Art Of Pricing Insurance IPOs

The Current Valuations May Not Be a Good Proxy for the Future

- Alok Bansal

There is quite a bit of euphoria in the stock market around the initial public offerings (IPOs) of insurance companies these days. Four IPOs of leading companies – ICICI Prudential Life, ICICI Lombard, SBI Life and General Insurance Corporation of India – have already been concluded. Some more, such as public sector insurer New India Assurance and private sector companies HDFC Standard Life and Reliance Nippon Life, are expected in the near future.

All the stocks of insurance companies that have been launched so far were oversubscribed. However, doubts have been raised about valuation of these stocks, and most analysts have cautioned that they may not give good returns in the short term.

Let’s see how valuation is done in the insurance sector.

The valuation exercise in the context of an insurance company (as it is in any valuation exercise) is more of an art than science. It involves not only measurement of past performance numbers, which is not difficult, but also a reasonably accurate estimate of future performance which is always tricky as it involves lot of assumptions. Through an insurance contract, insurer and insured enter into a multi-year contract (except for certain short tailed lines of businesses like travel, motor etc.). This has a direct implication as profits of an insurer cannot be determined with accuracy at the end of each financial year. They would hold considerable amount of capital and premiums in the reserves account to ensure they have ready capacity to meet the claims obligations as and when the need arises in future.

To assess the value of an insurance company, more specifically a life insurer, three components should be taken into consideration: Adjusted net asset value, value of in-force business (the sum of these two constituents is known as the embedded value), and value of future new business.