GIC Re-Unique Insurance Play?

(Anirudh72) #1

GIC Re-Unique insurance play?

GIC is India’s premier reinsurance company, a PSU enjoying 60% market share in India’s reinsurance market in FY17 (up from 45% in FY16 and 43% In FY15) and underwrote business from 162 countries. 95% of premiums are earned from the non-life space primarily in fire, motor, health and agriculture reinsurance. As per IRDA mandate, it is mandatory for insurance companies in India to cede a minimum of 5% of their risks to GIC (this has come down from 15% in FY13 to 5% now) and GIC also has a right of first refusal when it comes to Indian insurance companies seeking reinsurance.
As quoted in ICICI Lombard’s DRHP-“Additionally, under the IRDAI’s regulations, GIC Re, which is the only Indian re-insurer with the minimum credit rating required to gain this preferential status, has a right of first offer for all reinsurance ceded by an Indian non-life insurer. Hence, we may not have control over the amount of reinsurance we cede to GIC Re.” (GIC’s current credit rating is A-, they would need to work to improve this since foreign markets would likely require a rating of A or above to be competitive)
These regulations thus becomes a source of competitive advantage for GIC.
The Indian general insurance industry is underpenetrated and accounts for only 0.8% of GDP with an industry size of Rs 1.28 lakh crores. This is slated to grow at rates of 15%+ for the next few years.
The reinsurance market size was estimated at Rs 38800 crores in FY17 and is expected to reach Rs 70000 crores by 2022.(Going by H1FY18 numbers it is going to grow even faster than this)

Key success factor for the business- Warren Buffett puts it best-“An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is higher than market rates for money."

How does GIC do on this test?

GIC had combined ratios of 100.16%,107.03% and 108.86% in FY17,FY16 and FY15 respectively.This has since come down further to 99.4% in H1FY18 thus meaning GIC has now achieved underwriting profits.

Underwriting Analysis:
Combined ratio upto FY16 suggests that cost of funds was 7-8%(this is in line with money market rates).However, since last 18 months, there has been a significant improvement with combined ratio coming down to 100% in FY17 and 99.4% for the 6 months ended 30th September,2017.
Further digging reveals that this is primarily due to strong growth in earned premiums in agriculture segment (Premiums grew from Rs 915 crores to Rs 8250 crores, accounting for 31% of earned premiums in FY17 vs 6% in premiums in FY16).
Combined Ratio in agriculture segment was only 92% (vs 169% in FY16 and 113% in FY15) The underwriting profits in this segment were Rs 550 crores [vs (678) crores in FY16] This swing of Rs 1200 crores helped post significantly lower combined ratio on overall basis. It must be noted that GIC has now reinsured 30% of gross cropped area in India and that 77% of agricultural insurance has been reinsured with GIC.
ICICI Lombard’s DRHP spoke of the fact that GIC was the only reinsurer offering reasonable premiums for agriculture, hence all insurance companies have reinsured agriculture risk with GIC. This makes GIC risk prone in the event of a drought. Management claims that they have spread this risk nationwide and since there won’t be a nationwide drought according to them such risk is lowered.
It remains to be seen whether they can sustain the overall combined ratio at these levels especially since motor, health and fire insurance, the three segments accounting for approximately 21%, 21% and 13% of earned premiums respectively in FY17, all had underwriting losses.(Combined ratios of 114%,110% and 104% respectively). Even more worrying is the fact that these have been the only growing segments in the last 5 years. Other segments such as liability and engineering which have shown consistent underwriting profits have barely shown any growth in the last 5 years.
Thus, agricultural segment is primary driver of underwriting profitability and low combined ratios in FY17 (31% of earned premium) and H1 FY18 (46% of net premium) and it remains to be tested as to how robust this portfolio is and how badly it would be affected in case of a drought.
It must be noted that their DRHP states -“We paid premiums of ₹ 6,788.71 million (Rs 679 crores or 8% of gross premiums) for retrocessional coverage to mitigate the effect of potential large sized risks in our agriculture business line in Fiscal 2017. Our agriculture portfolio is covered under multiyear stop loss treaties with high rated reinsurers from international markets”.

Investment Portfolio Analysis:

The entire point of running an insurance or reinsurance business is to earn on the float.
The fair value of investments held by GIC Re is almost Rs 70,000 crores which have a carrying value of Rs 39000 crores(only equity investments have been marked to market on which there is a gain of Rs 30,000 odd crores)
Detailed analysis reveals that the company has been incrementally investing less in equities, with equities forming only 3% of incremental investments vs 14-20% in earlier years. The management seems to be cognizant of equity market valuations and thus seems to be taking some money off the table.
However, it was a little surprising to see the equity portfolio being very cyclical. The sector wise composition is as follows:
Mining & metals-16%
Auto and auto ancillary-8%
(Some clarity on this would be helpful)

Fixed Income returns in CG securities, SG securities as well as debentures and bonds is in the range of 8-9% over the last few years which is in line with prevailing rates. More than 90% of the fixed income portfolio is in AAA/AA rated securities or sovereign player implying minimal credit risk.

The overall investment yield over the past few years has been:
FY17- 12.34%
FY16- 12.9%
FY14- 14.1%

Premiums Written:
There has been strong growth in the net earned premiums due to substantial growth in the agriculture space. The net earned premiums for the past few years have been as follows:
H1FY18-Rs 22,485 crores
FY17-Rs 26,715 crores
FY16-Rs 15,173 crores
FY15- Rs 13,559 crores

The profit after tax for the past few years has been as follows:
H1 FY18- Rs 1809 crores(Annualized FY18=Rs 3618 crores)
FY17- Rs 3,127 crores
FY16- Rs 2,848 crores
FY15- Rs 2,802 crores
As per FY18E profit, stock trades at a PE of 18-19.
Return on Equity has been strong. The ROE’s for the last 3 years have been:
H1FY18- 19.6%
FY17- 17.4%
FY16- 16.21%
FY15- 18.97%
ROE’s have been 16%+ in the last 3 years and gradually improving. Underwriting has also improved with overall combined ratios coming down to 99.4% vs 107-108% earlier driven by agriculture insurance premiums received.

Risk Factors:
Competition-The IRDAI has permitted global reinsurers to enter the Indian market. This will lead to an increase in competitive intensity. However, GIC seems to be protected by the right of refusal it is armed with.

Exposure to agriculture/crop insurance- Due to government focus via the PMFBY (Pradhan Mantri Fasal Bima Yojana) this segment has enjoyed breakneck growth with earned premiums growing from 6% of premiums in FY16 to 31% in FY17 and 46% in H1FY18. This segment has been showing low loss ratios as of now, but performance of this segment would be critical to future profitability.
Alternative Sources of Reinsurance- The low interest rate environment has led to pension funds and hedge funds entering the reinsurance market

Considering the good underwriting performance (needs to be watched closely) and investment returns being earned, the stock seems to be available at very cheap valuations.
At current market cap of Rs 67,000 crores, the price to book ratio (including the fair value change account) is only 1.35. This is very cheap compared to other insurance companies such as ICICI Lombard which trades at a price to book ratio of more than 7 times(not saying that they should have same valuations but just seeing the discrepancy).

As Warren Buffett explains in his 1998 letter to shareholders-The key determinants are: (1) the amount of float that the business generates; (2) its cost; and (3) most important of all, the long-term outlook for both of these factors.

Hence, looking at these parameters GIC looks to be a solid long term bet which could offer steady returns.

Disclosure-I am far from an expert in analyzing insurance and reinsurance companies and hence apologize for any unintended errors in understanding.

Look forward to seeing a healthy debate on the pros and cons of investing in the business.

(sachit) #2

At the present prices, value of its investment book might actually be eve higher. A reasonable estimate might be around 45000 crores. This makes it an even better investment thesis assuming they are able to realise these investment profits.

(Anirudh72) #3

Yes they are focused on booking gains in the equity segment,the profits will be reinvested in debt instruments-hardening yields make that even better

(Gaurav Agarwal) #4

Good work @Anirudh72

What do you mean by “right of first refusal”? Do you mean that Indian insurance companies have to compulsorily give 5% business of GIC but GIC can refuse accepting the business?

How do we calculated cost of fund given combined ratio?

(Anirudh72) #5

Thanks @Gaurav_Agarwal

This means that the insurance cos(both public and private)have to cede 5% of business to GIC.This has to be accepted by GIC.This would probably be through proportional treaty reinsurance which means that all the policies written by that company are reinsured upto 5%(not 100% sure about this,but seems that way)
The right of refusal applies to the any insurance company seeking reinsurance. The insurance company must give first right to GIC to match premium being offered by any of its competitors.Thus if GIC finds pricing appropriate it can reinsure the risk and take that business from its competitors
This acts as a fundamental source of competitive advantage for GIC

(Anirudh72) #6

Combined ratio suggests excess amount paid out vs premiums received.Can very simplistically(not in the technical sense)be taken as cost of funds of the company.
Warren buffett alludes to free money available in his insurance businesses since they are underwriting profitably.
This is my understanding,do correct me if I’m wrong

(Gaurav Agarwal) #7

Company has some NPA, below from RHP

@Anirudh72 We need to understand what events will lead to massive payouts from Insurance company to farmers?

(Anirudh72) #8

The primary event would be inadequate rainfall/drought.Now,what GIC has done is that they have resinsured about 77% of crop insurance provided in India.So even though insurance companies are exposed to drought risk due to concentration of their exposure in 3-4 states,GIC has reinsured pan India risks and it is highly unlikely that the entire country would be hit by drought.If I remember correcetly,even when there was a major rainfall shortage 2 years ago,it was primarily 3-4 states like Maharashtra,Karnataka and Andhra/Telanagana which were hit.Further, they have priced the higher risks/payout associated with this segment and also taken retrocessional coverage from certain global reinsurers to limit overall loss exposure. Also, I take some solace looking at the underwriting profitability(though lets not just judge model robustness going by 18 months of data)

ICICI Lombard’s Q2 Concall Transcript explains their crop/agri reinsurance strategy:

If you look at the reinsurance structure that we
put in, almost 75% of reinsurance is through a proportional treaty
and roughly about 25% that we retain is our net. There is a stop
loss protection that we buy which triggers when the loss ratio
crosses a certain threshold.

Thus, GIC sells both proportional treaty and non proportional(stoploss) reinsurance policies to all insurance companies in India. This has the potential to be a highly lucrative and high growth segment though they will need to maintain discipline when underwriting

(Gaurav Agarwal) #9

After reading rhp, my understanding is insurance companies in India have ceded 77% of their risk to reinsurers like GIC and what GIC has re-insured is not mentioned in rhp.

Some more details how PMFBY works from RHP

According to this a part of premium has to be collected from Central and State Govt. Where will any delay in premium payment by Govt. reflect?

(Gaurav Agarwal) #10

My calculation for book value

book value

	share capital = 430
	reserves = 18844
	shareholders fund = 8235 (fair value change account)
		total = 27,509

no of shares

q2fy18 = 87.72

book value/share

q2fy18 = 313.6


770/313.6 = 2.5

(Anirudh72) #11

This would be receivable for insurance cos and not for GIC in my view

(Anirudh72) #12

We would need to include fair value change in policyholders fund also to calculate book value

(Gaurav Agarwal) #13

I do not think insurance company will pay to re-insurance company, if Govt. do not pay up?

Does the mark-to-market gains on investment of policyholders fund accrue to Shareholders?

On a separate note you can use quotes to reply on multiple issues in same message. Thanks

(sambandham82) #14

Which valuation metric is better for insurance company ? P/E or P/B?

Because P/E of 19 (FY19E EPS) also looks reasonable for a company that is expected to grow its EPS by at least 10%.

(Anirudh72) #15

As quoted in ICICI Lombard’s DRHP:

We obtain a major portion of our crop/weather reinsurance from General Insurance
Corporation of India (“GIC Re”), which is generally unavailable at suitable prices from other reinsurers. In
addition to the traditional risks with reinsurance, we face an increased amount of credit risk due to the
concentration of our reinsurance with one entity. Further, certain PMFBY tenders are for tenures longer than
one year. In such cases, we run the risk of having to agree to insure the crops without having reinsurance
guaranteed for future years.

My understanding is that more than 90% of crop reinsurance in India is provided by GIC

(Anirudh72) #16

In FY17 gross premium was Rs 33704 crores whereas receivables from insurance cos were Rs 867 crores-thus not material.Not sure about how the exact dynamics of payment works but the figures seem to suggest that there is not material amount of amount receivable by GIC

Yes,that is my understanding

(Anirudh72) #17

Not sure if P/E is an appropriate measure earnings would vary quite significantly dependent on claims that come up in a particular year.For example,in a year where there is a severe drought,earnings would fall a lot but wouldn’t represent sustainable earnings power of the company.
Also,EPS growth in FY18 to be much higher than 10% in my view(My guess would be PAT of atleast Rs 4000 crores in FY18 vs 3100 crores in FY17 unless some really unexpected claim comes up)

P/B is a much more appropriate measure to value any financial institution such as banks,NBFC’s and insurance/reinsurance companies since it reflects values of assets and liabilities(including fair value changes in the case of insurance & reinsurance cos) giving a more complete picture of the business in my view.Hence,feel that GIC at just 1.35x book value is very cheap as compared to other insurers.

Just for comparison,valuations of global reinsurers such as Swiss Re and Munich Re are around 0.9-1x P/B.
In my view,GIC should trade at atleast double these valuations considering that investment yields are way higher in India(12%+) vs only 4-5% in US and Europe, the massive growth opportunity in India (gross premiums for GIC have grown at CAGR of 45% between FY15 and FY17,doing even better to grow at 51% in H1FY18-that too on a high base). The recently announced Lloyd’s tie up (GIC-LLoyds Press Release.pdf (2.3 MB)
will help GIC to grow even faster and give it access to more diverse international risks and help reduce combined ratio further(I am given to understand that LLoyd’s combined ratio is in the range of 90%)
ROE’s for GIC exceed 18-19% whereas they are around 10-14% for the global reinsurers thus warranting a premium valuation
This is why I am comfortable buying GIC at these valuations. Stocks like these are usually ignored in the midst of a raging bull market when every person is busy hunting for the supposed multibaggers in the mid and small cap space

(sambandham82) #18

imageYear "Gross
Premium " "Earned
Premium " "Incurred
Claims " "Net
Commission " PBT PAT "Total
Assets " "Dividend
(%) " "Combined
2001-02 3282 2438 2295 636 357 307 10379 20 121.2
2002-03 4515 3186 2744 909 343 261 11695 22 115.6
2003-04 4641 3992 2895 1072 1277 1038 16441 30 100.2
2004-05 5122 4374 3703 1207 800 200 19552 30 113.2
2005-06 4881 4459 4573 1103 443 599 26424 20 128.3
2006-07 7404 5264 3623 1670 1789 1531 28524 72 101.4
2007-08 9316 7229 6011 2090 1067 993 36013 46 112.8
2008-09 8061 7806 6217 1749 1812 1407 30020 65 102.8
2009-10 9737 8076 6856 1930 1290 1775 43842 82 109.7
2010-11 11681 9544 8626 1926 1189 1033 49729 48 111.4
2011-12 13618 11316 14128 2282 -2490.67 (-)2468.75 53731 0 142.7
2012-13 15086 13322 10942 2906 2382 2345 59940 109 106.5
2013-14 14680 13609 12107 2449 2303 2253 66992 104.5 110.3
2014-15 15183 13558 11891 2784 2827 2693 78093 125.61 109
2015-16 18435 15172 12900 3490 2956 2848 79732 200 107.4
2016-17 33585 26714 21646 5404 3624 3127 94949 233 99.7

(sambandham82) #19

Though PAT is not linear historically, it has been consistent in the past 5 years. I am unable to open FY2012 annual report. why there is loss of 2368 Cr in this year? In FY13’s previous year column, it is mentioned that all sectors (Fire, marine & miscilleneous insurance) incurred loss.

Can an insurance company be valued on the basis of premium (like Price/Sales in other sector). If so, what is the appropraite multiple?

(Jaclyn) #20

If GIC is a unique play, why was then it got subscribed by just 1.37 times in its IPO? More than 50% of the QIB was grabbed by LIC indicating most of the big funds have avoided.

It is not a small cap company. If the institutional investors could not see value in a large cap and have avoided it what does that mean?

Some questions for people to ponder over on this so called opportunity.