In February 2022, the Union Government filed its Draft Red Herring Prospectus [DRHP] with the Securities and Exchange Board of India [SEBI] and took the formal step toward disinvesting a part of its stake in the Life Insurance Corporation of India [LIC] through an Initial Public Offering [IPO]. The terms of the IPO, especially the manner in which the offer has been priced, have set off allegations that this is the biggest ever scam in the history of privatisation in India. The privatisation of India’s biggest insurance provider, also among the biggest in the world, would result in substantial losses to not just LIC’s policyholders but the government.
V Sridhar, a senior journalist, is a member of the People’s Commission on Public Sector and Public Services, which was constituted in the background of the government’s renewed push towards privatisation in the midst of the COVID-related crisis. Sridhar has written extensively on the LIC IPO, proving it to be a major scandal in the realm of privatisation in India. His insight provides not only a unique perspective on the rights of LIC policyholders but what the privatisation of this unique institution implies for the spread of the culture of life insurance in India.
Sridhar spoke with The Leaflet on the basics of LIC’s nature of operations, and the implications of its IPO.
Edited excerpts from the interview:
Q: Can you tell us how LIC, being one of the biggest insurance operators in the Indian market, is globally sui generis in the world of finance?
A: The life insurance business was historically and typically structured as a mutual company where the members of the company were its shareholders. In such a structure, profits that arose were distributed amongst the shareholders; there was no appropriation of profits by an external source. They were thus akin to a cooperative housing society, for instance. Over time, while this organisational structure changed for other insurance companies, the LIC continued to be structured as a mutual company, even though it was not formally or legally termed as such. However, after the changes introduced in the Finance Act of 2021, the government has asserted its rights as a shareholder. These changes were introduced explicitly in order to help it divest its “stake” in the LIC. How fair is this, given the historical journey of the LIC?
During the first 55 years of its 66 years since the formation of the LIC, the government invested only rupees five crores as initial capital in 1956. The rest of the money, for the expansion of its operations, came from the policyholders. In effect, policyholders provided the risk capital for the LIC’s expansion for most of its life. Furthermore, when LIC was nationalised after taking over 245 insurance companies (that threatened the interests of their policyholders), the compensation was paid to such companies from funds provided by the policyholders. Hence, it was natural that LIC paid 95 per cent of its surplus to the policyholders and only five per cent to the government, an entity that is now claiming to be the owner of LIC.
“Ordinary people who trusted Participatory Policies for their stability and decent returns, will now stay away from LIC as it shifts its focus elsewhere.
LIC is sui generis, firstly, because, till the Finance Act of 2021, it was not structured as a typical company. For most of its existence and until 2021, it functioned like a mutual company since the contribution of risk capital came from the policyholders. Secondly, each of the millions of policies is guaranteed by the government, though, significantly, the guarantee has never had to be invoked. When LIC pioneered the concept of life insurance, this guarantee backed every single policy. And, LIC’s good track record of redeeming its policies gave confidence to the policyholders.
In global finance, ‘Too Big to Fail’ is often used to describe the fact that the mega banks are so big that their collapse poses system-wide risks to the entire financial sector. This is not some fancy notion; it actually proved to be true during the global financial crisis of the last decade from which we are yet to recover fully. In contrast to this, LIC, I would say has been ‘Too Good to Fail’.
Q: Can you explain the idea of Embedded Value [EV] as a measure of a life insurance company’s worth? Can you further give a brief on the low multiplication value, in relation to EV, adopted in the case of the LIC IPO?
A: EV is used uniquely for valuing insurance companies. The concept is of recent vintage. It is an actuarial (the business of evaluating insurance claims and performing the calculations that estimate risks), not just a financial concept. The point is that EV does not measure the true worth of a company but instead measures the potential returns to shareholders. During the financial crisis of 2008 many insurance companies collapsed. The EV concept caught on in a big way when there was a spate of mergers and acquisitions in the global insurance business. The concept was used by acquirers to estimate the potential returns from the acquisition of these failed insurance companies. It is a limited concept meant specifically to measure the potential returns for the shareholders of the company making the acquisition.
Typically, EV is calculated before an IPO.
But it is important to stress what the EV is not about. Firstly, a company’s goodwill is not considered in the estimation of the EV. Remember, millions of households, over generations, have been associated with LIC over six decades. It is by far the most popular and well-known brand in India. The resulting goodwill or brand value of LIC is not included in the EV even though the acquiring entity benefits from it.
Secondly, the market value of its substantial real estate assets are not included in the EV computation. Remember, LIC has vast assets not only in metropolitan cities but in almost every city and town in India. As India’s biggest realtor the current value of LIC’s assets would be of a mind boggling, perhaps running into at least several lakh crore rupees. Mind you, the risk capital for the acquisition of these assets had come primarily from policyholders. The government is now diluting 3.5 per cent of its stake in LIC and selling its shares to private individuals. The new acquirers of the company, who would effectively have a claim over the assets of the company, even though neither they nor the government have contributed anything towards the acquisition of these assets. How is that fair?
The EV is of limited importance in the real world, and hence, every insurance company applies a multiplication factor to arrive at the price at which it offers its shares to potential shareholders. In India, we have had three major IPOs of life insurance companies – HDFC Life, SBI Life, and ICICI Prudential Life, which are considered “benchmarks”. LIC has the biggest market share – in terms of policies it has 75 per cent of the market, and in terms of the value of the premium, it has about two-thirds of the market. Thus, there is no justification for LIC’s multiplication factor being less than that used for its three main private sector rivals.
Initially, when the IPO was being considered in February, the multiplication value was expected to range between 2.5 to 4, in line with the valuation of the private insurance companies. But when the IPO was announced in late April, the EV was found to be 1.1, indicating a huge loss. Hence, the question is: how can the value of LIC have come down so sharply within a span of a few weeks? If the market was not willing to pay the multiple, why didn’t the government just postpone the issue? This is why I term it as India’s biggest-ever privatisation scam.
Also read: Serious concerns over proposed LIC IPO
Q: You talk about the millions of policyholders who would be affected due to India’s biggest ever IPO. Can you explain the loss to policyholders and the gain to investors due to this disinvestment because of the deep discount?
A: With the government offloading 3.5 per cent of its stake in LIC, it implies that the new owners would own 3.5 per cent of all that LIC is worth.
Life insurance policies can be broadly classified as participatory or non-participatory in nature. In a non-participatory policy, you just get what you are insured for. There are two costs involved – a part of the premium goes towards the risk borne by the insurer and the other part is for the maintenance of the policy (for instance, overheads and employee salaries). A participatory policy, apart from the two elements of cost, includes a saving component where the policyholder provides the funds and participates in the risk. This reward is in the form of bonuses paid to policyholders.
Previously, LIC managed a consolidated Life Fund; in September 2021 this corpus was about 36 lakh crore rupees. With the amendments to the LIC Act, 1956, effected by the Finance Act of 2021, LIC bifurcated the Life Fund into those of Participatory and Non-Participatory funds, with the latter accounting for about one-third of the total fund in September 2021. Significantly, the EV increased from Rs. 0.96 lakh crores in March 2021 to around Rs. 5.4 lakh crores after the bifurcation was implemented. What explains this spectacular jump in EV within a span of six months?
Prior to the 2021 amendment, 95 per cent of the profits from the consolidated corpus, including profits from non-participatory policies, were distributed to the policyholders. This was based on the logic that since policyholders primarily bore the investment risk, they were entitled to the overwhelming portion of the surpluses that emanated from non-Participatory policies. Remember, Participatory policyholders even bore the risk of losses that arose from non-Participatory Policies. However, the amendments take these surpluses away from policyholders and transfer them to the shareholders, including the new shareholders after the IPO. Now, shareholders will get 100 per cent of the profits from the policies. Policyholders get nothing at all.
“The LIC privatisation is entirely unique as it is disinvesting an entity that the government does not even own. The government’s claim to LIC as an owner is suspect.
Now, let us come back to the explanation of how the EV increased so dramatically. Remember, the EV is nothing but a measure of the present value of future profits for the shareholders. The sharp increase in EV, by a whopping 518 per cent in a matter of six months, is directly a result of the expropriation of the corpus — and the surplus that flows from it — that belonged to the policyholders. Thus, there is an expropriation from policyholders, handing the profits over to the shareholders, including the new shareholders coming through the IPO. Moreover, participatory Policyholders lose even more. The share of the surplus they are now getting is to fall from the current level of 95 per cent to 90 per cent very soon, and perhaps even lower in a few years.
It is a blatantly fraudulent argument that a portion of the IPO is reserved for policyholders. Firstly, no other insurance company has a wide-scale scope as LIC, covering a broad range of the Indian population. The average premium for a policy is much smaller in the case of the LIC, when compared to its private “peers”. This is because LIC covers a large segment of ordinary Indians with low incomes, unlike the private insurers. In fact, this is why LIC is a household name in India. Even if there is a quota for policyholders, only the more affluent policyholders would be able to apply for these shares; policyholders with lesser means would be unable to participate in the IPO.
Secondly, with LIC having about 240 million policyholders forming around 20 per cent of the Indian population, and with only a small percentage that is reserved for policyholders through the lottery system, (in case of oversubscription, not everyone will get the shares) the policyholders are looted and affected. It is important to reiterate that while policyholders as a class would be short-changed, a few of them may become shareholders. Thus, the allotted quota only allows the policyholder to enter a lottery system by which they may or may not get shares. While ALL policyholders would suffer the consequences of expropriation, a small fraction of them may become shareholders; even that gain may not be enough to cover the losses they would suffer.
Q: In one of your articles, you mentioned the government’s rush to sell a portion of its stake in LIC, particularly in view of the war in Ukraine or in meeting the deadline for filing its Draft RHP with SEBI. Can you elaborate on these and other reasons, if any, for this rush?
A: Globally, investors have turned risk-averse. The war in Ukraine has compounded problems but there already existed a situation of high inflation, most notably of skyrocketing oil prices. The race by monetary authorities worldwide to raise interest rates has deterred investors from venturing into stocks. This is reflected in the recent and ongoing collapse of share markets, not just in India but elsewhere. Since the COVID-19 pandemic, every government, except India, has been loosening its monetary policy; this is now being reversed. This is the environment in which the government has decided to go ahead with the IPO.
The Draft RHP was filed in February with a deadline that closes on May 12. Overshooting this deadline would have required the LIC to file a revised DRHP incorporating the results for the year ending March 2022. This may have taken a few months. Hence, in a situation where it would have been perfectly reasonable and logical to walk away from the IPO, the government decided to go ahead with it, despite the adverse market conditions.
The RHP, filed on April 26, contains the multiplication factor of three leading peers of LIC. As of April 22, the ratio of market capitalisation to EV of the LIC’s three main competitors was between 2.49 and 3.96. All this is contained in the RHP filed with SEBI on April 26, 2022 (page 105). What this means is that the market arrived at this multiplication factor after taking into account the adverse market conditions. The implied multiplication factor of 1.11 in the case of LIC raises an important question: why would the market only heavily discount the most dominant life insurance company in India, while valuing the private insurers more favourably despite the “adverse” market conditions? The inescapable conclusion is that LIC has been deliberately undervalued.
Q: What does the IPO mean for the future of LIC?
A: As previously mentioned, LIC offers a range of policies. In a country that lacks a welfare system, a trustworthy insurer who offers stable returns plays a very important social welfare function. Since LIC is a public institution, it is under the constant glare of public scrutiny. It is a vibrant institution that has pioneered life insurance and promoted the culture of life insurance in India.
This status of LIC is bound to change after the IPO. Firstly, LIC has openly declared that it will gradually withdraw from offering participatory policies. These policies gave it a compelling advantage in terms of popular acceptance. Ordinary people who trusted Participatory Policies for their stability and decent returns, will now stay away from LIC as it shifts its focus elsewhere.
Secondly, unlike most of the private insurers, LIC provided very little equity-linked life insurance (investing insurance into equities/shares). In the case of such policies the risk is entirely on the investor. After the IPO, it is likely that there will be pressure on LIC to function like a clone of the private insurers. It will, thus, lose its unique character. As a result, ordinary Indians of lesser means, who lack the ability to undertake risks associated with equity markets, will turn away from life insurance. This will have adverse consequences for the penetration of life insurance in India. For the purpose of global comparison, insurance forms a mere three per cent of the GDP in India. With the IPO, the insurance penetration in the GDP is unlikely to improve.
The culture of life insurance, which LIC pioneered, is likely to suffer a huge setback as a result of the changes made to LIC’s character.
The other major characteristic of the LIC’s conduct was that it was subjected to stringent norms that regulated how its investments policyholders’ funds were made. Thus, 8o per cent of its investments were in government securities that are very secure by nature. This is important in the case of the LIC. It has millions of policyholders who are not financially affluent and who are not looking for investing in risky high-return investments. As a result of the IPO and gradually over time, these regulations are likely to be loosened.
Q: What does the LIC IPO signify in the broader realm of privatisation in India?
A: In the cases of privatisation of Air India, Bharat Aluminium Company, or the proposed sale of the Shipping Corporation of India, the most objectionable factor of privatisation of these companies has been the way in which the government has undermined and undervalued these companies. The LIC privatisation is entirely unique as it is disinvesting an entity that the government does not even own. The government’s claim to LIC as an owner is suspect.
“The culture of life insurance, which LIC pioneered, is likely to suffer a huge setback as a result of the changes made to LIC’s character.
The public sector is legally considered to be an arm of the State in implementing its policies. With privatisation, all the means to kick-start the economy are throttled, especially considering that we are yet to recover from the effects of the pandemic.
It is important to appreciate that the eventual privatisation of a publicly-owned entity is only one event in a long process or a culmination of a process by which public sector companies are run down, making the field favourable for privatisation. For instance, Air India was sabotaged, deliberately undermined, and derailed for years prior to its privatisation.
Every instance of privatisation is, by definition, bound to be a scam. In the case of Air India’s privatisation, the Tatas took over a portion of its debt. The deal provides the group tax benefits, which imply a loss to the exchequer.
Privatisation is bound to be a scandal because the valuation is based on the logic that it must be “attractive” for the private buyer. That is why every instance of privatisation rests on a dubious assessment of a publicly-owned company’s true value.