LIC’s road to the IPO


How does the LIC make revenue? How is the Government planning to attract investors?

How does the LIC make revenue? How is the Government planning to attract investors?

The story so far: The Life Insurance Corporation of India (LIC) filed its draft red herring prospectus on Sunday to kick-start the initial public offering (IPO) process. The Government, which owns 100% of LIC, will be offloading 5% of its stake through the IPO. All the proceeds from the IPO, which is in the form of an offer for sale and is expected to total up to at least ₹ 60,000 crore, will go towards meeting the Government’s disinvestment target for FY22.

What does the LIC do?

LIC makes money by selling various kinds of life insurance products. The company collects premiums from customers promising to pay a certain amount as insurance cover in case of death, disability due to accident, etc. Then like any other insurance company, when LIC annually pays out less against individual claims than what it collects as premium from all its policyholders, it makes a profit.

The company also invests some of the premium it collects and other surplus money into stocks, government bonds and other investment products, returns from which add to its overall profits. LIC, which manages about ₹ 37 lakh crore in assets and underwrites three out of every four life insurance policies in the country, reported a net profit of ₹ 1,437 crore in the first half of FY22.

LIC also redistributes most of its profits back to policyholders in the form of bonuses. In fact, LIC currently pays out just 5% of its profits to the sole shareholder – the Government. The remaining 95% of the profits is either reinvested back into the company or distributed to policyholders as bonuses. This allows LIC to market its insurance policies to its policyholders as investment products besides the element of risk coverage, although critics argue the returns offered by LIC are lower when compared with other investments.

Why are policyholders worried about the IPO?

The Government, which wants to sell 5% of its stake in LIC to the public, has recognized that the way LIC distributes its profits can turn out to be a problem in attracting a lot of investors. Investors who buy shares of LIC would want a larger share of the profits earned by LIC each year if they are to purchase the shares offered by the Government at a price desired by the Government. After all, the price that investors are willing to pay for the shares of any company depends on the future cash flow that they expect from owning the shares. All this means that the share of profits that is distributed to policyholders is likely to drop as the Government tries to sell its stake in LIC at the best price. In fact, reports suggest that by FY25, the share of LIC’s profits that would be distributed to policyholders would drop to 90%, from 95%, with the remaining profits going to shareholders including the Government. In short, as the Government tries hard to make its stake sale attractive to investors participating in the IPO, the returns that policyholders could expect from their policies could diminish going forward.

What lies ahead?

Policyholders may likely reconsider their investment in LIC’s products as the percentage of LIC’s profits redistributed to them drops going forward, thus affecting their returns. Also, the primary appeal of LIC among policyholders has been the implicit sovereign guarantee offered by the Center which has convinced policyholders to park their money with LIC despite low returns. In fact, in a country like India which has no proper safety net for citizens, some have seen LIC as offering low but safe returns to millions of citizens.

Supporters of the IPO, however, argue that the hit to policyholder returns must be weighed against the benefits of greater private participation in the management of LIC’s assets. LIC parks most of its capital in government bonds and this money can be better used in other ways that yield higher returns and also help the economy. The higher returns can even trickle down to policyholders if greater competition is encouraged in the insurance industry. With a greater share of profits going to shareholders, returns would also become commensurate with the risk undertaken.

It should be noted that LIC has been used as a piggy bank by the Center for years to bail out many failing businesses. LIC’s purchase of IDBI Bank, for instance, came under criticism as making no business sense. LIC’s investments in other struggling companies such as DHFL, Reliance Capital etc. have also come under similar scrutiny. There is likely to be greater resistance from shareholders to such non-core use of LIC’s capital when its shares are traded publicly. The Center last year, for instance, walked back its decision to take a larger share of IRCTC’s earnings after investors dumped the company’s shares.

THE GIST

The Life Insurance Corporation of India (LIC) filed its draft red herring prospectus on Sunday to kick-start the IPO process. LIC makes money by selling various insurance products but unlike other insurance companies, LIC redistributes most of its profits back to policyholders in the form of bonuses.

The Government, which wants to sell 5% of its stake in LIC, has recognized that these methods of profit redistributing can put off investors. Investors who buy shares would want a larger share of the profits earned by LIC each year. This means that the share of profits that is distributed to policyholders is likely to drop as the Government tries to sell its stake in LIC at the best price.

LIC has been used as a piggy bank by the Center to bail out many failing businesses. LIC’s purchase of IDBI Bank as well as its investments in other struggling companies such as DHFL, Reliance Capital etc. have come under scrutiny. There is likely to be greater resistance to such endeavors when its shares are traded in the stock market.



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