M&A Critique

Consolidation trigger in insurance industry

The Indian insurance industry, which has been passing through a tough phase since the 2008 financial downturn and host of regulatory changes thereafter, is seeing cases of consolidation. The proposed merger of Max Life Insurance with HDFC Life is the first major consolidation move in the life insurance segment since the year 2000 when private insurance companies were allowed to operate.  The second such deal took place in the non-life insurance segment when L&T General merged with HDFC Ergo General Insurance recently.

The merger of Max Life and HDFC Life will create the country’s largest private sector life insurer with assets under management of over Rs 1 lakh crore and premium income of nearly Rs 26,000 crore. At present, Max Financial Services owns 68.01% stake in Max Life Insurance with the remaining share is with Mitsui Sumitomo Insurance and Axis Bank. Similarly, HDFC holds 61.63% and Standard Life holds 35% in HDFC Life, with the rest held by others. If the deal goes through, the new entity would be automatically listed. There would be no open offer because the merger is being pursued as an amalgamation through a scheme of arrangement under the Companies Act, which is exempted from the provisions of The Takeover Code. No cash will change hands and there will merely be an exchange of shares. The swap ratio for the merger is yet to be decided.  The combined embedded value of the two insurers is Rs 15,822 crore. The proposed merger, however, would be subject to due diligence, board, shareholder and regulatory approvals and other requisite approvals as needed.

In India, the insurance industry has 24 life insurance companies, 29 general insurance companies and five standalone health insurer, besides one each for re-insurance, agriculture and export credit. Even in the past, there were talks of mergers of quite a few companies, but the deals were not fruitful. In March 2013, L&T, Future Group and Generali Group had signed a non-binding term sheet for the merger of L&T General Insurance and Future Generali Indian Insurance. However, a year later they called off the merger due to inordinate delay in finalizing the transaction.

Max Life-HDFC Life: The two to tango

The proposed merger will be executed in two steps. At first, Max Life will merge with its listed parent Max Financial Services, which owns 65% in the subsidiary. After that HDFC Life will merge with Max Life paving the way for the listing of HDFC Life, which till recently was independently pursuing plans for an Initial Public Offering like ICICI Lombard. Max Life and HDFC Life have complementary strengths and strong bancassurance channels. The merger will bring in strong product synergies as HDFC Life is strong in unit-linked insurance plans or ULIP, while Max Life has a higher share of non-ULIP products.  The transaction will also give a leg-up to its distribution model. HDFC Life is a strong player in western India while Max Life is dominant in North India. The deal will elevate HDFC Life to the number one slot followed by ICICI Prudential Life and SBI Life. At present, ICICI Prudential is the market leader in the private sector with a share of 23.1% at the end of March 2016. The combined market share of HDFC Life and Max Life would be an estimated 24.7%  out of the share of private insurer. State-owned Life Insurance Corporation of India commands the lion’s share of the total market at 73.05%, according to the annual report of Insurance Regulatory and Development Authority of India.

Also, despite being the fourth largest player among private life insurers with assets under management of Rs 35,824 crore as on March 2016, Max Life is among the most profitable players in the business. Max Life’s net profit for FY16 stood at Rs 439 crore as compared with Rs 818 crore of HDFC Life on an AUM of Rs 74,247 crore. Given the better return profile of Max Life, the deal will be highly valued accretive for the shareholders of Max Life and Max Financial Services (MFSL), which holds 68% stake in Max Life. Moreover, the quality of Max Life is better than the others, there is a higher proportion of long-term savings business, healthy operational efficiency and strong bancassurance tie-ups.

HDFC Life will gain from the proposed merger deal as it will get access to equity market through reverse merger route as MFSL is a listed entity. The deal relieves HDFC Life of going through the initial public offering process.  The agreement provides for a mutually agreed exclusivity period for due diligence and discussions between the parties in relation to a proposed transaction.

Road ahead for consolidation

For the life insurance industry, falling growth in new business premium and increasing competition from top bank-promoted life insurance companies would force several insurers to rework their business models or look at mergers to survive and have meaning full growth to at least protect its present market share. Insurance business needs bigger asset under management and those companies that are promoted by banks have an edge over other insurers in terms of distribution. Non-bank promoted life insurers have to shell out huge sign-up bonuses to a bank to act as their corporate agent which even over a long period does not work out economically. So, smaller companies will look at merging to achieve economies of scale. Moreover, while insurers are focused on traditional endowment plans, people are looking at insurance cover for protection, health and annuity.

The merger of HDFC Life and Max Life could encourage other large companies to take similar steps to drive economies of scale, herby serving customer needs better. This is required as the industry is too fragmented now, with the top four of the total 23 private entities constituting 65% of the private life insurance market. Some of them have less than one percent market share and they risk irrelevance at a time when the need is to build scale and a better distribution network. This is because the expenses are still to come down to international levels and the scale is not seeing a significant rise – in fact, the life insurance industry, which was growing at a compounded annual growth rate of 35% from 2000 to 2008, has slowed down to six-eight percent in the past few years.

To find growth capital in such a situation is never going to be an easy task. Well-planned mergers will reduce costs and lead to more efficient use of capital to support solvency margin requirements. The merger of Max Life and HDFC Life, which will eventually lead to the listing of HDFC Life, will also help immensely in price discovery or unlocking of valuation in the market. Large insurance companies, born through such consolidation, will have the wherewithal to increase insurance penetration, which has stagnated at about 2% of GDP, compared to 7% in South Korea, 13% in Hong Kong and 16% in Taiwan.   With 66% of the country’s population being below 35 years of age, the favourable demographics provide great potential for the life insurance industry.

Also, apart from mergers and acquisitions, in order to reach the next phase of growth, insurance companies will look at listing on the stock exchange. Any insurance company operating in India for over 10 years can go for listing. In fact, ICICI Prudential would become the first major insurance company to be listed through an IPO after parent ICICI Bank decided to sell a part of its stake to the public. India’s largest private sector life insurer filed offer document with regulators for an issue that could raise around Rs 6,325 crore for the parent, while valuing the company at close to Rs 50,000 crore. Insurance companies will surely add novelty value to Indian stock exchanges as there are no listed entities yet.

While consolidation may be a good idea to raise insurance penetration, the joint venture structure of the insurance companies means that the process of exit by any promoter, if the need arises, would be complicated, and might involve complex discussions around valuation of the business.

Though consolidation is the need but for the consolidation to work there has to be proper synergies and the merging parties need to add value to the deal. A large company buying a smaller player will not get scale easily because the distribution for most life insurance players is not that great. Insurance companies will have to factor in that before looking at mergers as that is going to crucial for growth.

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M & A Critique