Mixed margin trends even as sharp VNB declines for all.

1QFY21 Summary: Mixed margin trends even as sharp VNB declines for all. Life insurers (HDFC Life, ICICI Prudential Life and SBI Life) reported 29-43% yoy declines in VNB in 1QFY21 on the back of lower APE. Shifting the product mix to non-par/protection expanded margins for ICICI Life and SBI Life while a high non-par base compressed margin for HDFC Life. Other highlights are strong expense management (a combination of pullback in fixed and variable expenses) and lower persistency likely due to a reprieve granted by IRDA. We retain BUY on SBI Life (FV Rs1,050) and ICICI Prudential Life (FV Rs500) while rich valuations drive REDUCE for HDFC Life (FV Rs560).

HDFC Life: Steep 43% yoy decline in VNB in 1QFY21

HDFC Life reported a 43% yoy decline in VNB in 1QFY21 on the back of 30% yoy decline in APE and 550 bps yoy VNB margin compression. A drop in the share of protection business by 470 bps yoy to 13.1%, led by 81% yoy decline in group protection (credit life down 74% yoy) and 65% yoy decline in non-par savings business to 27% (high base on 51% in1QFY20) of overall APE led to the compression. This was likely amplified by lower operating leverage during the quarter.

ICICI Prudential Life: Low APE growth and lower protection margin led to 35% yoy VNB decline

ICICI Prudential Life reported 35% yoy decline in VNB on the back of a 44% decline in APE. VNB margin expansion to 24.4% (up 340 bps yoy/270 bps qoq) was driven by a decline in share of ULIPs (down 2,760 bps yoy) and increase in the share of high-margin protection policies (1,145 bps yoy) and non-linked policies (up 1,615 bps yoy). However, the margin within protection was down yoy as the company did not fully pass on hikes in reinsurance rates to its customers. Persistency of 81.8% in the 13th month for 2MFY20 was lower than 82.5% built into its assumption, however, the company highlighted that that the same has not yet been reflected in its VNB margins as persistency is improving mom (82.2% in June).

SBI Life: VNB expansion tempered by lower protection margins and interest rate fall

SBI Life reported a 29% decline in VNB; this was driven by a 32% decline in APE. Overall APE declined, while non-par savings were up 3.6X yoy, to 18% of APE. Protection was down 24% yoy; individual protection was down 36% yoy. Unlike its immediate peers, SBI Life is yet to see strong traction in the individual protection segment even as its credit protection remained strong as SBI pushed this product to existing home loan borrowers. Weakness in capital markets continued to pressure ULIPs (down 51% yoy). VNB margin expanded 80 bps yoy to 18.7% despite a 620 bps yoy expansion on account of a change in product mix towards a higher share of non-par and protection mix, the difference was largely due to a decline in interest rates (mostly affecting non-par business) and rise in reinsurance rates which was not passed on.

Attractive entry points for SBI Life and ICICI Prudential Life; rich valuations for HDFC Life

SBI Life’s focus on non-par business and HDFC Life’s diversified product bouquet augur well for superior VNB growth, while ICICI Prudential Life will likely face challenges on the APE front. HDFC Life (FV Rs560) continues to trade at a significant premium to peers, driving our REDUCE rating; we find attractive entry points for SBI Life (BUY; FV Rs1,050) and ICICI Prudential Life (BUY FV Rs500), though near-term volume challenges persist for ICICI Prudential Life.

Steep decline in VNB in 1QFY21

• Decline in APE growth higher for life insurers with high share of ULIPs. Life insurers reported a 30-44% yoy decline in APE in 1QFY21 owing to lower volumes due to lockdowns and a sharp decline in ULIPs led by weakness in capital markets. ICICI Prudential life and SBI Life with a higher share of ULIPs declined at a faster pace compared to HDFC Life which has a diversified product bouquet. SBI Life’s fall in APE was cushioned by strong growth in the non-par segment while ICICI continues to remain cautious in this segment, thereby leading to weak APE.

                We expect a 2-19% decline in APE for life insurers in FY2021E (down 2% for HDFC Life, down 19% for ICICI Prudential Life and down 8% for SBI Life) owing to lower volumes in 1QFY21 and pressure on ULIPs. A balanced product suite and ability to toggle between product classes will help HDFC Life report better growth compared to peers. SBI Life will focus on increasing non-par business (on a low base) and cushion APE decline. ICICI Prudential Life will however face dual challenges of lower ULIP volumes and a cautious stance in the non-par segment, driving a steep decline in APE.

• Individual protection strong for HDFC Life and ICICI Prudential Life; credit life relatively better for SBI Life. Individual protection APE was up 51% for HDFC Life. ICICI Prudential Life does not report individual protection APE on a quarterly basis, though management attributed a significant proportion of protection growth to the retail business. Contrary to these insurers, SBI Life’s individual protection APE was down 36% yoy. The company’s protection product is yet to gain traction through the agency channel.

                Credit life was strong for SBI Life compared to peers. ICICI Prudential Life and HDFC Life saw >70% yoy decline in credit life during the quarter owing to lower disbursements by financial institutions. SBI Life focused on cross-selling credit life to existing customers (who had previously not opted for credit life) and this segment saw strong traction. Management guidance suggests that demand remains strong in this segment post the pandemic as customers display increased risk aversion.

• HDFC Life’s growth driven by par, while non-par strong improves for SBI Life and annuity for ICICI Prudential Life. In the savings business, key drivers for growth differed across players with par driving growth for HDFC Life (up 2.9X yoy) (27% of overall APE in 1QFY21 compared to 16% in FY2020) while non-par was strong for SBI Life (up 3.6X yoy) (18.1% of overall APE in 1QFY21 compared to 6.6% in FY2020). ICICI Prudential did not report APE mix for the non-linked savings business, though annuity was strong for the company (new business premium up >10% yoy). Annuity APE on an individual basis declined ~22% yoy for HDCF Life. SBI Life reported a 59% yoy decline in par segment.
• Impact of change in product mix on VNB margins yet to reflect fully. VNB declined 29-43% yoy for life insurers on the back of a sharp decline in APE. VNB margins expanded 340 bps yoy for ICICI Prudential Life, led by a sharp increase in protection APE to 26% in 1QFY21 from 15% in 1QFY20 and decreasing share of ULIPs in savings business; this was however partially offset by a rise in reinsurance rates which was not fully passed on by ICICI Prudential Life (the company however increase high margin tele-medical based protection policies from mid-May providing some cushion to margins). Similarly, SBI Life’s VNB margins expanded 80 bps yoy; the share of non-par savings and protection increased to ~31% in 1QFY21 from 14% in 1QFY21. A sharp change in product mix, however, did not fully reflect on expansion in margins largely on account of (1) increase in reinsurance rates which have not been fully passed on to retail customers and (2) lower operating leverage due to sharp decline in ULIPs. A drop in VNB margins by 550 bps yoy for HDFC Life was led by lower non-par and group protection in 1QFY21 compared to 1QFY20. However, increasing share of the new par product and drop in ULIPs provided some support.

        We expect life insurers to report flat to 400 bps yoy VNB margin expansion in FY2021E thereby leading to 2-4% yoy decline in VNB. The expansion in margins will be an interplay of (1) increase in protection mix, (2) reprised protection product sold in 2HFY21 for ICICI Prudential Life and SBI Life, (3) gradual improvement in operating leverage and (4) increase in non-linked savings businesses and drop in ULIPs. HDFC Life will however likely reorient its product mix towards higher share of par and lower share on non-par savings thereby leading to flat VNB margins in FY2021E (on a high base).

• Bancassurance better for HDFC Life versus others. The share of APE through bancassurance channel declined 58% yoy (share of bancassurance down 1,285 bps yoy) for ICICI Prudential Life and 40% yoy for SBI Life (share of bancassurance down 720 bps yoy), while it was down 18% yoy for HDFC Life (share of bancassurance increased 300 bps yoy). The sharp increase in business through banca for HDFC Life was driven by traction in par and term insurance products through this channel. Normally, ULIPs are the dominant product across banca channel and a sharp decline in ULIP volumes led to the drop in share of bancassurance for ICICI Prudential Life and SBI Life.

                Direct and online channels reported marginal 7% yoy decline for HDFC Life (share of these channels increased 400 bps yoy) owing to strong traction in par and term insurance business through direct channels while it was up 29% yoy for SBI Life led by strong growth in direct channels. Direct channel for ICICI Prudential Life was down 46% yoy (share down 55 bps yoy).

• Persistency ratios have declined across most players. On a sequential basis, persistency trends were weak cross most companies. Management of most of these players highlighted that customers utilized grace periods for renewals and as such, mom trends are encouraging with renewals gradually picking up. Persistency trends for most players have improved sequentially from trough levels observed in April 2020 and early trends in July are better than June 2020. ULIP persistency has been weak over the past few quarters and has declined across select buckets for most players. HDFC Life’s management guided that ULIP persistency is weaker for high ticket ULIPs. Broadly speaking, protection persistency has held across these insurers.

                We expect persistency to remain weak in FY2021E due to a higher focus on capital preservation by retail customers. This will likely lead to marginal negative variance for these players.

                On a qoq basis, persistency held on relatively better for HDFC Life followed by SBI Life (marginal increase in higher buckets), while it declined sharply for ICICI Prudential Life (likely due to higher share of high ticket ULIPs).

• Focus on cost efficiencies. FY2021E will see a sharp decline in APE for life insures owing to lower volumes in 1QFY21 and weakness in capital markets driving lower ULIPs. Amidst lower volumes, companies have increased focus on improving cost-efficiencies by

          (1)reducing/deferring discretionary expenses, (2) increasing share of variable cost in overall cost structure, (3) pause in business expansion and (4) renegotiation of various fixed expenses like rent. HDFC Life, which operates at higher cost ratios compared to ICICI Prudential Life and SBI Life, reported a sharp decline in cost/APE to 20.5% (down 815 bps yoy). Overall expenses declined 25% yoy HDFC Life. In contrast, SBI Life’s expenses were up 3% yoy; the company operates at best-in class opex ratio and further headroom for improvement in negligible. Despite focus on cost control, investment in technology/digital initiatives and sourcing platforms remain high.

• Solvency ratios improved sequentially. Solvency ratios increased for most players by 6-44% qoq in 1QFY21 led by improvement in equity markets. Capital position is comfortable for most of these companies. HDFC Life is however consider raising tier-II capital to the tune of Rs6 bn of strengthen capital buffers (solvency ratio of 1.9X is lower than ICICI Prudential Life and SBI Life at >2X) and has sufficient growth capital to drive its protection business as risk aversion has increased among consumer post the pandemic.

Source:Kotak Institutional Equities Research