As regards the ongoing conflict between the IRDA and SEBI about jurisdiction over ULIPs, we believe 'status quo' will be difficult to maintain in light of the Finance Minister's comment on phasing-out the current 'front load' structure in the life insurance space. Such a structure, if implemented, will be significantly negative for the industry. The implementation would lead to sharp decline in sales & persistency in the short term, pressurise margins and have negative impact on valuations. · Current high commission structure seems to be the bone of contention. The life insurance industry sports a high commission structure, wherein the agent is paid a huge incentive on fresh sales that is currently capped at 40% of the first-year premium, with subsequent renewal commissions of 2-5%. Regulations have rendered mutual funds 'no front load' from August 1, '09. Given that ULIPs with a significant investment component contribute ~90% of incremental insurance sales, different incentive structures of the life insurance and mutual fund industries seem to have become a bone of contention between authorities, primarily SEBI and IRDA. · 'No-load' could lead to sharp decline in sales. In our view, the objective of phasing-out of high commissions has been partially achieved by the charge-caps introduced by IRDA (Annexure 1). We maintain that a 'no front-load' policy can lead to sharp decline in new business sales in the absence of strong incentives to agents to 'push' products. Sales agents may mull alternate career options as high commissions on new business give way to low trail commissions, thereby impounding their earnings. Agents, in the absence of new product sales, would be left with little incentive to continue business. · Risk to persistency, margins. At present, the primary source of insurance distributors' income is the high first-year commissions (ceiling at 40% of premium) from sale of new products. Moving to low trail commissions (2-5%) will impact persistency of existing products in the interim as service levels for existing customers suffers significantly. This might impact margins as companies will not be able to realise 'operating leverage' from strong growth in sales from the existing agency force. Hence, this will be a double blow to the new business margins of insurers due to falling persistency and absence of operating leverage. However, longer term persistency might improve as 'switching' & 'mis-selling' declines. · Maintain estimates as we await clarity. At present, valuations for most companies are driven by strong sales & margin outlook reflected in Goodwill (70-80%), while Embedded Value forms a smaller part (20-30%). Valuations of life insurance entities will suffer significantly if either the products become 'no-load' or SEBI stance on regulation of ULIPs is implemented. We await further clarity on the issue and keep our estimates unchanged. We believe it will be difficult to implement a 'no-load' structure, given the already high capital infusions, dependence of ~3mn agents on commissions and high proportion of ULIPs in sales. However, any ruling that advocates trail commissions or a ban on ULIPs will be significantly negative for the sector. Within our insurance coverage universe, Aditya Birla Nuvo, Reliance Capital and Bajaj FinServ will be most-impacted as life insurance business accounts for a significant proportion of their valuations. Impact on SBI and HDFC will be limited as insurance contributes a smaller proportion of their valuations.
Safe Harbor Statement:
Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.
Nothing in this article is, or should be construed as, investment advice.
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