One of the defining features of 2017 has been the public listing of five insurance companies, in life insurance and non-life insurance space. In the case of life insurance companies the markets responded positively and analysts worry that valuations are stretched largely due to market sentiments and the supply and demand gap. Amitabh Chaudhry, managing director and chief executive officer, HDFC Standard Life Insurance Co. Ltd—the insurer got listed last month-- talks to Mint Money about the potential for the industry to generate value in the future that justifies the valuation. Also being the chairman of the product committee that was constituted by Irdai to look into product reforms, he takes us through some of the key takeaways from the report that was published by Irdai on 14th December. Edited excerpts:
In January, the insurance regulator set up a committee to review existing product regulations, but the report took a long time to come out. Can you tell us why it took so long?
The products committee comprises of leading names from the industry. Together, we have had discussions on different areas, taking into consideration the interest of consumers as well as insurers. The discussions have revolved around aspects such as product design, persistency, surrender value, distribution, file and use, investment and reinsurance. The report took time as there were multiple views to consider.
One of the topics before the committee was to look at surrender value in traditional plans. The report hasn’t given concrete steps on how to increase the surrender value, but it has presented two diverse views: one that asks for status quo and the other that recommends increasing the surrender value. And the report has given two ways to increase the surrender value but why not come with a concrete solution?
Surrender value on conventional products was one aspect that was discussed in detail. Since the views were quite diverse, alternatives have been recommended in the report because the committee couldn’t agree on a solution and most of the industry wanted status quo.
Having said that, the report has recommended two methods and both these methods will lead to enhanced surrender values. These recommendations are slightly radical and will impact current product designs, pricing and business models of insurers. But, in the long run, both these approaches will help the industry provide better value to the customer, not just at maturity but during the entire lifecycle of the policy.
You have suggested three ways to improve persistency: by making commissions flexible, by treating regular premium policy as single premium, and by offering a secondary market. How will these improve persistency?
Making commissions flexible will help insurers drive the behaviour of distributors to improve persistency. For example, a distributor with lower persistency can be paid increasing renewal commission rather than high first-year commission. Similarly, linking benefits, surrender values and commissions to each single premium will automatically align the interests of the distributors and customers. As for secondary market, the concept is that even after the customer surrenders the policy, it continues, with one insurer paying premiums to the original insurer in return of the maturity benefit with cover continuance on the life of the customer. This ensures that the policy is persistent as the future premiums are paid to the original insurer according to the original insurance contract. The only difference is that the future premiums are paid by another insurer, instead of the customer (after surrender).
The committee in its report also focussed on disclosures and recommended several disclosures. However, in the case of traditional investment plans that guarantee returns upfront, there has been no recommendation to disclose the net return as was also proposed by the Sumit Bose Committee report. Why is that?
In case of par products, where a bonus is declared, the benefits are at the discretion of the company. While in case of non-par products, the benefits are clear and known to the customer at the outset. When it comes to surrender value of a traditional product, there are two aspects: a special surrender value and a guaranteed surrender value. The special surrender value is typically higher than the guaranteed surrender value and it can usually be changed only after regulatory approval.
The Committee has a view that the current disclosures for non-par products, especially the benefit illustration, adequately communicates the various benefits to the customer year on year during the policy term. This representation for the non-par savings products is the simplest as the benefits are known to the customer at the outset.
Coming to listing and valuations, many analysts hold the view that valuations are stretched largely due to market sentiments and huge demand and supply gap. And this becomes even more visible when you compare life insurance companies in India with their Asian peers. So what are the reasons for being so bullish?
The business is being valued by investors who are investing globally in the insurance industry. They are the same people who are investing in India as well. They are willing to pay for it because clearly they believe in the India growth story and see huge potential for the life insurance sector. The margins in other countries in the Asian market are quite high and the margins can only go down from here, whereas the margins in India, which are currently low, have the potential to go up. There is a huge protection gap in India and given that protection products have the highest margins, there is a large opportunity for the insurance industry. After demonetization we have seen a greater financialization of savings, which will add to the growth. I can safely say that the industry can continue to grow in the higher teens in the long term. Apart from the confidence that investors have in the growth story, it’s also important to understand that the industry has undergone major reforms and is now settling down, the models have matured and we have had consistent growth for the last 4 years if we include this year too.
So in your view demonetization has been a major contributor to financialization of assets?
I think yes. The government is making a very clear statement: if you want to avoid tax or your sources of income, life can become very difficult for you. Now it’s just much simpler to pay taxes and be worry-free. This means more money is coming to the real economy because where else will the money go? People are looking for options beyond gold and real estate.
Coming back to margins, can you explain the contributing factors to your profit margins?
The first is that we have a well-balanced product mix across our distribution channels so that each channel is profitable.
Then, as a brand, HDFC Life is cost-conscious and that is reflected in how we spend and save money.
The third is our high share of protection business. In protection there are two parts: One is retail, where we sell term plans and other pure protection plans like health, and then there is the group business. Retail protection is about 5% of our overall portfolio currently. But if you also include the group business, then the share of protection jumps to 11% on annual premium equivalent basis. We have about 125 relationships with different entities such as banks, NBFCs and financial institutions. I feel investors definitely see value in us because nobody has the size and spread of distribution like we do.
You said that given the low margins, it can only move up for life insurance companies in India. But can they beat their Asian peers that can be as high as 50%?
I am not talking about 50% margins but there is enough room to grow from the current levels. There are two to three ways in which you can improve margins. You sell products which are high-margin, or reduce the cost or increase productivity. Some insurers are trying to increase productivity by focussing on attaining scale. Costs come down with economies of scale. Our strategy is to look for pools of profitability.
Also, given our strengths, we are in a better spot to take bets on the future. For instance, we have said we want to get into reinsurance business through our subsidiary in Dubai. We took 2 years to set up this subsidiary and no other private company has it. Of course, it’s a 5-10 year bet, but if it works out, it can give us additional profitability; and remember, reinsurance is purely protection. We also took a bet on the pension sector and even after being a 4-year late entrant, we are among the top in this space.
One concern in the life insurance industry is very high expense ratios. Most companies including yours have their expense ratios in double digits which analysts believe to be very high.
I don’t think expense ratios tell you the full story. One company may want to invest in its distribution channels to attain productivity whereas others may have a different view. All the investments are seen as an expense item. People, technology, group partners, all of these factors make up for expenses. Over a period of time, it will reach a scale where it will start coming down. Now, of course, we are doing whatever we can to control our expenses. We are using technology in a big way thereby empowering partners and customers. In fact, for us and for the industry, you will notice that branch expansion has started coming down and insurers are leveraging their distribution relationships.
Having a dedicated bancassurance partner that is also a part of promoter-group company is seen as a success recipe for controlling expenses. Till recently, HDFC Bank was your tied corporate agent, but it also sells products of two other companies. How will this impact your costs, margins and business?
HDFC Bank contributes substantially to our business. The regulator has been nudging for an open architecture and even though it’s optional we know that directionally that’s where the industry is headed. So even though we have a greater reliance on HDFC Bank, open architecture also pushes us to cultivate more relationships. It’s important to face competition and hopefully we will continue to have a lion’s share of the bank’s third party business. As for its impact on our business and financials, that’s where the job of management kicks in.