Indian insurers may merge for scale

More consolidiation could be on the way as life insurers cut M&A deals in a bid to compete with the dominant, state-owned player, say experts at S&P Global Market Intelligence.

Indian insurers may merge for scale

More mergers among Indian life insurers may follow HDFC Standard Life Insurance's agreement to take over Max Life Insurance, as they seek scale in a high-cost market dominated by a single state-owned company.

M&A is the quickest way for life insurers in India to gain share in a market controlled by Life Insurance Corp of India, or LIC, the sole wholly state-owned life insurer in India. Also, scale can help them counter high operating costs.

"From an M&A consolidation perspective, there will be activity. We do expect to see a couple of deals for sure," said Peeyush Dalmia, a partner at McKinsey & Co.

The merged company of HDFC Standard Life and Max Life, the industry's fourth- and sixth-largest companies by assets, respectively, will be second to LIC in asset size. It will also have the biggest market share in terms of new business for a private sector life insurer in India.

Even so, the industry's new No. 2 will hardly rival LIC. HDFC Standard Life and Max Life accounted for a combined 6% of industrywide new life insurance premiums in the first seven months of 2016, while LIC commanded a 73.7% share, up from 72.9% a year earlier, according to data from India's Life Insurance Council. The remaining 20% is up for grabs among 22 institutions.

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The two-dozen companies are competing for pieces of a seemingly promising industry. India's insurance market was the 12th-largest in the world in 2015 in terms of total premiums, with a low level of penetration that gives the sector abundant room for more growth, a Swiss Re report shows. The life segment is the larger part of the industry and raked in about US$20.54 billion in new premium income in the year to March, according to the India Brand Equity Foundation, a government agency promoting the country's products and services.

Yet, life insurance is a low margin business in India, with operating costs erasing most income. Operating expenses were equal to an asset-weighted average of 97.31% of operating income at the three largest life insurers in India in the 12 months through March, the highest level in a sample of seven emerging economies in Asia and Japan, according to SNL Financial data, an offering of S&P Global Market Intelligence.

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For most Indian insurers, maintaining sales resources is too costly relative to income they generate, Dalmia said.

"The market is huge but there are challenges in distribution. Unless you have an existing network to leverage, it is extremely expensive and time-consuming to build it bottom up. There aren't many successful examples," he said.

LIC can count on size to compensate for inefficiency. The company had a meager return on average assets of 0.12% in fiscal 2015-2016, compared to 1.63% for its current closest competitor, ICICI Prudential Life Insurance Co. Ltd. Yet, that adds up to substantial earnings for the state insurer, which at the end of March held 21 times more assets than the top private sector institution.

LIC's dominance means the economics of hiring sales agents work for the company, unlike for other life insurers, Dalmia said. LIC earned almost all of its premiums through agents and direct distribution channels, according to SNL data.

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"Expenses are very high. Distribution costs are still significant in India," said Bhavik Hathi, managing director and financial services lead at Alvarez & Marsal Transaction Advisory Group.

The three biggest life insurers after LIC are joint ventures between banks and foreign firms, so they have captive bancassurance channels, which can help them cut operating costs. Among them, at HDFC Standard Life, which can utilize HDFC Bank branches, bancassurance accounted for 76% of premiums earned in fiscal 2015-2016, the highest ratio in the peer group.

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Some companies may follow in the footsteps of Max Life, opting to merge with those with extensive bancassurance relationships, Dalmia said.

"Potentially, there will be more deals around bancassurance," he said.

Any such moves would intensify the fight for market share among Indian life insurers.

"Clearly the guys who are building up reserves will want to use that capital to increase market share. Whoever controls market share will have a better profitability profile," Hathi said.

The article is authored by Ranina Sanglap and Syed Salman Shah at S&P Global Market Intelligence.

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