ICICI Lombard - Quality franchise in under penetrated industry

[vivek_mashrani]

About the company:

• ICICI Lombard is one of the largest general insurance company in India based on Gross Direct Premium Income in FY19. It was founded as a JV between ICICI Bank and Fairfax Financial Holdings in 2000.

• For fiscal 2019, ICICI Lombard issued 26.5 million (on GDPI basis) policies, translating into a market share of 8.5% among all non-life insurers in India and 15.6% among private-sector non-life insurers in India.

• Key distribution channels are direct sales, individual agents, corporate agents - banks, other corporate agents, MISPs, brokers and digital, through which they service their individual, corporate and government customers.

• The company offers a comprehensive and well diversified range of products, including motor (50% of total mix), health, travel & personal accident (25%), fire (12%), marine (3%) and others, through multiple distribution channels. All figures as of 9M 2020 (please see figure below).

Source: Company presentation

Key Financials:

Source: Investor Presentation

Business Model:
Typically how general insurance companies work >> They have short tail i.e. short duration of policies unlike life insurance (where you have term insurance policies even more than 10-15 years). General insurance policies on the other hand are on an average of 1-2 years.

Key metric to track is (a) Combined Ratio (b) Investment Yield

Combined Ratio = Expense Ratio + Loss Ratio
where, expense ratio gives operating expenses as a % of earned premiums
and, Loss ratio gives claims expenses as % of earned premiums

On the top of this insurance company keeps these funds into short term investments, mainly debt securities (typically matching their liabilities). Any money earned on this is an additional income. So, as far as company can operate below combined ratio of 100% they can enjoy this additional income and price their premiums attractively.

Now coming to ICICI Lombard metrics:

Since last few years they have been easily able to maintain combined ratio below 100%. There was spike in between as they incurred heavy losses in crop insurance (and now if you see product mix in 1st figure, they have significantly reduced exposure to crop insurance).

Source: Investor Presentation (observe spike in crop insurance loss ratios during FY2018)

Coming to investment returns, they typically leverage debt portfolio to gain substantial returns (which pretty much boosts their RoE).

Source: Investor Presentation

• If you multiple realised return with leverage figures, you will get pretty close to RoE figures. So, typically higher interest rate environment without much changes in rates is favourable for higher investment return,(you can say in that sense we are around bottom of cycle).

Below is the RoE trend reflecting the same:

Source: Company presentation

Investment Rationale:
Long runway - Some of the products like motor insurance is now compulsory by law. Increased awareness + triggers on corporate travel as well as rail insurance are helping the industry. The penetration levels of general insurance are still very low compared to matured markets.

Source: Investor Presentation
Brand Name - ICICI is a strong brand name in India and it will help the company grow its business and give more bargaining power with distributors
**Distribution network:**Over the years, ICICI Lombard has grown its multi-channel distribution, including strong digital presence as well as penetration to Tier 3 and Tier 4 towns. Over the years, if digital and direct policies increases, it will boost their profitability and/or increase pricing competitiveness due to lowering of expense ratio.
Better understanding of Indian demographics - One needs good understanding of customer base and deep underwriting capabilities. ICICI Lombard has both due to it’s Indian partner + underwriting expertise from world class insurance partner.
Diverse customer base: This multi-channel distribution network enables ICICI Lombard to offer its products to a diverse set of customers, including large and mid-sized corporates, small and medium-sized enterprises, central and state governments, and individuals. Over the years, it has moved from a largely corporate focussed business model to a more diversified mix of business.
Scarcity Premium - ICCI Lombard is one of the few General insurance companies listed in India. This way it garners scarcity premium

Key Risks

• Big catastrophic risk can prove difficult in terms of higher claim outgo. We have seen this playing out almost every year. Underwriting and reinsurance capability is very critical in such cases. Good diversification of portfolio across geographies and product lines also helps in such cases.

Source: Company presentation

• Weakness in solvency ratio or increase in regulatory requirement: This would require further dilution or capital raising. As per current norms, solvency ratios are quite good.

Source: HDFC Research report (link provided in references)

• Threat from competition and aggressive pricing: Many single product insurers might have better underwriting capabilities in their product area and could provide better pricing. Also, in highly competitive scenario, premiums can go really competitive and insurers tend to price premiums abnormally low and sacrifice part of their investment income. This can lead to lower RoE and reduced profitability. Also, any regulatory changes that allows life insurance players to come into general insurance can lead to increased competition in future.

• Assumptions of underlying reserve requirements: Loss reserves are based on estimates as to future claims liabilities and if they prove inadequate, it could lead to further reserve additions and materially adversely affect the results of operations

• Distribution partners: Significant portion of sales is derived from sales to the customers of agents/intermediaries affiliated with motor vehicle manufacturers (“MVMs”) and from channel partners like ICICI Bank. Any material impact in such partnership and significantly reduce competitiveness of ICICI Lombard

• Regulatory changes: Any unfavourable regulations around it’s key products can deteriorate its competitiveness

• Market and interest rate risks: Investment portfolio and hence premium pricing could be affected in case of adverse market and interest rate movements

• Concentration Risks: ICICI Lombard has historically derived and continue to derive a certain portion of its corporate premium from a limited number of large clients. It expects that a certain portion of its corporate premium will continue to be derived from a limited number of clients in the future. If there is any disruption here, it can reduce number of renewals and hence profitability

• Disruption from direct players, startups and digital-only players: Business has risk from new players and startups coming into digital-channel and willing to price competitive rates of premium can disrupt the various segments and product lines

Valuation: ICICI Lombard currently trades at ~6x P/B and ~33 PE on trailing basis.

References:
http://content.icicidirect.com/mailimages/IDirect_ICICILombard_MgmtNote.pdf

ICICI%20Lombard%20General%20Insurance%20Company%20Limited%20IPO%20Note-201709131127316197229.pdf

ICICI%20Lombard%20-%203QFY20%20-%20HDFC%20sec-202001190905297343521.pdf

fy2019.pdf

Disclaimer: Tracking. This is not a buy/sell recommendation. Please do your own due diligence and consult your financial advisor.

[Chandragupta]

Thank you @vivek_mashrani for starting this thread! Insurance financials are very different, and we are not familiar with it. I just started learning about them recently! Please share your views on the below point:

I noticed that the entire focus is of the company presentation is on GDPI, but the real metric that should be tracked is NEP (Net Earned Premium). GDPI is the gross premium earned, but you can re-insure the policy, cede some premium and reduce the risk. NEP is the premium earned on the risk you are bearing, and hence the real indicator of your underwriting efficiency.

For ICICI Lombard, the picture looked like this:

Thus, ICICI Lombard is primarily a Motor and Health insurance company which in 2019 comprised 78% of the total NEP. This share must have gone up even further this year I guess since they have stopped crop insurance which was no. 3 last year with another 7%.

From NEP, we should deduct Claims, to see what the result of the pure underwriting operation is:

This is the figure (Rs.20.67 billion) that should be tracked rather than the GDPI. From this, if we deduct Agent’s Commission, we get the profitability of the core Insurance operation.

I was surprised to see so much emphasis on GDPI and almost nothing on NEP. It is easy for someone to boost GDPI when they are going to anyway re-insure a large part of the risk.

Is my understanding correct? Your views please!

(Disc: Have a tracking position)

[vivek_mashrani]

You are right. This is more to give idea about ranking in Industry where Gross is generally norm and product portfolio perspective.

If you think about it, although currently they reinsure niche product lines, once they reach certain scale they can take more underwriting risk as they do in motor.

For shareholders, as I mentioned, only two parameters are key - combined ratio and investment yield on levered basis. This will broadly form basis for RoE and price you pay.

[vivek_mashrani]

That’s true. You mentioned important point on expense ratio. This is where private players have an edge as they can do lot of advancement in digital channels and compete with less efficient public sector players. This again is a risk from digital-only startups entering the space. Even premium calculation and claim settlement is being done faster by such players.

[gordon_gekko]

Can I ask a simple question. How many of you people have insurance from ICICI Lombard. Did you buy this because of your relationship with your bank or you chose by comparing existing products?
Personally I chose cheaper products in the market for auto insurance like acko. Before this I had from kotak, bajaj alianz. Even kotak’s premium is lower than that of Icici’s. Claim process was also very smooth. Now for acko Im paying much much lower. I don’t understand why people buy insurance from Lombard. Given that the company revenue share is skewed towards auto insurance, is this not a significant risk?

[vivek_mashrani]

You are right and it’s mentioned in key risks. However, if player like ICICI Lombard has such scale, what stops them to make robust digital platform (which they already have been doing to an extent and improvising) and provide low direct premium to customers coming through online channel? Plus insurance is about trust and strong brand which takes time to build.

[zygo23554]

This will be a series of posts.

Part I - Market Landscape, Key Industry Concepts & Definitions

Market Landscape

Key Trends which I think are important to note -

• Public sector insurers losing market share to Private Insurers
• Segments with a retail centric customer base are the most value accretive segments, higher retention ratios seen in these segments
• PSU’s competing on price in the Govt and bulk segments, volume driven by not necessarily value accretive
• Large Corporate segment continues to be price sensitive, buyer’s market
• Underwriting profits are non-existent at the industry level as of date
• IRDA spends higher monitoring time on retail segments that are not discretionary (Motor)
• IRDA starting to clamp down on selling malpractices – bring in MISP act to discipline dealers and to cap commissions, making motor TP mandatory for new vehicles
• GIC Re continues to be the leading reinsurer who sets the prices for most asset policies which in turn is based off pricing prevalent in global markets
• IRDA broadening the agent/broker footprint and streamlining the approval process for new distributors (on the line of what SEBI is doing in the investments segment)

General Insurance - Key Concepts?

How does accounting work?

• Premium is collected in advance; it works on cash before cover model. Hence premium income is recognized in accrual method over period of time, balance tracked as advance premium in balance sheet
• Commission adjustment follows premium revenue recognition methodology
• Acquisition expenses (distribution expenses under Opex) however are not deferred but captured as and when they occur
• Bond Portfolio in Investment Book is HTM and not MTM. Hence duration risk inherent is taken off books until the sale is made, hence higher interest rates work well. Equity and other investments are subject to MTM and to capital gains as per existing tax laws

What are key things to track?

• What proportion of the GDPI is retained and how much is passed onto the reinsurer? Reinsured proportion is different for various segments – Fire at 85%, Marine at 55%, Motor at 10%, Health at 25%. Intuitively the segments with the largest tail risks are reinsured away while those with granular risks that can be estimated and controlled are retained
• Claims to Net Premium – this is known as Loss Ratio. This indicates whether the business/segment is profitable at an underwriting level before commission and Opex
• Combined Ratio – (Claims + Opex+ adjustments for commission)/NWP. This indicates whether the business/segment is making money before considering investment income
• Investment Book and Investment Yield – self explanatory

Insights

• A general insurer can make annual profits by running the business at Nil underwriting profit and purely through Investment Income. Investment Book to Net Worth is a key ratio to track and can provide a significant moat beyond a threshold scale. Example – Assume Book is 300 while net worth is 100, at an investment yield of 8%, the ROE becomes 20%+
• A higher ROE thus gives the business a lot of ability to either (both being discretionary) –
  1) Invest into growth through better distribution/terms to channel
  2) Keep competition at bay through better pricing terms to customers
• Contrary to the initial assessment, underwriting profits work counterintuitively in the industry. Underwriting profits are desirable but not necessary for a business beyond a threshold scale on the Investment Book relative to net worth
• Tail risk in asset segments like Fire & Marine can be reinsured away at a price, thus keeping risk much lower than what appears at first glance. Better the granularity of the book, lower is the risk in the overall business
• From 2016 onward, Opex of Private Insurers has been outpacing Public Insurers by a significant amount. This indicates that Private Insurers are investing into distribution/channel and taking market share away from Public Insurers at an alarming pace, especially in Motor Insurance which is a value accretive segment

[zygo23554]

Part II - Specifics of the Business Segments & Numbers

Fire (Cr)	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
GWP			308	380	487	545	633	745	916	1,085
YoY Growth (%)				23%	28%	12%	16%	18%	23%	18%
Adj for Re	-	-	178	237	332	432	527	604	759	894
Net Premium			130	143	155	113	106	141	157	191
Adj for reserves			16	5	1	4	6	17	14	33
Net Premium Earned			115	136	153	109	99	123	144	158
Net Premium/GWP			42%	38%	32%	21%	17%	19%	17%	18%

Marine (Cr)	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
GWP			199	229	252	246	300	341	366	444
YoY Growth (%)				15%	10%	-2%	22%	14%	7%	21%
Adj for Re	-	-	140	112	95	89	113	155	162	198
Net Premium			59	117	157	157	187	186	204	246
Adj for reserves			5	29	1	-3	2	-7	8	9
Net Premium Earned			54	88	157	160	185	192	196	236
Net Premium/GWP			30%	51%	62%	64%	62%	55%	56%	55%

Motor	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
GWP			2,139	2,706	3,214	3,416	4,150	4,542	5,250	6,423
YoY Growth (%)				27%	19%	6%	21%	9%	16%	22%
Adj for Re	-	-	-125	681	769	798	736	776	580	667
Net Premium			2,264	2,025	2,445	2,618	3,414	3,766	4,670	5,756
Adj for reserves			362	-117	150	121	454	226	527	720
Net Premium Earned			1,901	2,141	2,295	2,497	2,959	3,540	4,142	5,035
Net Premium/GWP			106%	75%	76%	77%	82%	83%	89%	90%

Health + PA	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
GWP			1,575	1,762	1,684	1,551	1,663	2,027	2,302	2,796
YoY Growth (%)				12%	-4%	-8%	7%	22%	14%	21%
Adj for Re	-	-	245	380	504	429	481	555	673	670
Net Premium			1,330	1,382	1,180	1,122	1,182	1,472	1,629	2,126
Adj for reserves			167	182	-112	61	105	136	280	300
Net Premium Earned			1,163	1,199	1,247	1,061	1,075	1,335	1,348	1,826
Net Premium/GWP			84%	78%	70%	72%	71%	73%	71%	76%

What does one notice here?

• Each business segment has a different % of the GWP that gets reinsured. The Net Premium/GWP essentially tells you where the tail risks are
• One can see the distinction between the B2C segment (health & motor) and the B2B segments (Fire, Marine). The retention ratio is much higher for the B2C book since the risk is granular and gets spread across a very high number of customers
• In the B2B segments, the company works as a sales engine with a minor part of the risk being retained on the books while majority is reinsured away. Now it is important to note that reinsurance premium is determined by the Indian and Global reinsurers, there is no great advantage that any company has over competition unless the volumes are comparably very high where a bulk discount can be taken. Even with Re, there are ways and means of placing business, one can either cut a blanket deal where Re says we buy 80% of what your underwrite, or one places specific blocks of deals.
• While crop numbers aren’t included above, the retention rate was 23-25% which means 75% of the GWP was being reinsured away

Overall one can make the inference that a big part of the tail risks are being reinsured away. In scenarios like a massive earthquake, floods etc the bulk of the claims are paid out by the Re and not ICICI Lombard.

Next will be to see how underwriting profits and operating expenses are spread across these lines of business.

Fire (INR Cr)	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
Premium Earned - Net	90	113	115	139	154	109	100	124	144	158
P/L on sales of investments	5	3	1	1	3	5	8	8	7	7
Others
FX	0	-1	2	-1	0	0	0	0	0	-3
Investment Income from Pool	7	13	1	12	15	18	21	21	23	20
Misc Income	0	0	0	0	0		0	0	0	0
Interest, Dividend & Rent	5	5	7	10	14	18	20	18	18	21
Total Income (A)	107	133	125	161	185	150	148	170	192	203
Claims Incurred (net)	66	112	91	97	103	102	63	85	62	131
Commission (net)	-11	2	6	4	-10	-29	-49	-50	-48	-26
Opex	47	46	52	64	44	38	22	35	46	41
Premium Deficiency	0	0	0	0	0	0	0	0	0	0
Total (B)	102	160	149	164	137	111	36	71	59	147
Operating P/L (A- B)	5	-27	-24	-4	49	39	111	100	133	57
Opex to Net Premium	52%	41%	46%	46%	28%	35%	22%	29%	32%	26%
Claims to Net Premium	73%	99%	79%	70%	67%	94%	64%	68%	43%	83%

Marine (INR Cr)	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
Premium Earned - Net	32	42	54	88	157	160	185	192	196	237
P/L on sales of investments	3	1	1	1	2	4	7	7	6	5
Others
FX	0	-1	0	0	0	0	-1	0	0	1
Investment Income from Pool	0	0	0	0	0	0	0	0	0	0
Misc Income	0	0	0	0	0	0	0	0	0	0
Interest, Dividend & Rent	3	3	4	7	11	13	16	16	14	16
Total Income (A)	39	45	58	96	169	177	207	215	216	259
Claims Incurred (net)	27	47	52	74	153	158	180	161	106	199
Commission (net)	-8	-8	-6	6	16	10	21	18	25	32
Opex	25	27	34	38	42	49	39	45	38	64
Premium Deficiency	-10	2	0	-2	0	0	0	0	0	0
Total (B)	34	67	79	116	211	217	240	225	169	295
Operating P/L (A- B)	5	-22	-21	-21	-42	-40	-34	-10	47	-36
Opex to Net Premium	76%	63%	63%	43%	27%	30%	21%	24%	20%	27%
Claims to Net Premium	83%	111%	96%	84%	97%	99%	98%	84%	54%	84%

All Other Lines (INR Cr)	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
Premium Earned - Net	2,071	2,701	3,381	3,783	4,043	3,966	4,538	5,848	6,573	7,981
P/L on sales of investments	131	87	43	55	117	166	256	284	316	307
Others
FX	1	-0	0	0	2	-1	-1	-7	-2	9
Investment Income from Pool	47	52	85	2	3	4	4	4	5	9
Misc Income	-	-	-	-	-	-	18	27	2	4
Interest, Dividend & Rent	135	159	253	390	513	557	623	668	765	980
Total Income (A)	2,384	2,999	3,762	4,230	4,677	4,693	5,437	6,824	7,658	9,290
Claims Incurred (net)	1,856	2,571	3,459	3,209	3,364	3,183	3,685	4,708	5,146	5,978
Commission (net)	40	-48	-61	-192	-236	-355	-300	-403	-261	217
Opex	484	607	787	916	1,129	1,300	1,650	1,901	2,028	1,884
Premium Deficiency	-	-	-	-	-	-	-	-	-	-
Total (B)	2,380	3,130	4,184	3,933	4,257	4,127	5,035	6,207	6,914	8,079
Operating P/L (A- B)	5	-131	-422	297	421	566	402	617	744	1,211
Opex to Net Premium	23%	22%	23%	24%	28%	33%	36%	33%	31%	24%
Op P/L to Net Premium				8%	10%	14%	9%	11%	11%	15%
Claims to Net Premium	90%	95%	102%	85%	83%	80%	81%	81%	78%	75%

The tables above are self explanatory. See the Operating P/L item across the business segments, one can clearly see where the company is making money and how. Point to note is that the investment income is tracked and reported separately for each business segment

Loss Ratio = Claims to Net Premium
Opex Ratio = Operating Expenses to Net Premium

Both these put together gives us the Combined Ratio, just note that this ratio has Net Written Premium in the denominator while the other two have Net Earned Premium in the denominator

To now summarize -

[zygo23554]

Part III - Understanding the Operating Expenses

Fire (Cr)	2016	2017	2018	2019		Marine	2016	2017	2018	2019
Employee Benefits	9.14	14.5	21.47	13.92		Employee Benefits	15.85	18.67	17.09	37.16
Travel & Conveyance	0.94	1.34	2.37	1.29		Travel & Conveyance	1.46	1.49	1.46	4.17
Training	0.09	0.15	0.24	0.22		Training	0.18	0.25	0.19	0.39
Rents, Rates & Taxes	1.17	1.68	2.04	1.41		Rents, Rates & Taxes	2.02	2.1	2.48	1.89
Repairs & Maintenance	0.73	1.04	1.33	1.28		Repairs & Maintenance	0.95	1.11	1.15	1.13
Printing etc	0.16	0.16	0.18	0.22		Printing etc	0.25	0.18	0.22	0.25
Communication	0.63	0.82	1.13	0.79		Communication	1.07	1.02	0.83	0.88
Legal & Prof charges	1.04	1.32	2.14	4.5		Legal & Prof charges	1.73	1.79	2.32	3.84
Auditor Fees	0.03	0.03	0.04	0.04		Auditor Fees	0.05	0.05	0.05	0.05
Advert & Publicity	0.8	1.35	2.52	1.92		Advert & Publicity	1.47	1.77	1.63	1.27
Interest & Bank Charges	0.12	0.23	0.12	0.24		Interest & Bank Charges	0.22	0.3	0.14	0.24
Others						Others
Business Support	3.91	7.48	1.68	0.32		Business Support	7.38	9.75	2.37	0.35
Sales Promotion	2.33	3.77	8.2	13.5		Sales Promotion	4.28	4.94	5.8	10.39
Misc	0.13	0.43	1.06	0.29		Misc	0.22	0.58	1.22	0.44
Depreciation	1.06	1.12	1.07	1.21		Depreciation	1.86	1.47	1.3	1.83

Motor - Opex (Cr)	2012	2013	2014	2015	2016	2017	2018	2019				Health + PA (Cr)	2012	2013	2014	2015	2016	2017	2018	2019
Employee Benefits	107.56	132.35	170.76	190.15	203.34	245.16	207.5	260.31				Employee Benefits	79.18	86.2	82.42	81.45	83.55	103.24	162.52	194.13
Travel & Conveyance	11.3	13.6	18.83	20.33	13.88	13.49	14.74	21.3				Travel & Conveyance	8.31	8.86	9.09	8.71	7.67	8.1	13.75	14.52
Training	1.47	1.51	1.87	2.77	2.71	3.73	3.1	4.8				Training	1.08	0.99	0.89	1.19	0.94	1.41	1.55	2.7
Rents, Rates & Taxes	15.3	20.8	32.9	33.04	41.5	46.24	59.33	45.12				Rents, Rates & Taxes	11.25	13.54	15.64	14.14	12.96	24.12	22.05	18.4
Repairs & Maintenance	9.16	10.24	14.04	18.78	18.18	20.61	31.34	29.75				Repairs & Maintenance	6.74	6.67	6.77	8.05	6.61	9.05	16.24	15.65
Printing etc	2.4	2.61	4.21	6.11	5.26	4.71	6.27	6.33				Printing etc	1.77	1.7	2.02	2.6	2.33	2.43	2.64	3.62
Communication	13.33	13.47	17.89	25.36	27.32	24.28	21.48	16.03				Communication	9.82	8.77	8.64	10.85	6.79	7.64	18.02	15.83
Legal & Prof charges	34	27.58	32.46	41.11	29.47	38.94	52.38	57.79				Legal & Prof charges	25.03	17.95	15.67	17.62	15.52	19.63	23.55	34.44
Auditor Fees	0.26	0.38	0.48	0.57	0.95	0.9	1.07	1.23				Auditor Fees	0.15	0.19	0.23	0.24	0.36	0.36	0.37	0.45
Advert & Publicity	24.32	25.4	48.02	56.35	82.32	77.49	87.86	124.37				Advert & Publicity	17.9	16.54	23.17	24.14	18.09	19.88	46.38	36.48
Interest & Bank Charges	3	3.5	4.74	7.38	10.69	10.89	13	19.16				Interest & Bank Charges	2.22	2.27	2.29	3.16	2.42	2.98	3.97	6.62
Others												Others
Business Support					483.16	526.67	547.64	6.97				Business Support					99.42	125.91	19.33	3.5
Sales Promotion	19.22	39	68.52	114.27	212.74	211.72	185.17	410.56				Sales Promotion	75.6	89.2	102.27	114.2	47.75	55.83	122.15	206.11
Misc	102.54	137.68	211.73	266.48	0.13	-0.67	5.44	1.26				Misc	14.16	25.4	33.07	48.97	2.63	2.98	2.95	2.66
Depreciation	18.52	21.52	9.86	14.9	35.91	30.72	29.95	35.58				Depreciation	13.63	14.01	13.04	13.59	12.12	12	10.83	13.64

What stands out here?
Note the expenses on these innocuous looking line items under Motor and Health - Business Promotion, Sales Promotion & Miscellaneous Expenses. Over and above the commission paid to the channel, what are these?

There appears to be no consistency in tracking these expenses across players in the market, you can see the same trend in HDFC Ergo and Bajaj Alliance General books. Notice the very wide range below

Opex	HDFC Ergo	Bajaj Allianz
Adverts	240	75
Business Promotion		92
Marketing & Support		405
Legal & Professional	243	16
Misc Expenses	16	71
Training	64	0.1

Let me call the sum of these expenses - Discretionary Expenses. Summing these up for Motor and Health lines and comparing with the commission paid…

Motor	2016	2017	2018	2019		Health + PA	2016	2017	2018	2019
Commission - Gross	119	165	358	681		Commission - Gross	142	164	203	243
% of GWP	3%	4%	7%	10%		% of GWP	6%	8%	8%	9%
Business Support	483	527	548	7		Business Support	99	126	19	4
Sales Promotion	213	212	185	411		Sales Promotion	48	56	122	206
Misc	0	-1	5	1		Misc	3	3	3	3
Discretionary Total	696	738	738	419		Discretionary Total	150	185	144	212

Notice the sudden spike in commission paid for Motor in 2019 after IRDA put out a note that commissions paid to dealers are capped and that there cannot be too much creativity in incentivising the dealers. Of course there are some investments being made into building virtual offices for their motor insurance agents but the numbers are much higher in my assessment. Come to your own conclusions on what this spending is - my sense is these are channel friendly incentives given the amount of divergence we are seeing in capturing these expenses across industry players.

Do note the extent of discretionary spends compared to the annual PAT, for FY19 it was a sum of 631 Cr for motor + Health while the annual PAT was 1049 Cr.

The right way of seeing this is that the company can run the business at a much higher PAT but is instead choosing to invest into building the channel and capturing market share rather than sit on a high PAT. This is what they are doing right now, once they optimize on channel building they may instead choose to incentivise customers through reduced premium to keep sales growing? That is what a smart management would do to ensure business grows at 15%+ over the next 10-15 years.

Summary

Now let us observe the investment book - approx 25,000 Cr as of Dec 2019. Assuming this gets deployed at a gross yield of 7%, investment yield pre tax will be in the range of 1750 Cr.

Putting the math together, the company can run the business at 0 underwriting profit while making all the money from the investment yield and keep increasing PAT over the years.

ROE = PAT/Net Worth

Writing this as

ROE = ((Post Tax Investment yield)/Investment Book) * (Investment Book/Net Worth)
ROE = Post Tax Investment Yield % * Investment Ratio

Assume that the post tax investment yield is 4.5% on a conservative basis
As of now the Investment is 4x+

Which means ROE can be 18%+ even when company continues to run business at 0 underwriting profits and chooses to invest into building distribution channel and eventually reducing pricing to customers. This ROE can be 30% today if the company wants it to be but the medium term growth will start to suffer eventually.

Hence, 20% ROE at 15% growth over the next 10 years. Is it possible? Is so what valuation would one want to pay for this business? Come to your own conclusions…

All other aspects like risks, overall business etc are already covered in the thread. My intention was to slice and dice the financials in such a way (after understanding accounting) to draw some inferences that may not be available with a cursory look

Disclaimer: I am a SEBI registered IA, ICICI Lombard is part of the investment portfolio under advice by me for a set of customers. Transactions in the past 30 days, may buy more based on market conditions

[dj123]

Great initiative by Vivek and zygo. I have recently started reading about the insurance sector and I do find it interesting. The whole maths that even if the premium collected by the company goes into settling the claims , there can be substantial returns generated by the float. Also if the claim ratio is less than 100 % than it adds to the bottom line.
Can you please help me where can I read more about the same :-1 1. How are the premiums or insurance cover charges decided in the industry. Is there a trend which is visible for the same or it is based on the basis of competition.
2. What specifically is the role of irda and how can it affect the industry dynamics for good or bad.
3. Are there other moving parts which can be discussed and read about. General insurance is mostly economy linked and has there been a cyclical nature observed in this industry.
Regards
Divyansh
Disc : just reading to understand more

[Chandragupta]

What will the impact of COVID-19 be on the company and the insurance industry in general? All existing health policies cover COVID-19, but granular details like the amount of coverage, age profile of the insured and place of treatment (government hospitals are free) will determine how much losses the each company has to bear. On the positive side, road claims will fall dramatically, for so long as traffic situation does not normalize. There are also reports of corporate customers invoking “loss of profit” clauses in their insurance contracts. While the companies claim this is not covered, if matter goes into litigation, one never knows how the judges may decide. They may have a soft corner for the affected, which will be a big blow to the insurance companies. Besides this, there is the significant impact on the yield on assets held, especially the equity portfolio.

Beyond the immediate impact, demand for insurance will almost certainly rise in the long run. Premiums will go up as insurance companies factor in a higher probability of Black Swan events. Regulators may demand higher capital adequacies.

One thing is certain - insurance will now remain in focus for a long time to come.

[gurjota]

Company has launched a dedicated insurance cover for Corona Virus at Rs. 149 for sum insured of Rs. 25,000. Company will pay 100% of the opted Sum Insured as a lump sum in the event of first diagnosis itself.

Quick and innovative product offering - based on the existing count of cases and trajectory over past 10 days.

Press Release - https://www.icicilombard.com/docs/default-source/media-release/press-release---covid-19.pdf?sfvrsn=39fd6b8d_6

Disc: Invested

[tmjagtap27]

insurance-and-float2.pdf (1.7 MB)
This document explains the significance of float in general insurance companies

[vivek_mashrani]

Valid points. On the investments side, unlike life insurance companies, general insurance has much lower equity investments.

For ICICI Lombard, Investment portfolio mix for 9M2020 is:
Corporate bonds 50.3%,
G-Sec 31.1% and
Equity 11.0%

Though, corporate bonds weightage is high. And if situation worsens, and corporates quality deteriorates, they are likely to have some hit here. This is definitely a risk if situation worsens.

[zygo23554]

Most of the business clocked by a general insurance company is non-discretionary and does not get impacted by the current situation.

Asset Insurance (Fire & Marine) - No business will stop renewing their asset cover even if the plant is locked down for 6 months. One small fire can wipe out the entire gross block of the plant, the risk is just too high.

Motor Insurance - This is mandatory and once again not discretionary. No vehicle owner will take the risk of breaking the law and not buying OD insurance even if vehicle gets parked for 6 months. As for TP, this is now mandated at the time of buying the vehicle as a long term cover. Since new vehicle sales can more or less become zero for some months, this part of the business will surely get impacted

Health Insurance - If anything current situation stresses the importance of health cover rather than the other way around. One should expect more people signing up for health insurance over the next 2-3 years

As for industry dynamics

I like to see things in parallel with what SEBI has been doing in the investment management industry. Any regulator in India prioritizes consumers first and then market players. IRDA is pretty much aware that the mis selling component in insurance is as high as what is prevalent in MF if not higher. If you study the history of what IRDA has done, they have clamped down on commissions, started restricting incentives that can be paid out to the channel through means other than commission and streamlined the regulation process of intermediaries. See the Motor Insurance service provider act and how that has put a ceiling on how much commission can be paid out to dealers since they were having an inordinate amount of influence on the vehicle insurance procedure. Over a period of time, the ability of a new entrant to come in big and “buy market share” will only come down due to the transparency and higher regulations imposed.

As was the case with the AMC hypothesis, we will know in 2-3 years to which direction will the balance of power swing - Insurers or the channel. If the power balance does swing to the side of Insurers, imagine that amount of savings that can accrue to the Insurers due to reduced discretionary channel expenses (refer my post earlier in this thread for the numbers involved here)

Pricing

There are some segments where the Insurer just acts as a business sourcing agent for the reinsurers who determine the pricing. If 75% of the GWP is being reinsured, it is the Reinsurer who sets the pricing and not the Insurer.

For segments like Motor, IRDA does set the pricing to a good extent since these are compulsory by law. IRDA does not want to be in a situation where motor insurance is mandated but the pricing gets determined and dominated by a cartel of 3-4 players who end up making a lot of money. Once again see this as similar to AMC, while regulator will not tell exactly what has to be charged, they will ensure a healthy range so that end consumer interest is protected.

Health and Life Insurance - There are well defined models in place which will be used by all the players. For e.g, in life insurance you have the mortality tables that have been assessed and standardized using models, while the industry is still in the growth phase it is a sensible assumption to assume that pricing of most players will be clustered within a tight range. It is only after the maturity phase is reached that players will start competing more on price, initially the race will be run mostly on who can source business more easily and build scale in the process. This can be viewed both as an advantage and a disadvantage since pricing is now considered a big priority in the growth phase, will always take a back seat to building scale through better market coverage.

[Chandragupta]

It is too simplistic to make such generalisations.

HDFC Limited is not the cheapest home loan provider, nor is HDFC MF the lowest cost or best performing MF. My experience with HDFC Bank customer service is quite bad, I closed my demat account with them last year. I also have a poor opinion about Bajaj Finance, as the biggest spammer on earth (in this I see a reflection of management ethics). Yet, all these have not prevented them from business success or stock market success. I continue to use ICICI Direct since last many years even though I know there are cheaper alternatives. And LIC & PSU insurers continue to retain large market shares even though they may not be the most efficient. Same with PSU Banks - which hold 70% market share more than 25 years after private players were allowed.

People like us (financially savvy & discerning) are very few. The masses base their decision on different criteria. My general observation is that financial services are primarily a distribution business. The other important thing that matters is brand name & public confidence. These are the primary drivers of success. While evaluating a stock, experience of an individual customer or even employee opinion shouldn’t be attached much importance. What matters are the numbers.

[pramodblr]

It’s a group insurance (B2B2C) product.

[pramodblr]

general insurance products are commodity products… insurers have no pricing power…
people like you and me would go to the cheapest provider. Scale is very important. the market leader can spend a lot on advertising. for many lay people… brand recall is what drives to go to a particular insurer…

GEICO’s ad budget is much bigger than Progressive by virtue of being market leader. brand recall matters.

[pramodblr]

GDPI is not Gross premium earned. Its the premium received by selling its own insurance products. between GDPI and NEP, there is another layer called Gross Written Premiums = GDPI + reinsurance inward.

GWP = GDPI + premium inwards reinsurance contracts.

After ceding some business to reinsurance, GWP becomes NWP.

GWP > GDPI > NWP > NEP

Though GDPI is almost equal to GWP in an Indian context. GDPI gives me an idea how the insurer fared in the league tables, even though could have different reinsurance strategy.

[Chandragupta]

Yes. I have used the term ‘gross premium’ in a loose generic way (hence the small ‘g’ and ‘p’) and not in a strict technical sense.