Proposed direct tax law could trim value of life insurers by 25%

Mumbai: The proposed new direct tax law will be a setback toshareholders and customers of life insurance companies. According to global actuarial and consulting firm Milliman, the embedded value — a valuation measure for life companies — is expected to drop by 25%. Embedded value is the addition of future profits from current business and net asset value.
Last month, the Narendra Modi government constituted a six-member task force — headed by CBDT member Arbind Modi — to come out with a new direct tax legislation.The new law is expected to be in place by 2019 and is aimed at simplifying tax by reducing tax rates and removing exemptions.
According to Milliman, the margins for Indian insurance companies as a percentage of value of new business (VNB) is the lowest in Asia.
In life insurance, accounting profits on new businesses are suppressed as acquisition costs are booked upfront.
Analysts, therefore, use the VNB to measure how well a company has done in any given year. While the VNB reflects value added during the year in absolute terms, VNB margin is a ratio that mirrors profitability.
For listed Indian companies, the margin ranges from 10.1% to 21.6%. As compared to this, AIA, which operates in Asian emerging markets, has a VNB margin of 52.8% and Aviva Singapore 85%. According to Sanket Kawatkar, Milliman’s principal and life insurance practice leader (India), the slim margins are a reflection of the low share of protection policies and stringent prescriptions by the insurance regulator on charges.
In India, three life insurers have gone public — ICICI Prudential Life, SBI Life and HDFC Life. ICICI Pru Life’s offer price valued the company at Rs 47,956 crore. In the case of SBI Life, it was Rs 70,000 crore and for HDFC Life Rs 58,083 crore. The pricing reflects a multiple of 3.4-4.2 times of the embedded value (EV).
Speaking at a discussion forum on the life insurance sector, Philip Jackson, consulting actuary with Milliman, said that Indian life insurance companies’ stock prices appear to be out of line against Asian peers. “What this indicates is that investors expect very strong growth in coming years. Unless insurers are able to maintain future new business growth and profitability, the high EV multiple currently enjoyed by insurers would not be sustained,” said Jackson.
In Asia, China Life has a price-to-embedded value ratio of 0.88. It is 2.21 for AIA group and 1.06 for Samsung Life. As against this, ICICI Pru Life has a multiple of 3.15, SBI Life 3.6 and HDFC Life 5.3.
According to Kawatkar, the proposed direct tax legislation could shave off 25% from the embedded value of the companies. Also the reduced tax benefit for customers would have implications on future growth that could impact share price. Kawatkar said that part of the record growth in FY17 was fuelled by demonetisation. However, it has been difficult to sustain this and in September 2017 growth had eased to 4%.