Investing in Life insurance companies may appear risky as these businesses consist of long-term products and services, and also require high initial acquisition cost.
Therefore, a financial statement that provides the current year’s realised income, with the entire acquisition cost charged upfront, provide an incomplete picture of value creation and profitability is what one should look at on investing in these companies.
So, we will discuss some key financial parameter that you can use to analyse Life Insurance (LIC) companies before investing in them.
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|Value of new business(VNB)|
|Value of new business (VNB) margin|
1. Embedded Value (EV)
Embedded Value is a measure of the value of the Life insurance Company. This is an important metric, which reflects the expected profitability from the current underwritten policies plus current net worth.
EV is computed as the sum of the adjusted net worth (ANW) and the discounted value of profits from in-force policies (VIF).
A Consistent performance in the growth of Embedded Value indicates stability.
Companies which experience huge dips or spikes are required to be tracked closely as any change in product strategy, distribution model, expense performance, persistency gets reflected in the EV. An investor should track the EV Year on year.
2. Value of new business (VNB)
Value of new business is used to measure profitability of the new business written in a period. It is the present value of all future profits to shareholders measured at the time of writing of the new business contract.
VNB is crucial in understanding fair valuations. It is an appropriate measure to assess an insurer’s earning.
3. Value of new business (VNB) margin
VNB margin is the most important metric that a shareholder must track.
VNB Margin indicates the profit margin of Life Insurance Company.
VBN margin is calculated by dividing the Value of New Business by Annualized Premium Equivalent (Regular Premium +10% of Single Premium).
For ex:- A VBN margin of 20% would means that if the insurer underwrote new business premium for a particular mix of products of Rs. 100 in a year, the expected profit over the lifetime of that business is Rs.20.
Companies with high VNB margins are good from a profitability point of view.
Insurers derive higher VNB margin from their protection business. If a company wants to improve its margins, they have to focus more on the protection business.
4. Persistency Ratio
Persistency ratio measures how long customer persists with their policies. This is an important metric to track as persistency is a key driver of the profitability for an insurer.
Global average of 13th month persistency (policy that renew after a year) is close to 90% whereas the 61st month persistency (policy that renew after 5 years) is about 65%.
For example:- If the 61ST month Persistency ratio of a company is 50%, it means half of company customers are not paying premium after five years.
Persistency is an important metric to consider while evaluating stocks of a life insurance company and should compared with global benchmarks. The higher the number of years the policy continues, higher is the profitability.
5. Solvency Ratio
Solvency ratio defines how good or bad an insurance company’s financial situation is on defined solvency norms.
According to Insurance Regulatory and Development Authority of India (IRDAI) guidelines, all companies are required to maintain a solvency ratio of 150% to minimize bankruptcy risk.
Solvency ratio is calculated as the amount of Available solvency margin (AMS) in relation to the amount of Required Solvency Margin (RSM).
(The ASM is the value of the company’s assets over liabilities, and RSM is based on net premiums and defined as per IRDAI guidelines.)
Solvency ratio helps investors in identifying whether the company has enough buffers to settle all claims in extreme situation. It is good indicator of an insurance company’s financial capacity to meet both its short-term and long-term liabilities.
All these metrics mentioned above are important factor in evaluating the fundamentals of a life insurance company.
These metrics should be compared with life insurance companies peers to decide whether one should invest in that particular stock or not.
Insurance penetration in India continues to be low, which means there is a greater scope for multi-year growth.
Digitization and its fastest implementation will help the life insurance companies to grow their business.
An investor should also include some of the softer parameters such as the brand image, which too determines the valuations.