IRDA TO FRAME BENCHMARKS FOR VALUING INSURANCE FIRMS

Hyderabad: Valuation of insurance companies is back on the regulator’s radar. The Insurance Regulatory and Development Authority (IRDA) is on course to develop commonly-accepted benchmarks and disclosures to value insurance companies as this would be crucial when Indian partners dilute their shareholding.
The present regulation requires Indian promoters with a majority shareholding to dilute their stakes through an initial public offering (IPO) at the end of the tenth year of operations. The value of insurance companies hinges on several assumptions which could result in wide variations. It is different from valuing, say, brick-and-mortar companies listed on the stock exchange. Their valuation is generally based on the price-earning multiple — a measure of the price paid for a share relative to the profit earned per share. A high PE multiple suggests that investors expect higher earnings growth in the future. But this exercise is much more complex for insurers. Once an insurance company receives the premium from the policy holder, it has to fork out money for commission and other marketing expenses. The balance is invested in debt and equities and interest is added to the original investment. Then, on the date of valuation the solvency margins and mathematical reserves are deducted from this corpus. Solvency margin is the excess of assets over liabilities that an insurer maintains as a prudential measure in the interest of policy holders. Mathematical reserve is the provision made by an insurer to cover liabilities on long-term insurance contracts. The balance amount in the corpus is used to pay claims and the net money that is available is the profit. If the insurance product is a participating product — eligible for bonus — only 10% of the profit belongs to the shareholder. The balance is used to declare bonus and belongs to the policy holder. If it is a non-participating product, the entire profit belongs to the shareholder. Hence, the profit can vary widely as the actual experience may differ from what has been assumed in pricing — cost, claims experience, investment yield and so on. In the worst-case scenario, the projected profit will be much lower than what has been assumed in the pricing. Valuation of insurers, hence, hinges on the assumptions and hidden profit which can fluctuate wildly. “It is important for the industry to follow some uniform method in estimating various components. This, in turn, will bring some closeness in the final outcome on valuation between various companies. Internationally, this issue has gained prominence with professional bodies setting valuation norms. Rating agencies event comment on these norms. In the days to come, the same will happen in India,” Irda member actuary R Kannan said. Irda chairman J Hari Narayan also reckons that issues such as valuation of companies will take the centre stage when the industry consolidates through mergers and acquisitions. Mr Narayan’s predecessor C S Rao had set up a panel to suggest ways to value insurance companies. Irda may now set up a broad-based committee to look at such issues. “There is a case for significant improvements in transparency and disclosure standards of the insurance industry. As a run up to the prospective initial public offerings, there is a need to agree on common disclosure practices, financial ratios and operational benchmarks so that there is a consensus among analysts to have a proper valuation for different companies”, Watson Wyatt managing director R Krishnamurthy said. Currently, the new business achieved profit — which reflects the value of a company’s earnings potential under a set of assumptions — is used for the valuation of insurers. Another method is the embedded value method or the value of the existing business in the books of the company. India’s insurance sector accounts for around 5% per cent of the GDP and has the largest number of life insurance policies in force in the world.

Source: The Economic Times