In the past, there have been instances when some of the disinvestment issues were sold short even before the share sale opened, destabilizing the entire exercise. The short-sellers have usually been a mixed bunch: those unhappy with the sale price, securities firm denied a role in the sell-off process or investors unhappy with India valuations. Given the strategic importance of the LIC issue, the government may well have gamely taken all objections on board.
Some of the concerns are indeed valid. Valuations are fickle, never etched in stone. In his book ‘Lectures on Economic and Financial Sector Reforms in India’, former Reserve Bank of India governor Y. V. Reddy writes: “It must be recognized that financial markets trade in risks, which is very difficult to evaluate”. Mint reported on 13 April that keen to lure more investors to the IPO, the government may revise the cut-off price valuation of LIC downwards to around ₹11 trillion from its initial planned valuation of around ₹16 trillion. If it goes through with such a revision, will it be for this reason?
The LIC valuation exercise was completed towards the end of 2021 and the draft red herring prospectus, more than 600 pages long, was filed in the first half of February 2022. The world flipped in the second half, after Russian forces walked into Ukraine. But did the fundamental assumptions about LIC’s valuation change?
The first home truth is that LIC’s business share has been slowly shrinking, even though it is still India’s largest life insurance company. LIC’s total number of individual policies and group policies (in terms of lives insured) came down from 75 million during FY19 to 62.43 million during FY20, a drop of over 16%. The following year, FY21, it further dropped by another 15.84% to 52.54 million.
Looking at the overall trend, it does seem that even FY22 will be much of the same. Data is available only for the first two quarters (ending September 2021) and the total lives insured till then are 19.07 million, against 30.72 million for the same period in FY19, 19.76 million in FY20 and 16.46 million in FY21.
It is also pertinent to mention here that the estimates of Indian ‘embedded value’ for LIC, which will determine how the government and investment banks price the share sale, also merits a second look, given the shifting risk parameters. The ‘embedded value’, in short, is the sum of the present value of future profits plus the market value of net assets.
The department of investment and public asset management, in the ministry of finance, had appointed actuarial consultants, Milliman Advisors LLP to work out the business projections for the future and provide embedded value for LIC. What is really odd is how the present value of future profits jumps from ₹104,772 crore at March-end, 2021, to ₹546,992 crore by September 2021. This then sends the embedded value also spiralling—from ₹95,605 crore to ₹5,39,686 crore.
Milliman has an explanation for the jump in the embedded value. It can be traced to the LIC Act amendment implemented through the Finance Bill 2021 and endorsed by LIC’s board in January 2022. The amendment bifurcated what used to be a single policyholders’ fund into two separate funds with effect from September 2021.
The same decision then decided to apportion dividends and bonuses between these two funds, based on their function: a “participating fund” in which policyholders will have a 95% share of the valuation surplus (going down over the next 2-3 years to 90% and the balance rising to reward shareholders). Valuation surpluses from the other fund, called the non-participating fund–which includes assets backing statutory liabilities, provisions for solvency margin and non-participating global reserves–will be reserved entirely for rewarding shareholders.
According to Milliman, if this crucial bifurcation had not happened, the 31 September embedded value would have been only ₹1,24,767 crore, implying that the design and implementation of the bifurcation will eventually benefit shareholders more and perhaps not so much policyholders. Robin Hood in reverse, if you please!
On this crucial decision, and some other related issues, hang not only multiple concerns over valuation methodology but also some key governance concerns. Most global institutional investors today are absolutely prickly about governance issues. The bifurcation, even though amended by Parliament, is likely to affect the future performance of the corporation, including its ability to keep enrolling new policyholders, and thereby the stickiness of the embedded valuation number. It also creates an artificial hierarchy between policyholders and shareholders, thereby sowing seeds of future discord.
The other key governance concern is the way the government gifted itself 622.49 crore shares through two tranches of bonus issues, against free reserves outstanding on 31 March 2020, and the government’s share of surplus for FY20 and FY21. This has taken the government’s total ownership to 632.49 crore shares. The disinvestment is being accomplished through the sale of these shares.
Global institutional investors may eventually open their wallets for the LIC share sale, but it will likely be at a valuation that balances out the impact of the funds bifurcation on the corporation’s future growth and the current governance concerns.
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