Can you tell me more about this embedded valuation of LIC and how this embedded value sharply increased in six months?
Answer
Answer
In the draft red herring prospectus (DRHP) filed for the LIC IPO, there is a separate section showing embedded value calculation for LIC. Here is what the embedded value means and why it was up so sharply.
a) The embedded value is the actuarial valuation for an insurance company and is the basis for valuing in the market. Embedded value combines the cash flow power of the insurer for the present and also the future.
b) In the case of LIC, Milliman Advisors was appointed to work out the embedded valuation of LIC, as they are world renowned specialists in that. The global benchmark to peg market value an insurance company at 2.6 times to 4.1 times the embedded value.
c) Based on the mandate, Milliman arrived at the embedded value for LIC at Rs.539,686 crore. However, what is more interesting is that the embedded value of LIC stood at Rs.95,605 crore in Mar-21 but shot up 496% to Rs.539,686 crore by Sep-21.
d) This spike in embedded value was achieved by LIC by changing the methodology of holding and distributing its surplus. Instead of holding under one consolidated head, LIC bifurcated into participatory and non-participatory funds, which boosted the EV.
e) Look at the numbers. LIC’s Consolidated Life Fund stood at Rs.34.33 trillion in Mar-21. Post classification, LIC had participatory fund of Rs.24.57 trillion and non-participatory fund of Rs.11.37 trillion. Now shareholders get 100% of non-participatory surplus and up to 10% of participatory surplus. That explains the boost in embedded value.
f) To sum it up, in the old scenario, value of non-participatory surplus was a small fraction. With bifurcation, non-participatory surplus goes entirely to shareholders. This was reflected in higher Embedded Value distributable to shareholders.
g) That is the reason, the embedded value of LIC got boosted by nearly 6-fold between March 2021 and September 2021. The net result of this exercise was a much higher valuation for LIC by just tweaking the way its surplus was accounted for.