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Indian Insurance Industry – Focus Max India

September 2011

TABLE OF CONTENTS

I. Industry Analysis

1. Overview (Nationalized Era)

2. Deregulation 1997-2010

3. IRDA Regulations 2010-2011

4. The Market Today

i. Demographics

ii. Competitive Landscape

iii. Products and Product Mix

iv. Ongoing Concerns and Developments

II. Max India

1. Overview

2. Life Insurance Business

i. Pre Regulation

ii. Post Regulation

3. Comparison with Competitors

4. New Strategies

5. Other Key Information

i. Management of MNYL

ii. Stock Metrics and Performance

III. Valuation

1. Value of Life Insurance Business

2. Value for FY12

i. Key Assumptions

ii. Valuations

iii. Scenario Analysis

IV. Conclusions

1. Key Positives

2. Key Risks

3. Overall Conclusions

V. Appendix

1. IRDA Regulations

2. Definitions of Policies

3. Details on Proposed DTC

4. Shareholding of Max India

5. Broker Estimates

6. Alternate Analysis

7. Key Management of Max India

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I. Industry Analysis

Overview (Nationalized Era):

On January 1956 the Indian government nationalized the Life Insurance Industry by merging 250 companies

into one large organization named the Life Insurance Corporation of India (“LIC”). However, LIC failed to in-

crease insurance penetration in India (remained below 1% till the late 1990s), and the premium underwritten

grew at a meager CAGR of 10.6% between 1956 and 2000. Furthermore there was little to no product innova-

tion as LIC had no incentive to do so as it had full control of the market.

Deregulation 1997-2010:

In Dec‟97, Insurance Regulatory and Development Authority (IRDA) Act was passed, paving the way for the

entry of private players. New licenses were given to private players with a cap of 26% on foreign equity share

capital. As of 31st March 2011, there are 22 private players and one public company. Most private companies

have a foreign partner with 26% equity stake. The deregulation period was marked by rapid expansion of pri-

vate players, the growth of Unit Linked Products (“ULIPS”), and Policy Holders aiming for quick market gains.

Growth in the sector: The insurance sector grew at a CAGR of 25% from 2001-10 (after the sector was open

for private investment). The growth rates for Private Players and LIC however have been starkly different.

Sector Growth over Time

*growth rates are based on the insurance premium underwritten

LIC losing share: Owing to the mammoth growth shown by the Private Life Insurance companies during the

deregulated period, LIC steadily lost market share to the private players.

LIC vs. Private Market Share

1956-2000 2001-2010

Private Players - 185.0%

LIC 10.6% 20.0%

Consolidated 10.6% 25.0%

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Indian market dominated by saving products: During this period the Indian Insurance market was primarily

driven by savings oriented products with negligible share of pure protection, annuities and pensions. Among the

savings oriented products unit linked products account for 42% of the savings products premium underwritten

in FY 2010. For the private players, ULIPs account for 86% of the savings products premium underwritten in

FY2010.

Saving Products Dominate Sales (FY10) Private Player Product Mix (FY10)

Strong correlation between industry performance and capital markets: As a lot of the craze for ULIPs

(products where performance is linked to public markets) was driven by strong capital markets, it was natural

that the Life Insurance Industry did well when capital markets were in a bull phase. Policy Holders were hooked

on to short term gains and were attracted to the aggressive structure of ULIPs. However the subsequent drop in

markets resulted in a drop in First Year Premiums (“FYP”).

Correlation between Industry and Markets

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IRDA Regulations 2010-2011:

With the fall of the markets in late 2008, several ULIP policy holders saw their investments wash away and be-

gan to cash out. Furthermore sales of new policies diminished (see chart above) as market conditions made

ULIPs unattractive. However Insurance companies continued to make money as ULIPs came with heavy sur-

render charges which had ample PnL built into them.

The bifurcation of the interests and profits between insurance companies and policy holders led to the IRDA

stepping in and make sweeping regulatory changes with regards to ULIPs (this is after the courts decided that

the IRDA was indeed the regulatory body responsible for these products – and not SEBI). The IRDA felt that

mis-selling of the product instigated by high agent commissions, the one-sided profit structure, and overall ar-

rangement of the product was unfair to policy holders. In July 2010 the IRDA announced the following

changes. For full details on the regulations below please see the Appendix.

IRDA Regulation and Effect on various Industry Participants

IRDA guidelines Insurer Agent/ Distributor Policy Holder

Lock in period of

minimum 5 years

Negative as short term in-

vestors would not invest in

ULIPS. Long term might

lead to better persistency

ratios

More difficult to find

buyers for the policies

Deterrent but mixed

feelings as this is

coupled with cap on

ULIP charges and sur-

render charges

Rationalization of

distributors commis-

sion

Negative

Negative

Would magnify the re-

turns

Cap on Surrender

charges

Negative

Would magnify returns

Minimum sum as-

sured

Negative as higher solvency

requirements

Mixed effect. Policy

holders would lose out

because of age

Capping of ULIP

charges

Would hit margins

Magnified returns

FDI stake and IPO

norms

Would unlock value Returns will increase if

more value created

Post regulation the life insurance industry as a whole recorded a 15% growth in new business premium during

FY11. While LIC grew by 22% during FY11, private players witnessed medium growth of 2.6% due to new

regulations set by the IRDA. Some industry experts have stated that the new regulations have pushed the market

back three years (in terms of Annual Premium Equivalents).

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The Market Today:

Demographics: There are several key demographics and figures which make the Indian Industry highly attrac-

tive. With the new focus on long term savings, insurance products already suit the needs for many policy hold-

ers. Long term Investment is a function of the savings rate of the country and with one the highest savings rate

(more than 35% of GDP) in the world, India is one of the most attractive markets for long term savings.

It is predicted that in the future a vast proportion of growth is likely to come from change in allocation of wealth

by Indian individuals. A large proportion of the savings is routed to the bank deposits rather than more efficient

long term saving instruments like insurance and mutual funds, predominantly due to limited financial know-

ledge. However with financial literacy improving it is expected that the proportion of mutual funds and life in-

surance will improve, given most of the Indian population is still young and with a higher risk profile.

Savings Distributions in India

Furthermore India‟s insurance density (Insurance premium per capita) is amongst the lowest in the world. With

a young population, increasing risk appetite, growing financial knowledge, and a high GDP growth rate, the

density numbers are poised to increase rapidly.

Insurance Density

Competitive Landscape: The private market has 22 players with most of the leading companies being pro-

moted by private sector banks. While LIC still dominates the market, these private players have made signifi-

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cant headway over the last decade. The market share composition has changed significantly between FY10 and

FY11 due to the change in regulations, and companies that were able to adapt have won out (at least in the short

run). Market Share by New Business Annual Premium Equivalent (“APE”)

However over the last few years there are clear winners in terms of the size of AUMs, with bank promoted

companies doing well by leveraging their branch distributions to capture market share and total premiums.

AUM Growth & Size of Top Players

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Products and Product Mix: There are several variations of products (albeit minor), being offered by the vari-

ous companies however the core types of products are broadly categorized into five types; Term Insurance

(Pure Protection), Endowments, Unit Linked Polices, Single Premium Products, and Pension polices. Term In-

surance, Endowments, and Pension policies are commonly known as “Traditional Policies”. A full definition of

the products can be found in the Appendix.

Product Metric Comparisons

Due to the changes in regulations and the drop in profitability of ULIPs most Indian Insurers have significantly

altered their product mix. It is likely that the industry as a whole will settle at a 50:50 product split between

Traditional and ULIP products.

Product Mix (Jan – Sep 2010) Product Mix (Oct - Jun 2010)

Ongoing Concerns and Developments: The New Direct Tax Code (“DTC”) proposed by the Income Tax de-

partment of India poses significant risks to the sector. While there is not clear timeline for when the DTC would

be implemented, several executives in the industry have hinted that its implementation would bring down over-

all profit and valuations of Indian Life Insurance business (from 7-10%). Full details of the DTC proposed

changes are in the Appendix.

97%

85%

92%

92%

95%

85%

63%

75%

3%

15%

8%

8%

5%

15%

37%

25%

SBI Life

HDFC Life

ICICI Pru

Birla Sunlife

Aviva Life

Tata AIG

Bajaj Allianz

MYNL

ULIP Traditional

85%

75%

60%

60%

57%

55%

50%

15%

15%

25%

40%

40%

43%

45%

50%

85%

SBI Life

HDFC Life

ICICI Pru

Birla Sunlife

Aviva Life

Tata AIG

Bajaj Allianz

MYNL

ULIP Traditional

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DTC Impact

DTC guidelines Insurer Policy holder

Tax rate

(From 12.5% to 25%)

Would hit margins Higher share of surplus

MAT

Would hit margins and push

away breakeven

Would erode the returns

Taxation on Individual

(Transfer from EEE to EET)

Would reduce takers for policy

Policy holders might then choose

other tax exempt schemes

The IRDA is also meant to come out with clarifications on the following:

Guidelines for IPO of Insurance businesses. This will unlock value and allow promoters to monetize

their investments. No firm deadline on when the regulations are to be released, however the industry ex-

pects these to come out by March 2012.

The IRDA may also allow FDI investments to increase to 49%, however this is still in the discussion

phase.

II. MAX India

Overview:

Max India Limited (“Max”) is involved in the Life Insurance, Health Insurance, Healthcare services, and Clini-

cal Research businesses. It has several group companies which specialize in one of the above verticals. Overall

its businesses have had revenue CAGR of 32% from FY07-FY11.

Max New York Life (“MNYL”): A 74:26 JV with New York Life. 89% of the revenues of Max are de-

rived from MNYL

Max Bupa: Max‟s health insurance business, which is a 74:26 JV, but with Bupa Finance PLC.

Max Healthcare Institute Limited: A healthcare provider of standard, seamless, integrated and inter-

national class healthcare services. It provides primary, secondary, and tertiary care with 8 healthcare fa-

cilities across the country.

Max Neeman Medical International: Provides clinical research services across the entire value chain

of new drug development to pharmaceutical, biotech and clinical research customers.

Max Specialty Films: Manufactures a range of sophisticated barrier and packaging films.

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Key Metrics

Due to most of the value of the stock being derived from the Life Insurance business, Max is the only appropri-

ate proxy for the Life Insurance business which can be accessed through public markets.

Life Insurance Business:

Pre-Regulation: Max New York Life Insurance Company Ltd. is a joint venture between Max India Limited,

and New York Life International, the international arm of New York Life, a Fortune 100 company. Incorpo-

rated in 2000, Max New York Life started commercial operation in April 2001.Prior to the IRDA regulations

Max took a more conservative approach to the business compared to its competitors. Its management chose not

to be aggressive on Bancassurance (using banks to distribute policies), and chose to build out their own agency

force instead. Furthermore Max was late to the game with regards to ULIPS and was one of the last of the pri-

vate players to enter this space. However once it did enter the space it did so aggressively and moved its ULIP

mix as high as 75% of the total, and expanded into 384 cities in the country.

Post-Regulation: Post regulation, like all other life insurance players MNYL has changed its mix from a pre-

dominantly ULIP heavy business to a more traditional focus business. However as illustrated previously, Max

has moved into this mix significantly quicker than any of its rivals. This is due to the fact MNYL had moved

into the ULIP business significantly later, and still maintained much of their infrastructure for selling traditional

products. This allowed MNYL to grow 9% in FY11 when the Industry fell 20%, and allowed Max to de-grow

only 14% in Q1FY12 when the rest of the industry de-grew 44% yoy.

However MNYL realized that it had missed a few things, and let their costs get out of hand, and currently have

the highest operating expenses amongst the top seven players.

INR (cr) FY08 FY09 FY10 FY11

Op. Rev 3,244 4,508 5,575 6,668

Tot. Rev 3,611 4,891 7,661 7,891growth % 35.45% 56.63% 3.00%

Tot. Expenses 3,671 5,224 7,747 7,859growth % 42.30% 48.30% 1.45%

PBT -60 -333 -86 32

LI AUM 3,575 5,405 10,121 13,836

growth % 51.19% 87.25% 36.71%

Total Premium 2,693 3,856 4,860 5,812

growth % 43.21% 26.04% 19.59%

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Expense Ratios (Opex to Total Premium)

Comparisons to Competitors:

MNYL has done exceedingly well in continuing to grow their business despite an adverse market and regulato-

ry environment. Their growth in Total Premium and APE is significantly above the averages.

New Strategies:

MNYL has undertaken a series of new initiatives in order to revamp their business. Along with McKinsey the

management of MNYL undertook a study to help them understand the industry better. This led to a reorganiza-

tion and a focus on Long Term Savings Products (LTSP), a focus on the Mass Affluent Market (incomes of Rs.

2 lakhs or higher), and various other strategies. This could mean higher productivity and more “sticky” busi-

ness.

Move away from mass customers to mass affluent customers with focus on long term savings protection

products (LTSP): Its focus shifted in the latter part of the decade due to high competitive pressures but now it

Company FY10 FY11 FY10 FY11

MNYL 26.0% 19.6% 3.0% 8.1%

ICICI Pru 7.6% 8.1% -4.8% -6.2%

Birla SunLife 20.4% 3.1% 5.5% -30.4%

Bajaj Allianz 7.5% -15.8% -9.9% -33.7%

HDFC SL 25.9% 28.5% 31.7% 9.4%

Kotak Old Mutual 22.4% 3.7% -14.2% -19.1%

SBI Life 40.1% 27.8% -2.1% -16.6%

Reliance Life - 33.9% - 21.1%

Average 21.4% 13.6% 1.3% -8.4%

Total Premium Growth APE Growth

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has achieved critical mass in business so it is realigning its focus on mass affluent customers only. It has histori-

cally focused on LTSP which helped it to nullify the impact of ULIP regulation. It will concentrate on LTSP

with minimum 10 year tenure and 20 times sum insured. This measure also makes future earnings less volatile

since it reduces the company‟s dependency on new business premiums.

Transform the current agency to a platinum standard: It decided to recruit well educated agents who have

focus on Insurance as full-time employment. It also reduced the span of control which will ensure higher ac-

countability and better performance. MNYL is renowned to have one the best agent force in the business. While

most agents train for 50 hours MNYLs agents train for a minimum of 300 hours. There are also a minimum of

two trainers per office, which means agents constantly go through re-training. Lastly, agent compensation is

now tied to long term earnings instead of sales, which helps to explain MNYLs higher persistency ratio (see be-

low).

Maintain overall persistency at least at 75% to 80%: The high quality agency channel and products should

be able to help meet the targets on persistency. Its current persistency levels are higher than industry average.

Persistency Ratio of Indian Insurers

Build a multichannel distribution network with bancassurance: MNYL entered into agreement with Axis

Bank which is in line with its strategy of concentrating on mass affluent market, given the high quality customer

base of Axis. For this agreement, Max has given a 4% stake to Axis Bank in MNYL. Post this agreement Max‟s

stake in MNYL came down to 70%. Going forward Max expects nearly a quarter of its distribution to go

through bancassurance from a meager 4% in FY10. This strategy will also help to reduce costs and boost mar-

gins. Currently on a ULIP distributed through its agency MNYL makes ~5% margin, however when distributed

through bancassurance the margin jumps to nearly 15%.

Focus on cost management: The management has decided to make a leaner company by cost savings of

Rs.4bn during FY11 (from FY10). This has largely been done by cutting down its presence from 384 cities to

135 cities and by cutting their number of agents by nearly 30,000 to 43, 692 in FY11. MNYL‟s expense ratio is

expected to fall to 18% from FY12 onwards.

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Proactively try and shape the regulatory agenda: The insurer has launched products confirming with DTC

and hence avoid any discontinuity after the tax changes. Moreover, Max it is one of the best placed insurance

companies to cope up with ULIP regulation given its low dependency on these products. Going forward MNYL

expects to maintain a 60:40 Traditional to ULIP mix.

Due to these changes MNYL has managed to turn profitable in FY11 with all product lines also turning profita-

ble. For the future MNYL management has indicated that they will focus on the following

Keep check on costs

New Product Designs to boost margins

Keep distributors happy (grow bancassurance, and reduce overall cost of distribution)

New Business Margins will come down to around 13-14% but meant to stabilize at 15-16% within a

years‟ time

Other Key Information:

Management of MNYL: MNYL has a professional management team with a depth of experience.

Rajesh Sud: CEO & Managing Director - Appointed CEO and Managing Director with effect from November

1, 2008. Prior to this was responsible for setting up distribution strategy for individual life business. Worked

with ANZ Grindlays prior to joining MNYL.

Rajit Mehta: Executive Director & Chief Operating Officer - He is also on the board of the company. Has been

appointed as the Chief Transformation officer, to facilitate the organization through its transformation over the

next 2-3 years.

Ashish Vohra: Senior Director & Chief Distribution Officer - He is instrumental in maintaining the company‟s

distribution footprints across the nation and acquiring key partnership and bank distribution alliances.

Prashant Tripathy: Director - Strategic Planning, Business Development - Prashant looks after the strategic

initiatives of the company and works closely with cross functional teams for business development developing

long-term strategy His role is to identify and develop new opportunities, initiatives and assist in the support of

new and existing external relationships.

V Viswanand: Director & Head-Products and Persistency Management- Set up the company‟s Agency distri-

bution channel in South & East India, and thereafter launched the Bancassurance and Direct Sales Distribution

channels. Over the past six years, both channels have evolved to become significant strategic contributors to

Max New York Life‟s growth.

Stock Metrics and Performance:

Key Numbers

CMP Shares

Outstanding (m) Mkt Cap (m) Free Float (m) 52 Week High/low

205 257 52,595 26,320 132 / 214

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Max India Stock Performance

What Analysts Are Saying: Stock analyst generally have a bullish view on Max India, with most recent re-

ports putting the price target anywhere between 220-250.

III. Valuation

Value of a Life Insurance Business:

The value of a Life Insurance company is driven by its outstanding business and its potential future earnings

(Appraisal Value). Thus most analysts value Indian Life Insurers on the following formula:

Appraisal Value = Embedded Value + NBAP * Capitalization Factor

where:

Embedded Value = Net worth + Value in Force

NBAP (New Business Achieved Profit) = APE * New Business Margin

Capitalization Factor = Multiple Allocated to future earnings (Typically between 9-14x)

Value in Force = Present Value of the profits that will emerge from a block of life insurance policies over time

APE (Annual Premium Equivalent) = First Year Premium + 10% of Single Premium

Start of the Financial Crisis

IRDA regulations and subsequent underperforman

ce of the industry

Max share price has help up

exceedingly well despite market

downturn

Broker

Date of

Report

Px at time

of report Target

Upside From

Current Px

BoAML 28-Aug-11 176 222 8.29%

Sharekhan 16-Aug-11 185 234 14.15%

Execution Noble 01-Jun-11 167 248 20.98%

Goldman Sachs 18-Mar-11 144 190 -7.32%

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We will value the business of MNYL based on this formula, analyst expectations, and guidance from manage-

ment.

Value for FY12:

The below assumptions are taken after considering conversations with management from MNYL and analyst

estimates.

Key Assumptions:

*FY12 APE is assumed to be flat to slightly higher than FY11 APE as per management guidence

Valuation:

Step 1) Appraisal Value Sensitivity

MNYL Appraisal Value for FY12 (Rs. crore)

NBAP %/Cap Factor 9 11 13 14

10% 5362 5717 6072 6249

11% 5522 5912 6303 6498

12% 5681 6107 6533 6746

13% 5841 6303 6764 6995

14% 6001 6498 6995 7243

Step 2) Discounted for Max‟s shareholding, addition of value of other business, application of Holdco discount

Max Target Price

NBAP %/Cap Factor 9 11 13 14

10% 169 178 188 193

11% 173 184 194 200

12% 177 189 201 206

13% 182 194 207 213

15% 186 200 213 220

Key Assumptions

Value Notes

Embedded Value (Rs. crore) 3764 Analyst Average + Mgmt Guidance

APE (Rs. crore) 1775 Mgmt Guidance

No. Shares (Rs. crore) 23

Max India Stake 70% After Axis Deal

Holding Co. Discount 10% Analyst Average

Margin Range 10-15% Mgmt Guidance

Multiple Range 9-14 Analyst Average

Value/Share of Other biz. 26 Analyst Average

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Scenario Analysis:

Cases of Evaluation

Pessimistic case Base case Optimistic case

New Business margin 12% 13% 15%

Capitalization factor 9 11 14

Price of Max India 177 194 220

*These values do not take into account the impact of DTC. If this were taken into account each of the scenario

price targets would drop by ~4%.

IV. Conclusions

Key Positives:

Conservative Approach to Risky business: MNYL‟s new product line is focused on long term savings and

mass affluent clients to focus on stable future business. They have stayed away from particularly risky ULIPs

that their competitors are offering.

First Mover into New Paradigm: MNYL was the quickest to move into the new product mix where ULIP‟s

share is to come down. This has allowed them to grow when the industry has fallen. Other competitors are to

follow suit.

Cost Consciousness: While they still maintain one of the highest cost ratios in the business, the company has

taken drastic measures to reduce their costs, and is making strong progress.

Strong Management: The Management teams of Max and MNYL are made up of seasoned professionals who

have solid track records in the financial industry.

Strong Agent Force: MNYL is renowned for having the strongest agent force in the business, and the new

compensation patterns are conducive towards supporting and building the firm‟s new strategies. This force has

also been trimmed down, and is now leaner in terms of costs to the company.

Key Tie-Up with Axis: While they may have been late to the game in this aspect, the new Bancassurance tie-up

will help to boost margins, increase distribution channels, and reduce costly agent base.

No New Capital Needed: MNYL is well capitalized; they are running a 322% Solvency Margin compared to

the 150% required. There may however be a ~Rs. 400crore need by Max to fund their healthcare and health in-

surance businesses.

All Policies Generating Surplus: As per FY11, all policy verticals have turned profitable and are now generat-

ing a surplus

Marquee Investors: Max has the backing of key investors such as Warburg Pincus, Goldman Sachs, IFC, and

Temasek (see Appendix)

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Key Risks:

Valuations: Max seems fairly valued at the moment with a price of Rs. 205/share. Furthermore if DTC is taken

into account current valuations might actually be on the higher side.

Net Margins (ROE) to remain lower than Competitors: As MNYL has just broken even the ROE of Max

will remain lower than competitors. However the gap should continue to close as all product lines are now add-

ing to the surplus.

New York Life Agreement: Under the agreement with NYL, if the FDI limits are increased to 49%, NYL has

the right to buy an additional stake of 23% at a 10% discount to Fair Market Value. While this would mean ad-

ditional cash for Max, it could result in reinvestment risk if the money is not invested in assets which yield as

much as MNYL.

DTC: If DTC comes into effect it will affect the entire industry on two fronts. Tax on the company itself will

increase, and the tax benefits derived from buying policies will be reduced. This will be a big negative for the

industry, which could have an impact of 7-10% on embedded values.

Macroeconomic / market conditions deteriorating: India is currently in a high interest rate and high inflation

environment, and this coupled with economic weakness in, Europe and the United States provides for an unsta-

ble horizon. As the financial crisis in 2008 illustrated, when Indian markets fall, most (if not stocks) follow suit

due to the high amount of embedded correlation. However, the share price of Max has held steady during the

recent turmoil, illustrating its resilience and investor confidence.

Regulations have set Industry back: The new IRDA regulations have set the industry back three years. This

has impacted margins, new business, and it will take some time before these metrics return to a steady state.

Overall Conclusions:

Over the long term most analysts would agree that Max is one of the most well placed Indian Insurance compa-

nies. Its new strategies, tie-ups, and cost cutting should help it continue to gain market share in the industry.

However the stock price has run up quite a lot recently (perhaps a reward for a solid performance), which makes

it difficult to see any value left on the table.

However considering the strength of the company it would make sense to purchase the price on corrections.

Due to potential DTC implications, setbacks from regulation, and low margins for the next year, a price of

Rs.170-180/share would make this scrip very attractive.

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V. Appendix

1. IRDA Regulations

Solvency Margins: Have been reduced recently and this should favour insurer‟s capital requirements

Cap on ULIP charges: In July 2009, IRDA introduced a ceiling of 300 bps on ULIP charges for contracts up

to 10 years and 225 bps for contracts over 10 years, effective Sept 2010. Most private players‟ ULIP charges in

FY09 were in excess of this limit.

The cap is likely to reduce NBAP (new business achieved profits) margins of private life insurers.

In addition, IRDA has also capped the fund management charge (FMC) at 150 bps for a policy up to 10 years

and at 125bps for a policy with more than 10 year tenure. FMC for debt funds used to be typically in the range

of 0.8-1.5%, and for equity funds it was 1.5-2.5%.

Capping Surrender Charges: IRDA has stipulated that no surrender charge can be levied by an insurer for

policies rendered from the fifth policy year (i.e. the policyholder would be entitled to receive the full fund value

on surrender after five years, albeit in annuity). This makes the policy more attractive for policyholders but caps

margins and reduces cash flow for insurance companies.

If however the Policy holder chooses to surrender before five years following charges will apply.

If the premium is less than Rs. 25,000: Lower of 20% of the Annual Premium/Fair Value of the Policy

up to a maximum of Rs. 3000

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If the premium is greater than Rs. 25,000: Lower of 6% of the Annual Premium/Fair Value of the Policy

up to a maximum of Rs. 6000

Lock In period of minimum 5 years and Minimum Paying term of 5 years: New IRDA guidelines require

lock in period of minimum 5 years (previously 3 years). Thus it is a negative for investors who were looking at

ULIP‟s over a short term investment horizon. This would reduce the amount of policies being sold by the insur-

er.

Rationalisation of distributor’s commission: The commission being paid to distributors has been capped, and

the commission will not be completely charged in the first year, instead spread over five years. Thus the distrib-

utors would have to ensure higher persistency rates for the policies.

Minimum Guaranteed return of 4.5% for pension products: This regulation has lead to most of the insurers

dumping the product as this regulation made the product highly unattractive for the insurers. This regulation

does not make much of a dent as the pension products formed a miniscule portion of total premium underwrit-

ten by private insurers.

Minimum sum assured: Change in this regulation has lead to insurers maintaining more capital as reserves.

Before After

Regular premium 5x AP Age < 45 years: higher of 10x AP or 0.5x tenure X AP

Age > 45 years: higher of 7x AP or 0.5x tenure X AP

Single premium Tenure < 10 years:

125% of SP

Age < 45 years: 125% of SP

Tenure > 10 years:

110% of SP

Age > 45 years: 110% of SP

Foreign Direct Investment: The government proposes to raise the foreign ownership ceiling for private sector

insurance companies from 26% currently to 49%. A rise in foreign ownership limit is directionally positive for

the insurance industry. Such a step will facilitate access to international capital, in turn enabling players to en-

hance their capital base for business expansion and aid value unlocking in the sector. No regulation has still

been passed.

2. Definitions of Policies

Term Insurance: Term insurance is the simplest form of insurance policy which covers only the risk of the in-

sured. The policy has no maturity value and the insurance company is liable to pay any amount only in the

event of death of the insured. This policy is not very popular in India, owing to

a) Indian mindset of „getting something back‟ at the end of the term

b) Lack of awareness as LIC never marketed such kind of policy

c) Agent don‟t push it aggressively as commissions are low on such policies

19

However these kinds of policies are more profitable for insurance companies as the NBAP (New Business

Achieved Profit) margins for such policies are around 43%. The upside for an insurance company for such poli-

cies comes from the mortality savings and the higher return on investments as the entire AUM belongs to the

insurance company.

Endowment: Endowment policies were the most popular form of insurance in India before Unit Linked prod-

ucts. These policies combine the risk element with the savings elements making it a more attractive proposition

to market. Agents also aggressively market such policies as the commission rates of such policies are the high-

est and it requires less effort to sell compared to term insurance.

Profitability on these policies is also high with NBAP margins ranging from 30%-35%, depending on the nature

of the policy (participating v/s non participating) and the actual returns on the AUM. In case of an endowment

policy insurance companies deduct charges from the premium amount (the deduction is largely adhoc and is

based after factoring in a level of expected mortality and economies of scale) and the balance is invested. In

case of participating policies 90% of the return made on the invested is given to the policyholder while in case

of non-participating policies the insurance company declares bonuses depending on the actual return (typically

range from 50-90%) The revenue stream for insurance company in endowment policy comes from mortality

gains, economies of scale and the surplus return on investments.

Unit Linked policies: ULIP are called as non-traditional policy, as its been introduced only after the private

players entered the market. However it has seen a sharp growth in demand and accounts for 80-90% of the in-

cremental market share. While initially the ULIP‟s generated significantly high NBAP margins for insurance

companies, the margins have since then come down, owing to rising competition and increasing awareness.

ULIP NBAP margins now, range around 20%.

Unlike endowment policies, insurance companies have to upfront mention the load charges that will be de-

ducted from the premium income towards risk premium, operating expenses and agent‟s commission. Also any

return on investment on ULIP would accrue fully to the insured. Thus the revenue stream for the insurance

company in such policies comes from the 1-2% asset management fees and the savings from mortality gains

(very limited as typically sum insured is very low) and c) economies of scale (again very limited as large econ-

omies of scale is already priced in by most of the insurance companies)

Single Premium Policies: Single Premium policies have also gained significant traction in the past 12-18

months, however, largely in the ULIP space. Single premium policies are least profitable from NBAP margin

point of view (as all the income is received upfront) and NBAP margins range from 3-4%. Single premium pol-

icies could be endowment or ULIP, however require only one premium to be paid upfront.

Pension: Pension policies form a miniscule portion of the total premium income as the pension sector in India

is not fully opened up. Pension policies involve a series of annual payments by the insured over the term of his

employment, which is invested by the insurance company and which cumulatively (including the return) is re-

turned to the insured on his retirement either by way of bullet payment or by annuity.

Group Insurance: Group insurance is an insurance coverage plan that covers a group of people who are the

employees of a common employer, group of professionals or society members, etc; under one master policy. A

common feature in most of the group insurances is that the premium cost is not based on the risk. In fact, the

premium paid by every member is the same. For example, in case of group health insurance plan of a company,

all the employees are under the same coverage and pay the same premium amount. They receive the same bene-

20

fits irrespective of their age or other factors. Group Insurance plan allows the members to purchase or renew

coverage during their association with the group subject to fulfillment of specific conditions. The payment of

premium for a group insurance policy is managed by payroll department of company where certain portion of

employee salary can be deducted towards premium payment or in some other cases company itself bears the

entire cost of policy as a means of benefit for employees.

3. Details on Proposed DTC

Tax rate: Currently, insurance companies are subject to a 12.5% tax rate and most have priced their products

using this tax rate in their calculation. The new direct tax code proposes to increase this tax rate to 25%, which

would hurt the profitability of insurance companies. The new DTC also proposes to allow companies to carry

forward losses to set off against future profits for an unlimited period, compared with 8 years currently. This

will enable insurance companies to set off losses even if breakeven gets delayed by a couple of years. However,

given that a large chunk of these losses were incurred over FY06-09 (which means set-off available till FY14-

17), most insurance companies would have been able to set off losses within 8 years. Hence, the extension of

the setoff period may not have a significant implication.

Taxation on maturity: The new DTC also proposes to tax the maturity proceeds of all savings, including in-

surance policies. Currently, maturity proceeds of an insurance policy are tax-free. Increasing tax incidence on

investments would discourage savings in general but the impact on insurance savings is likely to be more se-

vere, as insurance products would lose its relative tax arbitrage vis-à-vis other financial-savings products.

Minimum Alternate Tax: The new DTC also proposes minimum alternate tax (MAT) at 2% on policyholders‟

assets, which, if passed on to the policyholders, can lower investment returns further.

Minimum sum assured: For the annual premium to be eligible for deduction under 80C, the minimum sum

assured should be 20x annual premium. This regulation if effective might act as a deterrent for investors choos-

ing between insurance policies and other financial instruments. Till the time of compiling of this report , no formal word was out on DTC

4. Shareholding Structure of Max India

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5. Broker Estimates

FY12 Estimates (rs. crore)

Execution Noble Goldman Sachs BofAML

Embedded Value 3,770 3,744 3,780

Appraisal Value 6,477 6,929 6,118

6. Alternative Valuations

7. Key Management of Max India

Analjit Singh: Executive Chairman - The driving force behind Max Group‟s sustained growth and success in

the early 80s. Is an alumni of the Doon School and Graduate School of Management, Boston University.

Rahul Khosla: Managing Director – Expertise developed over 27 years in financial services having worked in

India and Singapore with organizations such as Visa, ANZ Grindlays, Bank of America, and American Express.

Prudential PLC 0.81

CNP Assurance 0.53

Old Mutual 0.58

Legal and General 0.72

Standard Life 0.61

St. James Place 0.84

Average 0.68

China Life 1.420

Ping An 1.510

CPIC 1.690

Average 1.54

AIA Group 1.397

CTIHC 1.420

Average 1.41

Bajaj Finserv 1.644

Aditya Birla Nuvo 1.720

Reliance Cap 3.463

Max India 1.315

Average 2.04

India

P/EV Multiples

Europe

China

Hong Kong

Company ROE FY11Implied Multiple for

LI Biz.

Max India 9.78% 11.33

Bajaj Finserv 50.37% 13.00

Aditya Birla Nuvo 23.57% 11.00

Reliance Cap 1.03% 11.00

Average 21.19% 11.58

Local Comaprisons (Analyst Averages)

P/EV Multiples: This table illustrates that insurance compa-

nies in developed markets typically trade at a P/EV of less

than 1, where as in developing markets this multiple is typi-

cally greater than 1. This difference implies that in developed

markets much of the value of a Life Insurance Company is

driven by EV rather than the New Business multiple as busi-

ness have matured. However in developed markets where the

businesses are quite new, the new business multiple makes

up most of the value.

Local Comparisons: Max tends to have a lower ROE than

some of its competitors due to it just breaking even, however

this should move up steadily as all product lines are now in

surplus. Furthermore the Implied multiple used for Max‟s

valuation seems in line with the rest of the industry.

22

Is a Fellow Member of the Institute of Chartered Accountants of India and holds a Bachelors degree with hon-

ors in Economics from St Stephen‟s College, Delhi.

Mohit Talwar: Director, Corporate Development – 31 years experience with the Oberoi Hotels, Bank of No-

va Scotia, Grindlays and Standard Chartered. Post Grad in Arts and Hospitality management.

Sujatha Ratnam: CFO – 22 years experience in Jubilant Organosys and Tata Motors. CA qualified.