HDFC Life Insurance Review | HDFC Life Insurance Business Model, Financials and Valuations.

HDFC Life Insurance Business Model, Financials and Valuations. Should you invest in HDFC Life Insurance?

Hello investors! here we'll talk about HDFC Life Insurance. We will talk about the business model, financials and valuations of HDFC Life Insurance.

Until 90's, there was a monopoly in the life insurance sector. It was dominated by Life Insurance Corporation of India (LIC). They didn't need to innovate and bring new products in the market because they knew they were the only players. But the Government allowed private players to enter this sector in 2000 and this is when HDFC Life Insurance company started. It started as a partnership between HDFC and Standard Life Aberdeen (well known provider of financial savings & investments services in the United Kingdom).

Management

The CEO is Vibha Padalkar. She has been in this company for more than 10 years. Prior to her appointment at HDFC Life Insurance, she has worked in varied sectors such as Global FMCG and in an international audit firm. She has done a great job in HDFC Life Insurance because this company is number one in market share among the private players.


Let's understand what these life insurance companies to do first. Basically it's a contract between a policyholder (customer), who will keep paying his premiums consistently and an insurance company, which will pay him if anything goes wrong but the products have changed a lot so we will talk about them. They do have many variations but at the end, they are divided into two products. We have linked and non-linked products.

Talking the difference between them. Let's start with linked. This company has earns 55% of their business with linked products. I'm sure you have heard about ULIP (Unit Linked Insurance Plan) but let's understand what this is.

Let's imagine that I'm a customer and I keep paying my premiums consistently to HDFC Life Insurance. A portion of the premium is utilized to provide insurance coverage and the remaining portion is invested in equity and debt instruments. So if the market moves up, my returns will be better but if the market goes down, my returns will decrease as well. So, it's linked with the equity market.

Now, let's talk about non-linked products. 45% of HDFC Life Insurance business comes from this segment. Non-linked products offer you protection and savings element built in. There are 2 categories in non linked products. The first one is participating policies and the second one is non participating policies. The reason it's called par policies is because you participate or share in the profits of HDFC Life Insurance company's par fund together with an insurance coverage.

The second product is non par policies, which is your traditional product, where you keep paying your premium and if something bad happens, the company will compensate you. You don't get any special payments here like par policies.

But how they sell these policies because many people think they sell all their product through their branches? You can see that they have various channels. The first one is Bancassurance, which contributes 64%. When a bank ties up with an insurance company to sell their product, it's known as Bancassurance. They have a big advantage here because everyone trusts HDFC bank. In the previous year, 28% of HDFC Life Insurance products were sold by HDFC group but they do have tie ups with other banks such as IDFC First and Bandhan bank.

4% of the business comes from Brokers and 13% comes from agencies. Please keep in mind when they get business from these sources, they will have to pay commission for this. Lastly, 19% of this business is direct, which means it goes through them directly .

How does HDFC Life Insurance work? 

Most of the companies are able to recognize revenue and profit once they have sold their product. But it's not the same with insurance companies and let me explain why.

Let's imagine that I own an insurance company and you want life insurance. Once everything is prepared, you will start paying your premiums, which is their first source of income but this is where all the problems start because even though I have started collecting premiums, I don't know whether I will have to pay you back the money as claim or not because if something bad happens to you, I will have to compensate for it. That's why we always look at the risk these companies are taking. We want them to take premiums but have as little claims as possible if we don't have to pay too many claims, we keep earning good money through premiums. So, the premiums are the first source of income.

What happens with their premiums? Let's imagine that you start paying premiums to me for many years and nothing bad happens to you so I have premium as a company, which I don't need right now as nothing bad happened. In this case, I will invest this premium and I will invest this in various places such as equities, bonds and real estate. As I will invest this money, I will be able to earn interest through that. This is their second source of income, which is investments.

Many international companies earn bulk of their profits through investments. There is one last source of income. As this business becomes profitable, the company takes these profits and invests that as well. They are able to earn interest on that profits. These are their three main sources of income.

Financials 

I will start with the balance sheet. Normally, I show you assets (properties, inventories and investment) and on the other hand we have liabilities, which is debt but we will see something different in insurance companies. Let's understand again how the business works. They make money through premiums and then they invest this amount. They are basically dealing with money. So we will see a big amount of money. Keep in mind, this is a debt free company. You already know this if you understood the business model. Total source of funds where the money is coming from.

The first one is shareholder's fund, which is 60 Billion ₹ . As HDFC Life Insurance keeps earning profits, this money will be going in shareholder's fund. So, they are showing you that 60 Billion ₹ is coming from shareholder's fund and that you have Policyholder's fund which is a bigger amount.

You might be thinking why this number is so big. As I told you before, when they collect premiums, they know that in the future, they will have many claims to pay. That's why it's such a big amount. As it's source of funds, it tells you that 1211 Billion ₹ is coming from the premiums as they know that in the future, they will have to pay many claims.

Earlier explained, all the money they earn, they will invest it later and that is the second category. It's showing you what they do with the money. So you can see that the shareholder's fund , they invest nearly everything and they do the same with Policyholder's fund. Now you understand why I wanted to explain the business model first.

Income statement and Some Changes 

Most of the companies have a simple product and they are able to make money once they sell their product but as explained earlier, insurance companies earn through premiums and investments. In this case I will show you only premiums because I want to show you the growth they have in their core business.

Keep in mind that they will have many expenses such as commissions but I didn't explain their biggest expense. As you know, they will be collecting premiums but they will have to settle many claims because something bad will always happen with some clients and this is their biggest expense, the claims they have to pay. Of course, they have to pay commissions and there are many more expenses involved with the business in this case. I will tell you their premiums and their profit of the last three years.

HDFC Life Insurance premiums went from ₹19,274 Crores in 2017 to ₹28,930 Crores in 2019. Their profits went from ₹886 Crores in 2017 to ₹1,277 Crores in 2019. They have shown good growth in premiums and profits .

This is where it gets interesting? Imagine that this company earns ₹100 Crores of profit this year and ₹200 Crores the next year. This is just an example. You might think this is a good thing but then, in the third year, they have to settle a lot of claims. This means that they will have to pay their clients and the money will go out of the business.

While we were getting excited for the profits of first and second year, now we realize that at the end, the company might not make so much money. That's why it's so hard to value insurance companies. You might know the profit they earned this year but you don't know the real expense that will come in the future.

Embedded value

Does this mean we can't value these companies? There is one metric that helps you, the Embedded Value. The insurance companies will tell you this value. So why is this so important? Embedded Value helps us to understand all the future profits the company will achieve from all the business they have done until now. So if HDFC Life Insurance company has given policies of ₹100 Rs, that won't be their real earning because they will have some claims in the future and they invest this money as well. So basically this value will tell you the value of this company based on all the business they have done until now and this also includes some extra cash that they don't need to run this business.

Basically, Embedded Value will tell you the value of the business and cash they have now. In this case, the embedded value of HDFC Life Insurance company is ₹18,301 Crores. In a way, we can say that the value of all the business they have done until now is ₹18,301 Crores.

You might be thinking that this is perfect because the company tells you the value of the business but there are some important points to know. The company is telling you the money they will earn in the future from the business done till now. This means that they have many assumptions. This means that this number is not perfect because it's a future calculation. They already gave the policies but we don't know how many claims they will get in the future.

This number is based on many calculations and assumptions so it's not an exact value but in this case, let's assume they are right.

Market Cap

If you take a look at the Market Cap, HDFC Life Insurance is ₹117,000 Crores. So why such a big difference? Embedded Value is ₹18,301 Crores and the Market Cap is ₹117,000 Crores. 

Let's understand the difference. Embedded Value helps us understand the value of the business done till now but the company will keep doing business in the future and that's why the company is so expensive and you see such a big gap between Embedded Value and Market Cap that's because many people think this company will grow at 20-25% their premiums and profits and this is where the problem lies. 

This is the main reason I won't invest in HDFC Life Insurance. This gap you see between Embedded Value and Market Cap is a lot. This gap is much small in other companies in this company. It is a very big gap because people expect this company to grow very quickly and they higher margins compared to other players but I would like this gap to be less. I will consider investing when the gap is smaller in HDFC Life Insurance.