How to IPO LIC?

 

The Story

The Union Budget of 2020–21 had a little surprise. The government finally announced its intention to partially sell off Life Insurance Corporation of India (LIC). And rumour has it that they’ve kicked off the whole process by hiring two pre-IPO transaction advisors already. So let’s talk about this mega IPO, shall we?

LIC is India’s largest financial institution. It manages close to ₹31 trillion in assets (out of India’s ₹40 trillion insurance industry). It sells 3 out of 4 life insurance policies sold in the country. It’s much bigger than the 23 private sector life insurance companies put together. And it is a profitable entity which has consistently delivered value to its only shareholder — the government of India.

However, when you try to go public and extract top value out of the IPO, you have to focus on other investors who might want to take part in the stake sale. Meaning you have to focus on maximising value for all parties and therein lies the first problem.

Every year, LIC generates a profit and does a little redistribution exercise. It ploughs back roughly 95% of the surplus back to policyholders and the remaining 5% to the government. This is great for LIC customers. They get the expected payout from their insurance plan and a lion’s share of the company’s profit pool. However private investors won’t be enthused with this scheme all that much. Imagine owning a part of LIC and being entitled to only 5% of the total surplus. That doesn’t bode well for you. So you need to switch it up.

Perhaps you could take a cue from private insurance companies. Those people have devised a neat little strategy to entice both policyholders and shareholders. Here's how this works. Insurance companies usually have two kinds of policies.

1. Participating policies — Where customers are entitled to a part of company profits in addition to other policy benefits.
2. Non-participating policies — Where customers get a fixed payout irrespective of the company's performance.

So in effect, they get to operate two funds. A PAR-fund, where they transfer a bulk of the profits to policyholders. And a non-PAR fund, where the entire surplus is transferred to shareholders. This way shareholders get to make more money. But LIC just has one common fund and 95% of the profits from the fund are redirected back to eligible policyholders as dividends, bonus etc. Shareholders get a pittance. So if LIC wants to get investors excited, they have to borrow some of these ideas from private companies.

However, you can’t push it too far.

Right now, LIC can offer a higher bonus on its policies because it has a structure that prioritizes the interests of policyholders above all else. If this structure is inverted, maybe LIC policies won’t be as attractive anymore. And if business prospects take a hit, shareholders won’t make a lot of money either way. So there’s a tradeoff here and you have to be very careful while you rejig the structure.

But you can’t do all of this unless you amend certain provisions of the LIC Act, 1956. Meaning the IPO is unlikely to get the green signal before parliament can come through.

But will this fundamentally alter the valuation LIC will be able to command in the market?

We can’t say for sure. Right now most insurance companies are valued based on this esoteric metric called the “Embedded value”. It takes into account all future profits you could make from the millions of active policies you’ve disbursed so far and it’s supposed to be a representation of the existing value that it adds to shareholders. But any amendments to the structure of LIC won’t change the outlook of future profits from policies you've disbursed already. The shareholders will only be entitled to the 5% surplus they were originally promised. It’s quite possible that future policies will focus on maximising shareholder value after the new amendments kick in. But right now, the company's embedded value won’t exactly blow your mind.

And the final problem — The government itself.

Even after the 10% disinvestment, the government will still own 90% of the company. So technically, LIC will continue to be a government-owned entity. Meaning it might continue to champion the cause of the people — in the name of national interest of course. Maybe LIC will continue to bail out companies. Maybe it will continue making investments that aren’t necessarily prudent. Maybe the government will still wield considerable influence and prioritize its own interest, which by the way doesn’t always align with the interests of other shareholders. So despite being the biggest, baddest insurance company in India, the company still has a few problems.

…

But you know what? It’s still LIC. It’ll probably be a blockbuster issue anyway.

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