Explained | The amendment that helped LIC’s embedded value

The amendment to Section 24 of the LIC Act, brought prior to commencing the IPO, segregated the previously single ‘Life Fund’ into participatory and non-participatory fund.

State-owned insurance company LIC filed its Draft Red-Herring Prospectus (DRHP) on Sunday. Noteworthy among the risk factors mentioned by the corporation was the splitting of the single ‘Life Fund’ into participatory and non-participatory funds. This will, however, have a positive impact on LIC’s valuations as it approaches the primary market. 

Let us start with participatory and non-participatory policies. Under a participatory policy, a policyholder can get a share of the profits of the company. This is received as a bonus. Examples of such products offered by LIC include  Jeevan Labh and  Bachat Plus. No such sharing of profits happens under non-participatory products, which under the LIC fold includes policies such as  Saral Pension and  Nivesh Plus.

 As all insurance companies do, LIC also reinvests premium monies that policyholders pay. The profits or surplus that comes about as a result was till September last year held in one single fund. This was the Life Fund. The surplus was divided in the 95:5 ratio between policyholders (in the form of bonuses) and shareholders (which is the Government, in the form of dividends).

But the amendment to Section 24 of the LIC Act has necessitated the segregation of the Life Fund into participatory and non-participatory funds, depending on the nature of the policies they support.

The amendment stipulates terms on how surplus is to be shared with respect to participatory and non-participatory funds. As for non-participating funds, surplus from the non-participating business would be transferred to shareholders. Surplus from participatory business, however, would be shared between policyholders and shareholders. 

Yes, there is a change to the way the surplus is divided between the policyholders and the shareholders. While the surplus from the Life Fund was historically divided in the 95:5 ratio, as far as the participatory fund is concerned this ratio will change to 90:10, “in a phased manner,” according to the DRHP document. This is in line with how surplus is distributed in the private sector. The surplus in the non-participatory fund, on the other hand, will be fully available for distribution to the shareholders.

The change, especially the one that has enabled 100% of the surplus in non-participatory funds to flow to the shareholder, has led to a massive jump in the value of a key metric called the Indian Embedded Value, or IEV. A Reuters report calls IEV “a measure of future cash flows in life insurance companies and the key financial gauge for insurers.” It also says, “The embedded value will help establish the market valuation of LIC and determine how much money the government raises in the flotation. That will be crucial for the government to help meet its divestment targets and keep its fiscal deficit in check.”