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