Is India's largest insurer as rock-solid as it is made out to be?

Haridas Mundhra did not hail from a wealthy family nor was he educated, but his unbridled ambition and manipulative zeal did ensure that he would emerge as the protagonist of what was to be independent India’s first financial scandal.

The Calcutta-based Mundhra hit the headlines in the early ‘50s when he acquired FC Osler, the Indian subsidiary of the largest European glass lamp-maker. His buyout binge continued when he snapped up controlling stake in Richardson & Cruddas, followed by Jessop & Co. His reputation as an aggressive M&A specialist grew when in 1955 he went on to acquire British India Corporation, and also the UK-based Turner Brothers’ 49% stake in Turner Morrison India.

But the leverage that was fuelling Mundhra’s meteoric rise was coming from our very own desi banks, who were largely lending against pledged stock of Mundhra’s group companies. And by manipulating prices on the Calcutta Stock Exchange with the help of brokers, he gave bankers a false sense of comfort on their exposure to his group. For instance, he struck a deal with British India Corporation to buy its shares at Rs.12, and later drove the stock price to Rs.14 having pledged the stock with banks for Rs.11.

By 1956 his game was up, as a slide in the broad market forced him to cough up more collateral. Even as Mundhra was making every attempt to stay afloat, one of the four banks that had lent money to Mundhra, discovered that fake share certificates were pledged with two of its branches. Around the same time, Feroze Gandhi, husband of Indira Gandhi was on an anti-corruption crusade that had led to the arrest of well-known businessman, Ramkrishna Dalmia, for defrauding his life insurance company, Bharat Insurance Corporation. That event resulted in Parliament passing the Life Insurance of India Act on 19 June, 1956, under which 245 private insurers were nationalised and consolidated under what was to be known as the Life Insurance Corporation (LIC).

In 1957, a plucky Mundhra managed to get a government institution to invest Rs.12.4 million by picking up shares of his six troubled companies from the open market. But the buzz around his dealings soon reached the corridors of power. In September 1957, Feroze raised the issue in Parliament, eventually blowing the lid off the scandal. Following the outcry, Feroze’s father-in-law and then-Prime Minister, Jawaharlal Nehru, set up a one-man panel headed by retired Bombay HC Justice, MC Chagla.

The government institution that had bailed out Mundhra was none other than LIC!

In fact, Chawla got the FM, the RBI Governor and the LIC chairman to depose in public in open lawns with loudspeakers as he believed the public had the right to know the truth! Though TT Krishnamachari, the FM, tried to distance himself from the move, implying that the investment would have been done at the behest of then-Finance Secretary, HM Patel, Chagla held the FM constitutionally responsible for the action taken by his secretary. Krishnamachari had to eventually resign in February 1958.

Since that fateful year, a lot of water has flown under the bridge in the ensuing six decades. LIC has grown in stature with 72% market share even as 24 private players set up shop once the sector was thrown open for competition, beginning 2000. But what has not changed is the lack of governance and accountability at the state-owned insurer, which over the years has turned out to be the lender of first resort for the government!

Though the Mundhra scandal cost the then-finance minister his job, it did not change a thing. In fact, a lot of investment decisions at LIC have been ‘guided’ by North Block – irrespective of the political party at the helm – with regulators, too, playing second-fiddle by being “accommodative” of any regulation breach committed by the corporation.

The rate at which the corporation has infused money into public sector enterprises is glaring. In fact, as per the central bank’s Handbook of Statistics for FY19, LIC’s total investment in public sector enterprises between FY15 and FY19 was nearly equal to the total amount the company invested in state-owned firms since 2000. As of FY14, it stood at Rs.11.94 trillion, out of which Rs.10.97 trillion was incremental exposure.

But from FY15 to FY19, as the economy floundered, India's largest insurer infused Rs.10.69 trillion into PSUs taking its net exposure to Rs.22.64 trillion (See: Public affair). Compared with that, its private exposure since FY00 to FY14 was Rs.3.16 trillion, of which Rs.3 trillion was incremental flows, while between FY15 and FY19, it infused Rs.670 billion into the private sector with total investment standing at Rs.3.96 trillion. 

Now, the corporation is being primed for a public listing as a cash-starved government is desperate for funds. While there is arguably some excitement around the biggest-ever IPO to hit the Indian capital market, a deep dive into the behemoth’s investments could well serve as a reality check.

Big is not always better
From 1980 to 1999, LIC’s AUM grew 20x to Rs.940 billion, but post the entry of private players, it grew 26x to Rs.30 trillion till FY20. LIC still is the biggest asset manager, dwarfing the combined assets of the private insurers. “LIC's biggest strength is its sovereign backing and trust quotient, which is hard for private players to replicate. The agency force is its biggest moat and though initially private players took the digital route, now even market leader HDFC Life is looking to go the agency way. Insurance is a push product and human interface works strongly in this business,” mentions Jignesh Shial, who tracks the sector at Emkay Global. LIC’s 1.1 million agents managed to sell 20.71 million new individual policies in FY20. But that’s where its heft ends.

Post 2000, only during four years — FY02-05 — LIC reported return from investment that was higher than the average 10-year bond yield (See: Rank Underperformer). One can argue that since majority of its funds are invested in papers and Treasury Bills of central and state governments, it’s hard to beat the benchmark yield. But with its one-third exposure to equities and bonds, the corporation should ideally have done well on the return front. More so as the broader NSE 500 Index had risen from 1,288 in April 2000 to 9,664 in March 2019.

According to transaction advisory firm RBSA Advisors, which released a valuation report on the life insurer in March, LIC’s investment yield is comparatively lower than its peers. The report states that investment in equities as a percentage of AUM for LIC is 15% versus 36% for private players, which partially explains the lower yield.

As per its Form L26 filing, as of March 2020, LIC’s AUM stood at Rs.30.66 trillion, of which, Rs.30.41 trillion was held under non-linked schemes (life, pension, & endowment) and the remainder (Rs.250 billion) in market-linked schemes (ULIPs). Of the total AUM, Rs.21.09 trillion (69%) was invested in government securities, Rs.4.9 trillion (15.98%) in equity shares, Rs.2.49 trillion (8%) in approved bonds, and the balance across other instruments.

LIC, however, does not reveal details of its investments either in its annual report or in the periodic disclosures. The only investment open to public scrutiny is its equity portfolio which was worth Rs.5.87 trillion (as on September 4) spread across 331 companies. In addition to that, it holds 25 infrequently traded stocks worth Rs.108 million. Of these, Modella Woollens tops the list with 17.84% stake.It is arguably the only asset management company in the world to hold stocks of companies whose names encompass the entire alphabet! This trivia aside, 13 large-cap stocks account for Rs.3.44 trillion (59%) of the entire equity exposure. Its top holding is Reliance Industries, where it owns 5.94% stake, worth Rs.814 billion. This is followed by ITC at Rs.373 billion, where it holds 16.27% stake (See: Legacy management). The other big ‘investment’ is in IDBI Bank, where it is the largest shareholder. Further, around Rs.2 trillion is held across 62 companies whose value ranges from Rs.10 billion to Rs.100 billion. LIC also has exposure to troubled groups such as ADAG, Jaiprakash Group and GMR Infra.

More noteworthy is that the value of more than 50% stocks (158) is below Rs.1 billion. Even worse? It owns 30 stocks, which are worth less than Rs.10 million and collectively account for Rs.141 million with an obscure Gajra Bevel Gears and Gujarat State Financial Corporation featuring at the bottom of the list with a value of Rs.200,000 each. 

The list of such shares is long, but Sampath Reddy, chief investment officer, Bajaj Allianz has a justification. “Over the years, in a diversified equity portfolio, even if some of the investments become laggards and end up as penny stocks, the winners would compensate and generate better overall portfolio return," he explains.

LIC’s dealings have also raised questions in the past. Manish Tewari, Indian National Congress MP and member of the Standing Committee on Finance, says, “Before the divestment, the government must come out with a White Paper in the Parliament clearly enunciating which companies were ailing or whose networth was bailed out by LIC in the past six years.” But despite the concerns raised, much of LIC’s active fund management remains shrouded in mystery. In fact, none of LIC's fund managers or analysts seem to be present during a company's earnings call.

LIC did not respond to questions mailed by Outlook Business to its public relations department, and calls made to its external public relations agency to get the insurance company’s side of the story, did not elicit a response either.

“Nation building”
Besides opaque fund management, LIC has also eroded a lot of wealth due to its investments in state enterprises, whose value has fallen 72% from its peak of Rs.4.31 trillion. Of the 68 PSUs in the portfolio, 12 stocks have seen erosion in the range of 90-98% from their respective all-time highs, with MTNL topping the list. A chunk of these are in public sector banks (PSBs), whose current valuation amounts to Rs.441 billion — down 75% from the peak of Rs.1.81 trillion. Most would call this a dismal record.

Even its equity investments in IDBI Bank and IL&FS have raised concerns over the lack of accountability from the corporation and the government. In fact, in July 2019, India Ratings pointed out in a report that, during FY14-19, the government and LIC together infused Rs.3 trillion (Rs.2.7 trillion by the government and Rs.300 billion by LIC) in PSBs.

As for IDBI Bank specifically, LIC’s FY19 annual report shows the total investment at Rs.240 billion. The market value of LIC’s 51% stake is Rs.202 billion, as of September 8, 2020, but that is an outcome of dismal free float. With the government and the LIC collective holding 98.11% stake, under 2% of the equity is available to trade in the market. Further, what cannot be ignored is that from FY16 to FY20, the bank has posted a cumulative loss of Rs.447 billion and is still under the prompt corrective action framework of the RBI with net NPA of 4.19%.

Now, with businesses still coming to terms with the impact of COVID-19 and the resultant demand destruction, the bank, unlike other PSBs is unlikely to come out of the woods anytime soon. In fact, the cumulative value of LIC’s stake in 10 PSBs, wherein it collectively holds around 36% stake, is worth Rs.53 billion and if one adds up the 9.98% holding in SBI, the value tots up to Rs.235 billion. Given that the other PSU banks’ loan book is many times larger than that of IDBI Bank, the distortion can’t be more glaring. Shankar Sharma, co-founder and chief strategist, First Global, believes it is par for the course for the corporation. “Given the state of government finances, it is not surprising to see LIC emerge as the lender of the last resort,” he says.

Having the government as your parent means even regulators are benevolent — the RBI reportedly gave LIC 12 years to pare its stake in IDBI Bank to 40%. Further, insurance regulator, IRDA, too, has taken a lenient approach. As per the insurance regulator’s rules, LIC can hold only up to 15% in a bank and, at best, double up, following a board approval. In the past as well, IRDA looked the other way when LIC bought 27% stake in Corporation Bank in 2002. The bank has since been merged into Union Bank of India, where LIC holds 3.37%.

Reddy of Bajaj Allianz explains why LIC’s investments in PSBs may not be the best strategy. He says, as a CIO he has never looked at state-owned banks, including SBI. “We prefer private sector financial institutions, as they are focused on profitability and growth. Public sector banks have not been able to attract talent and reward them on performance basis, hence losing out market share to private sector banks,” he says.

Now, some may argue that LIC also has massive holding in private banks (11 of them), which is 2.62x that of PSBs at Rs.575 billion. Its holding in ICICI Bank (10.15%) and HDFC Bank (3.48%) are valued at Rs.263 billion and Rs.213 billion, respectively. However, it is interesting to note that here as well, there are inexplicable investments. For instance, LIC aggressively bought into Yes Bank, increasing its stake from 0.75% to 4.98%, between September 2017 and July 2020, according to a recent regulatory filing. Though the bank raised Rs.150 billion from an FPO and is looking to clean up its book, LIC’s decision to double down on a ‘struggling’ bank, instead of other leading private banks, defies logic.

Even LIC’s portfolio of 19 MNC stocks, which is worth Rs.421 billion, has fallen from its peak valuation of Rs.641 billion, but of all its holdings, this bucket has seen the least erosion at 33%. Just two stocks, HUL and Maruti, account for more than 50% share at Rs.274 billion. Ideally, the corporation should have tanked up on these stocks, including those such as HUL and Nestle. In the case of Nestle it pruned its holding from 5.15% in 2017 to 1.99% in June 2020, similarly in HUL it sold down from 5% in 2012 to 2.60% in June 2020. But the stock, where it owns more than 10% stake is Castrol, whose market value is just Rs.12 billion. The least valued MNC in its portfolio is chemicals major BASF India, which is worth Rs.0.77 billion.

So the question arises, when the veil of secrecy is so thick around LIC’s investing framework, how is the government gearing up to go public? The DRHP should make for an interesting read as the government is in the process of shortlisting investment bankers to manage the listing. INC’s Tewari also points out that since LIC was created by statute, the government will have to discuss the proposal in the Parliament along with the corporation’s current financial state. When pointed out that bailouts were also prevalent during the days of the UPA, Tewari responds, “Let the government bring out a paper that takes a look at all investments made by LIC since 1999.”

With the government likely to stonewall Tewari’s proposal, it also has to gear up to explain LIC’s huge debt portfolio, which has started showing signs of stress.

Too much at stake 
The state-run insurer’s gross non-performing asset ratio in its debt portfolio has surged from 6.15% in March 2019 to 8.17% as of March 2020. On a net basis, the ratio worsened from 0.27% in FY19 to 0.79% in FY20. Of its Rs.31.24 trillion AUM as of March 2020, real estate exposure plus loans as a percentage of cash and invested assets stands at 4.22% against 4.09% in FY19.

LIC chairman MR Kumar, however, said early this year that the gross NPA should not be compared to that of banks as the stress threshold for banks is different from that of life insurers. Incidentally, LIC reveals its list of downgraded investments every quarter, but for March 2020, there was no public disclosure on investment downgrades even though it made a provision of Rs.125.6 billion for bad and doubtful debts, and Rs.121 billion for non-standard loans in FY20. 

As of December 2019, it had debt exposure, in the form of bond or loans, to Dewan Housing Finance, Reliance Capital, Yes Bank, Reliance Home Finance, IL&FS and Jaypee Infratech. Along with corporate exposure, its extensive lending to bankrupt state governments are cause for concern. As of December 2019, while 96% of its debt portfolio was in either sovereign or AAA-rated bonds, 37% of the sovereign exposure comprised state bonds. “It's not their equity portfolio that is of concern, but their debt investments. It is like Pandora's Box waiting to be opened. Only a true picture of their debt portfolio will give investors some real comfort,” says Shial.

Now that LIC is being dressed up for the IPO, investors might get a closer look at the insurer’s books. According to Reddy, the more important question is why despite managing such a huge AUM, the insurer’s profitability is so low. “LIC has dominant market share in life insurance premiums, with large asset under management. Even though, life insurance companies are looked at more on “Embedded Value “basis by investors, LIC’s share of profit in life insurance industry seem lower and offers scope for improvement,” he points out. On AUM of Rs.4,966 billion, the combined net profit of the top four private life insurers, including SBI Life, is Rs.83 billion compared with Rs.27 billion for LIC (See: Big, but not better). “It either means they are giving lot of benefits to customers or their cost of operations is too high,” adds Reddy. 

RBSA Advisors states in its report that LIC has relatively lower earning power because of relatively higher distribution of surplus to shareholders, lower investment yield and possibly sub-optimal underwriting practices. Currently, in the case of both participating plans (offer a minimum guaranteed return and shares profit that the fund makes) and non-participating policies (term plans, ULIPs or traditional plans where the benefits are defined upfront and the insurer enjoys the profit made from these plans), LIC pays only 5% of the profit to the shareholder (government) and 95% goes to policyholders. However, in the case of private insurers, shareholders have 100% right towards the surplus of non-participating policyholders. Thus, potential investors in LIC cannot have access to higher profit as the corporation has a common pool for both its participating and non-participating business.

Sure, LIC has managed to hold on to market share in the past decade and raked in total premium of Rs.3.79 trillion in FY20, but the jury is out on whether it will be able to sustain profitably in the next decade. Till premium inflow and investment return outruns payouts, LIC’s ship will sail steady (See: Lagging behind). According to RBSA Advisors, LIC has traditionally had the highest revenue contribution from non-participating plans compared with its peers. However, owing to increased focus on term plans, in FY19, HDFC Life overtook LIC in terms of higher contribution from non-participating plans at 42%, which more than doubled in three years. Generally, margin profiles for non-participating policies are 1.5-5x that of participating policies, depending on the type of product, states the report.

The million-dollar question then to which investors will seek answer to: Will LIC’s profit get any better from here on? Also, unlike private insurers, LIC does not disclose its embedded value (EV), which is the sum of present value of future profit from an existing business and shareholders’ net worth. Since insurance is a long-term business where a policyholder buys a policy today but continues to pay premiums into the future, a life insurer’s valuation is assessed by future profit that the current business can generate (See: Growth premium).

In the absence of EV, RBSA has estimated the valuation of LIC on basis of market cap as % of AUM to be in the range of Rs.9,900 billion to Rs.11,500 billion. According to a consultant with a leading management consulting firm, LIC’s EV could be low because of low profitability and over reliance on traditional products, where the interest rate fluctuation is massive. “If LIC wants to disclose its EV, they have to figure out the assumption for interest rates. If they calculate it conservatively, then its IPO value will be low. If too aggressive, they will have a great IPO which will later fizzle out,” he adds.

The sketchy disclosure notwithstanding, many believe LIC will be a heavyweight once listed. First Global’s Sharma says active fund managers cannot avoid having LIC in their portfolio. But whether it will deliver value to investors, is another question. “Most likely, the issue will be priced expensive with little left on the table for investors. The investment banker’s interest lies in making money for the shareholder, which in this case is the government, and not investors,” says Sharma.

While the market veteran is not hot on LIC for being the official bailout vehicle for the government, Emkay’s Shial is equally sceptical. “The government has never been minority shareholder friendly and we have seen how their intervention has spoilt the prospects of Coal India, despite its monopoly. I won't be surprised if LIC finds itself going the Coal India way, though financial services business is relatively transparent than a commodity business.”

The moot question is whether public scrutiny, post listing, will change the way LIC invests. The answer seems a resounding ‘NO’. With just 10% initial float, the government will continue to call the shots and just like with oil PSUs and PSBs, governance and accountability will be just as elusive.