LIC’s route to IPO

the story So Far: The Life Insurance Corporation of India (LIC) on Sunday filed its draft red herring prospectus to initiate the initial public offering (IPO) process. The government, which has 100% ownership of LIC, will sell its 5% stake through an IPO. All proceeds from the IPO, which is in the form of an offer for sale and is expected to total at least ₹60,000 crore, will go towards meeting the government’s disinvestment target for FY22.

What does LIC do?

LIC makes money by selling a variety of life insurance products. The company collects premiums from customers promising to pay a certain amount as insurance cover in case of death, disability due to accident etc. Then like any other insurance company, when LIC pays less than what it collects as premium against individual claims annually. From all its policyholders, it makes profit.

The company also invests some of the premium and other surplus money it collects in stocks, government bonds and other investment products, adding the returns to its overall profit. LIC, which manages around ₹37 lakh crore in assets and underwrites three out of every four life insurance policies in the country, reported a net profit of ₹1,437 crore in the first half of FY22.

LIC distributes most of its profits back to the policyholders in the form of bonuses. In fact, LIC currently gives only 5% of its profits to the sole shareholder – the government. The remaining 95% of the profits are either invested back in the company or distributed as bonus to the policyholders. This allows LIC to market its insurance policies as investment products to its policyholders in addition to the element of risk coverage, although critics argue that the returns offered by LIC are low compared to other investments.

Why are policyholders worried about IPOs?

The government, which wants to sell its 5% stake in LIC to the public, has recognized that the way LIC distributes its profits may be a problem in attracting a lot of investors. Investors who buy shares of LIC want a substantial portion of the profit earned by LIC every year if they want to buy the shares offered by the government at the price desired by the government. Ultimately, the price investors are willing to pay for shares of any given company depends on the future cash flows they expect to own the shares. This means that the share of profits to be distributed to policyholders is likely to fall as the government tries to sell its stake in LIC at the best price. In fact, reports suggest that by FY25, the share of LIC’s profits that will be distributed to policyholders will come down from 95% to 90%, with the rest of the profits going to the shareholders, including the government. In short, as the government works hard to make its stake sale attractive to investors participating in IPOs, the returns that policyholders can expect from their policies may go down further.

what lies ahead?

Policyholders can reconsider their investment in LIC’s products as a percentage of LIC’s profits are redistributed to them, thus affecting their returns. Also, LIC’s primary appeal among policyholders has been the implied sovereign guarantee given by the Center, which has convinced policyholders to park their money with LIC despite the diminishing returns. In fact, in a country like India where there is no proper safety net for citizens, some have seen LIC as offering low but safe returns to millions of citizens.

However, proponents of the IPO argue that the benefits of greater private participation in managing LIC’s assets should affect the policyholder’s returns. LIC invests most of its capital in government bonds and this money can be better utilized in other ways which give higher returns and also help the economy. Higher returns can also accrue to policyholders if more competition is encouraged in the insurance industry. With a greater share of profits going to shareholders, returns will also become commensurate with risk.

It should be noted that LIC has been used as a piggy bank by the Center over the years to bail out many failed businesses. For example, the purchase of IDBI Bank by LIC faced criticism for not making any business sense. LIC’s investments in other struggling companies like DHFL, Reliance Capital etc. have also come under similar scrutiny. Such non-core use of LIC’s capital is likely to have greater resistance from shareholders when its shares are publicly traded. For example, the Center last year withdrew its decision to take a major chunk of IRCTC’s earnings as investors dumped shares of the company.