Curious Case of LIC India

Finance Minister Nirmala Sitharaman had announced a stake sale in LIC through an initial public offer in the Union. The government primarily plans to meet its fiscal deficit target by achieving divestment of Rs 2.1 lakh crore for FY21 on the back of stake sale in state-run companies. It is looking at IPO of LIC, stake sale in Air India, BPCL, and IDBI Bank as well as by consolidating PSUs in the oil & gas and power sector.

On fiscal consolidation, the Budget conceded a slippage of 0.5 percentage points to 3.8 percent of GDP in 2019-20 but promised to bring it to 3.5 percent next year. In doing so, the government has stayed committed to the Fiscal Responsibility and Budget Management Act, which allows slippage of no more than half a percentage point in a year.

Valuation of LIC:

1.    Enterprise Value of LIC is 36 Trillion Rupees while the m-cap valuation is expected to be ?8-10 trillion. [Enterprise value = common equity at market value (this line item is also known as "market cap") + debt at market value (here debt refers to interest-bearing liabilities, both long-term and short-term) + minority interest at market value, if any + preferred equity at market value + unfunded pension liabilities and other debt-deemed provisions – value of associate companies – cash and cash equivalents.]

2.    In FY19, LIC generated a surplus of ?53,214.41 crores and paid ?2,611 crores as dividend to the government. In FY18, it generated a surplus of ?48,444 crores and paid ?2,430 crores to the government. Just for a perspective, RIL had posted a net profit of ?39,588 Crore

3.    The financial statement of Insurance companies consists of

                       I.        Policyholders Account (Technical Account)

                      II.        Shareholders Account (Non-Technical Account)

                    III.        Balance Sheet

                    IV.        Receipts and Payment Account (Cash Flow Statement)

                     V.        Segmental Reports relating to the funds

It’s very different, and the valuation becomes a bit complex for insurance companies, unlike other companies.

4.    The government aims to mop up ~90,000 crores from the listing of LIC and stake sale in IDBI Bank. (Assumption: They are willing to offload 10 percent of their stake in LIC) The government currently owns 100 percent in LIC. On the stake sale of IDBI Bank, which is substantially owned and controlled by LIC, The government currently holds around 46 percent in IDBI Bank.

5.    Market players fear the IPO could crowd out the secondary market as some investors would have to liquidate their existing holdings to invest in the mega IPO. The biggest IPO to hit the Indian market is that of Coal India, which had mopped up ~15,000 crores a decade ago

Regulation Hurdles in doing so:

1.    All companies are required to offer at least 10 percent in the IPO. The above calculations were also based on that assumption. If the government would be in favour to offload less than 10 percent, then they have to seek exemption from SEBI for the same.

2.    The most important question is whether the sovereign guarantee on LIC’s liabilities will continue (Liabilities for LIC is the insurance cover and claims that LIC do settle) If the government continues with the sovereign guarantee, there would be questions on LIC’s governance. However, if the government decides to discontinue the sovereign guarantee, retail investors will have issues with the quality of assets LIC is sitting on.

[But what is a sovereign guarantee? Sovereign Guarantee is a promise by the Government to discharge the liability of a third person in case of his default. Sovereign Guarantees are contingent liabilities of the Central and State Governments that come into play on the occurrence of an event covered by the guarantee. The guarantee cover of the Government of India (GoI) is limited only to the payment of principal and normal interest in case of default]

3.    LIC is not a company. It’s a corporation. The Committee on Reforms in the Insurance Sector or popularly known as Malhotra Committee Report had recommended repeal of LIC Act and converting the LIC into a company. The government also may have to amend the Section 5(1) of the LIC Act, which presently provides that the paid-up equity share capital of LIC shall be provided by the Central Government after due appropriation made by Parliament by law for the purpose. After getting transformed into the company, it will be governed by the Companies act.

4.    After amendment and listing, LIC will come under rigorous scrutiny and supervision of Irdai, wherein it will have to strictly maintain the solvency margin of 150 percent. LIC has reported its solvency ratio of 1.55 at the end of September 2019 against 1.51 in September 2018. While the solvency ratio threshold fixed by sector regulator Insurance Regulator and Development Authority of India (IRDAI) is 1.50, LIC’s solvency ratio has hovered around 1.5 in the last 11 years, reportedly the lowest in the industry. Solvency Margin: “Put simply, it indicates how solvent a company is, or how prepared it is to meet unforeseen exigencies. It is the extra capital that an insurance company is required to hold. As per the IRDA (Assets, Liabilities, and Solvency Margin of Insurers) Rules 2000, both life and general insurance companies need to maintain solvency margins. While all non-life insurers are required to follow the regulations, life insurance companies are expected to maintain a 150% solvency margin.”

5.    LIC holds more than 10 percent stake in particular companies in the capacity of an institutional shareholder, breaching the 10per cent cap laid down by IRDAI and SEBI.

Government shareholding will have to come down to 75 percent.

6.    For the last five years, LIC’s NPAs have been mounting substantially. While the outstanding bad loans were recorded as Rs 12,213 crore in 2014-15, it increased by 17% to Rs 14,283 crore in 2015-16, and further spiked by 27% to Rs 18,173 in 2016-17 and the figure was Rs 25,241 in 2017-18. In other words, LIC’s bad loans bulged by 145% from March 2015 to September 2019. The NPA of LIC alone is to the tune of 4.5 percent of NPAs of PSBs (The government on Feb 3, 2020, said the Non-Performing Assets (NPAs) of Public Sector Banks (PSBs) stood at ?7.27 lakh crore as on September 30, 2019.) LIC's gross NPAs rose to 6.10 percent in the first six months (April-September) of 2019-20. Gross NPAs have almost doubled in the last five years. The insurer always maintained a stable 1.5-2 percent gross NPAs.

References:

• https://www.capankajgoel.com/download/Study_Material/539854085-artilce2.pdf
• https://www.businessworld.in/article/Reliance-Industries-Climbing-New-Heights/20-01-2020-182387/
• https://en.wikipedia.org/wiki/Enterprise_value
• https://www.livemint.com/
• https://www.businesstoday.in/markets/ipo-corner/lic-ipo-nirmala-sitharaman-budget-lic-npas-reliance-industries-tcs-hdfc-bank-stocks/story/395342.html
• https://static-news.moneycontrol.com/static-mcnews/2019/09/LIC-Logo-770x433.jpg