and strong distribution channel. We are initiating coverage on HDFC Life (HOLD rating) and SBI Life (BUY rating). We believe strong growth and improvement in post cost overrun margins would lead to operating ROEV of 20.3% for HDFC Life and 19.7% for SBI Life by FY20E. We value HDFC Life at 4.0x FY20E EV, implying a TP of INR 410 and SBI Life at 3.0x FY20E EV, implying a TP of INR 890. Key Risks: a) An increase in the corporate tax rate from 14.2% to 34.6% could reduce margins by 290-560bps and EV by 13-20% b) Any form of open architecture with mandatory clause will be negative for insurers with strong bancassurance channels c) A sustained weakness in capital markets which could have an adverse impact on sale of unit linked policies d) any regulatory changes capping expense on par products could impact the industry adversely. Exhibit 1. Valuation summary Embedded Value APE APE growth New business Operating P/EV M.cap (INR bn) (INR bn) YoY (%) margin (%)* ROEV (%) (x) Company INR bn FY17 18E 19E 20E FY17 18E 19E 20E FY17 18E 19E 20E FY17 18E 19E 20E FY17 18E 19E 20E FY17 18E 19E 20E HDFC Life 783 125 147 174 205 41 55 67 81 13% 33% 23% 20% 22% 22% 22% 22% 22% 21% 20% 20% 6.3 5.3 4.5 3.8 SBI Life 700 165 202 245 296 63 86 106 128 40% 36% 24% 21% 15% 16% 16% 16% 18% 19% 20% 20% 4.2 3.5 2.9 2.4 ICICI Pru 549 162 181 204 230 65 86 103 123 27% 32% 21% 19% 10% 11% 12% 13% 16% 16% 17% 17% 3.4 3.0 2.7 2.4 Max Life 255 66 75 86 98 27 31 37 43 26% 18% 17% 17% 19% 19% 18% 18% 20% 19% 19% 19% 3.9 3.4 3.0 2.6 Bajaj Allianz 322 113 126 142 161 12 18 22 27 34% 42% 26% 23% -4% 1% 5% 9% 8% 9% 9% 10% 2.9 2.5 2.3 2.0 Birla SunLife 98 38 41 45 49 11 12 14 17 30% 15% 15% 16% -5% -3% -2% 2% 8% 8% 9% 10% 2.6 2.4 2.2 2.0 Source: Company, JM Financial; *Post cost overrun margins; JM Financial Institutional Securities Limited Page 2 Life Insurance Key Industry Charts Exhibit 2.

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