Vikas Khemani feels secure with this insurance bet

Stuff happens. Life is random and unpredictable. 2019 was a perfect illustration of this, with the floods in Kerala and Karnataka, and Cyclone Fani in Odisha to the big pandemic that has spooked everyone. In times of such uncertainty, insurance shines like a beacon. In India, the opportunity size of the insurance industry is huge, with the miniscule penetration in general insurance. Companies operating there usually don’t have to fight for growth. Therefore, we like ICICI Lombard. 

This industry has several things going for it. First is its size and scale. Second is the structural benefit inbuilt in the dynamics. Here, one receives cash upfront and pays later, leaving a large sum of money called ‘float’, which allows insurance companies to generate investment return while underwriting profit. That, in turn, helps these players generate good return on equity.

The Rs.1,700-billion general insurance industry has been growing at 16% CAGR for the past 20 years and yet the premium per capita stands at only $19 in India. Whereas, in countries such as China, South Africa and Brazil, that figure is 8x to 10x higher. Within sub-segments such as motor, only 25% of two-wheelers and 60% of cars are insured as compared to the global benchmark of 90%. Even with something as crucial as health insurance, penetration is merely 27% in the country, and 89% of the private expenditure incurred on healthcare is out of the consumer’s pocket. These dynamics leave ample room for players to penetrate and increase the size of risk coverage. 

The other interesting trend playing out is the large market share movement from public players to private players, quite similar to what is being seen with banks. In early 2000, private players held around 13% of the market, which has increased to 55% in FY20. The mood towards PSU players has not been too sanguine. The government has also allocated Rs.70 billion for mergers and the recapitalisation of general insurance companies to manage mandatory solvency ratios, which has soured the sentiment against them. 

In the recent past, regulatory changes such as mandatory third-party insurance of three years for four-wheelers and five years for two-wheelers have also helped the industry immensely. Thus, an insurance player gets the money upfront for three and five years — one could not ask for more in a float-oriented business.

Strong linkages
Focusing on ICICI Lombard, this company brings with it a strong parentage, well-known brand and an experienced leadership. All these factors form a great recipe to capture growth in any good business. The dynamic and capable leadership of Bhargava Dasgupta makes it even more exciting. He is one of the best CEOs I have come across, who has prioritised product innovation, technology and risk management.

ICICI Lombard is the largest private general insurer with a comprehensive and well-diversified product portfolio covering motor, health, fire, engineering, marine and more coupled with strong infrastructure of 265 branches, 910 virtual offices and over 10,000 employees. The insurer’s premium income grew 16% CAGR over the past five years and net profit at 16% CAGR. Strong solvency ratio, combined ratios and loss ratios in comparison to its peers only validate the strong underwriting skills, risk averseness culture of the company combined with focus on profitability (See: Getting it right). Their ability to reject a less profitable business is commendable. For instance, it exited its crop insurance business and did not chase commercial vehicle insurance when it stopped looking lucrative.

Yes, the recent regulatory plan of allowing life insurance players to sell health insurance policies can be an additional competitive factor, but I do not believe it will deter players such as ICICI Lombard. The company offers a huge back-end infrastructure across claims processing, tie-ups with third party administrators and hospitals. If anything, life insurance players should be wary of ICICI Lombard. Furthermore, corporates generally prefer insurance companies that provide a bouquet of services, so that they don’t have to deal with several vendors. 

What could have been another risk for the company — technology — has not yet posed a threat since the management has always been a bit ahead of the curve in terms of innovation and cost efficiency. 

Solid and solvent
We believe ICICI Lombard should be able to double its profit from Rs.11 billion to Rs.20 billion over the next four years and further enhance its market leadership. If anything could dent its path towards accelerated profitability growth, it is only regulatory risk and persistent economic slowdown. But a great company will know how to navigate turbulence.

Compounding at 15-20%, with no additional capital requirement and a huge retail customer base, ICICI Lombard is more of a consumer business than a financial services one. Can the company reach $50 billion in market cap over the next decade? I believe the probability is quite high. Of course, the stock is not trading cheap. At 5.7x its estimated FY21 P/BV, the stock may look expensive to many investors but a business like this will remain expensive. Sure, in equities, one should never overlook risk. But, investing has always been a game of probability in an ever-changing world. And ICICI Lombard will compound over a long period. As the saying goes — if you want quality stocks, you have to pay for it.