The curious case of jump in LIC's embedded value

Life Insurance Corporation of India's (LIC) draft red herring prospectus (DRHP) has understandably garnered a lot of interest. While the valuations at which the shares are offered to the investors remains to be seen, one factor that clearly stands out is the huge jump in embedded value (EV) in a short span of time.

EV is the present value of future profits plus the market value of net assets. For life insurance companies, one valuation parameter is looking at multiples of EV.

As per the Milliman report in the DRHP, LIC's EV as on 31 March 2021 stood at Rs95,605 crore. In six months, the EV surged to Rs539,686 crore. The rise is due to shareholders' interest in the non-participating funds increasing to 100%.

Earlier, the insurer had only one fund and the valuation surplus from the participating (par) and non-participating (non-par) business was distributed between policyholders and shareholders in a ratio of 95:5.

With effect from 30 September 2021, LIC has a participating fund and non-participating fund as a result of amendment in the Life Insurance Corporation Act by the Finance Act, 2021.

The entire surplus from non-participating fund is allocated to the shareholders and the ratio in par business will eventually reduce to 90:10 in line with the private players.

The Rs4.1 lakh crore is the difference between the EV before and after the amendment as on 30 September. Note that the government is looking to sell a 5% stake in the LIC IPO. Press reports have indicated a valuation of Rs10-15 lakh crore.