28th December 2016 INVESTMENT PERFORMANCE of LIFE INSURANCE CORPORATION of INDIA
Introduction 1) More than six months ago, in the month of April, I received the following mail. “I am Hitesh Soni, a LIC corporate club agent from Jayanagar Branch, Bangalore, since 2010. I have recently received the below enclosed mail from my prospecting client and I was not able to answer. I solicit your kind analysis on the various aspects particularly in respect to investment efficiency of LIC of India”. Regards Hitesh Soni The client had forwarded an article written by Shri. Vivek Kaul, an investment expert, on the efficiency of the LIC in matters relating to investment of policyholders’ funds. I have reproduced below the main part of that article. ------------------------------------------------------------------------------------------------
Vivek Kaul’s Diary Why It's Best to Stay Away from Buying LIC Policies Thu, 21 Apr 2016 The Life Insurance Corporation (LIC) of India is India's biggest insurance company. It is also India's biggest investment firm
It is so big that it keeps coming to the rescue of the government now and then, when the government cannot find enough buyers for the financial securities that it wants to sell.
Nevertheless, the question is, how good is LIC when it comes to generating returns on the investments it makes?
Before we figure that out, it is good to point out that LIC is basically an investment firm which also sells insurance. A major portion of the money that it collects as premium from Indians, against the so called insurance policies that it sells, is invested in stocks and bonds (both private as well as government)
The insurance policies that LIC sells are basically investment plans with a dash of insurance. And given that the premium that it collects and in turn invests, should be generating decent returns for the policyholders (actually investors). Of course, the tragedy is that most of these policy holders don't even know that they are actually investors.
So how do things look? The accompanying table gives us the investment track record of LIC between 2005-2006 and 2014-2015. As is clear from the table the investment record of LIC has been dismal to say the least. In 2014-2015, the investment firm earned a return of 7% on its investments. The average return on the 10-year government bond during the course of the year was 8.3%. The investment return of LIC was 130 basis points lower than the average return on a 10-year government bond. One basis point is one hundredth of a percentage.
[These numbers may not reflect mark-to-market on certain investments and hence the investment income may be higher, though it cannot meaningfully alter the returns.] In fact, the difference between the average returns on a 10-year government bond during the course of a year and the investment returns of LIC vary between 40 basis points and
180 basis points. This is a huge difference. The average return on investment for LIC over a period of ten years between 2005-2006 and 2014-2015 has been 6.7%. The average return on a ten-year bond has been 7.9%. The difference between the two returns is 120 basis points. In fact, the average rate of inflation between 2005-2006 and 2014-2015 was 8.85%. Hence, the average return on investment of LIC was lower than the rate of inflation as well.
Year
Income from Investments (Rs. Millions)
Investments (Rs.Millions)
Return (%)
Average Returns on 10 year Govt. Bonds
Difference (No. of basis points)
2014 – 15
1,354,830
19,462,490
7.00%
8.30%
130
2013 – 14
1,180,970
16,846,900
7.00%
8.40%
140
2012 – 13
1,038,820
14,864,670
7.00%
8.20%
120
2011 – 12
902,670
13,495,320
6.70%
8.50%
180
2010 – 11
776,670
12,665,390
6.10%
7.90%
180
2009 – 10
671,980
10,968,410
6.10%
7.30%
120
2008 – 09
565,830
8,154,840
6.90%
7.60%
70
2007 – 08
479,990
7,568,910
6.30%
7.90%
160
2006 – 07
405,720
6,132,670
6.60%
7.80%
120
2005 – 06
354,790
6,240,170
6.80%
7.20%
40
Source: Annual reports of LIC ------------------------------------------------------------------------------------------------
2) Due to indifferent health, I could not respond immediately to the above important mail. Better late than never, it is said and so, I am giving now
my response to the above article. Let us first see how the yield on investments is determined. For the benefit of those who may not be familiar with the method, I have given in detail the working for the Financial Year 2014 – 2015. Determination of Investment Income 3) The Revenue Account for the year appears in pages 130 – 131 of the Annual Report of the year 2014 - 15. Here, the first item is “Premiums earned” and the second item is “Income from investments”. Consider only the income from investments of “Non Linked Business”, since the method of determining the income from investments is different in the case of Linked Business. Here too consider only “Within India Business” and ignore “Out of India”. TABLE – 1 (Calculation of Investment Income) All Amounts to the nearest Rupees (million) Within India Interest, Dividend, Rent Profit on Sale/Redemption Loss on Sale/Redemption Total Investment Income
With Profit
Without Profit
1,044,851
254,890
1,299.741
182,747
16,905
199,652
(1,393)
(10,204)
(8,811) 1,218,787
270,402
Total
1,489,189
4) It may be noted that Profit/Loss on Sale/Redemption of investments has also been taken as part of investment income. In the case of equities, actual income from dividends will be quite low; say, 3 to 4%. The main income from equities comes from appreciation in asset value. In the case of unit linked portfolio, the appreciation in the asset value during the year will be taken as investment income during the year. In the
case of non-linked (traditional) business, only the actual profit booked will be taken as investment income. But, any decrease in asset value will be taken as Loss both under Linked and Non-linked business. (As per the regulations of the IRDA, only that decrease in asset value due to permanent impairment of the asset has to be taken as loss and any decrease due to market fluctuations is not to be considered as loss). So, in the case of traditional, non-linked business, Profit/Loss
on
Sale/Redemption of investments has to be taken as investment income
during the year. 5) Yield can be obtained by dividing the Investment Income by the total Amount Invested. So, the next step is to find total amount invested. In the case of LIC, assets pertaining to shareholders are negligible and so, only assets in the policyholders’ fund will be considered. Even here, only assets under Non-Linked fund will be taken into account since, the total investment income calculated above pertains only to Non-Linked Funds. 6) Let us first determine the assets pertaining to the Non-Linked funds of policyholders. This can be taken from the Balance Sheet (Form A-BS, Pages 128, 129 of the Annual Report of 2014 - 15). This has been divided into two parts; ♦ Sources of Funds and
♦ Application of Funds From “Sources of Funds”, we can determine the total value of assets and from “Application of Funds”, the total amount of investments can be determined. 7) Let us first consider Sources of Funds. This has been broadly divided into four parts,
• Shareholders’ Funds, • Borrowings, • Policyholders’ Funds • Funds for future appropriations 8) In the case of LIC of India, • The amount in shareholder’s fund is negligible and can be ignored. • The borrowings are throughout zero and so can be ignored. • Funds for future appropriations are also negligible throughout and can be ignored. • Consider only the third item, Policyholders’ Funds. 9) Under policyholders’ funds, there are only three items pertaining to Non-Linked fund, viz. • Credit/(Debit) Fair Value Change Account • Policy Liabilities and • Insurance Reserves The value of an asset is taken as the lesser of the market value and the book value of the asset. The difference between the (sum of market value of all assets) and the [sum of the (lesser of the market value and book value) of all assets) is given in the first item “Credit / (Debit) Fair Value Change Account”. Since, in the case of Non-Linked funds, appreciation in the market value of an asset is not taken as investment income unless the profit is actually booked, while determining the total value of the assets, the first item has to be ignored, and only the second and third items have to be added. So, the total value of Assets (to the nearest million) in the policyholders’ fund is, (17,300,463 + 81,907 = Rs.17,382,370 million)
10) Next consider Application of Funds for determining the total value of investments. What is the difference between Assets and Investments, one may ask. Interest accrued but not due, is an asset but, it cannot be invested. Outstanding premiums, advances given to employees and agents, Furniture and fittings, Office equipments … etc. will all come in this category. They are part of the assets, but cannot be invested. Outstanding claims, outstanding agency commission, … etc. are not assets, but can be invested. Greater the proportion of the assets that cannot be invested higher will be the financial strain on the organisation. 11) The values of different types of investments given under Application of Funds are the market values. However, what is required for calculating the yield on investments is the “lesser of the market value and book value”. This information is not available In the Annual Reports. Generally, the value of amount invested will be between, 90% and 95% of the value of assets. For the present let us assume that that the value of amount invested is 100% of the value of assets. The yield on investment calculated under this assumption will be slightly less than the actual yield and this will not be very material for our purpose. 12) So, can we take the yield on investments during the year 2014 – 2015 as? (Total investment income during the year / Total value of assets as at 31st March 2015)
The answer is NO. Let us see why.
13) From the Balance Sheet of 2013 – 2014 (Pages124, 125 of the Annual Report of that year) it can be seen that the total assets as at 31st March 2014 was (15,076,662 + 82,560 = Rs.15,159,222 million). That is, as at 1st April 2014, the total amount invested would have been about 95% of Rs.15,159,222 million. This increased gradually and stood at 95% of Rs.17,382,370 million as at 31st March 2015. On the assumption that the increase was uniform, the average amount invested during the year 2014 – 2015 would have been approximately, 95% of [0.5 x (15,159,222 + 17,382,370)] = 95% of (0.5 x 32,541,592) = 95% of Rs.16,270,796 million. Assuming that the entire asset would have been invested and not just 95% of it, the yield during the year will be, (1,489,189 / 16,270,796) = 9.15%. 14) It was seen in paragraph 11 that the amount invested will be between 90% and 95% of the assets. Let us take it as 95%. So, if we assumed that only 95% of the assets would have been invested, the yield will be, (9.15% / 0.95) = 9.63%. If we assume that only 90% of the assets would have been invested, the yield will be, (9.15% / 0.90) = 10.17%. That is, the actual yield will be between 9.63% and 10.17%. In fact, the proportion of assets that is invested is generally nearer to 90% than to 95%. It was, ♦ 86.2% in 1988 – 89 ♦ 86.4% in 1989 – 90, ♦ 87.3% in 1992 – 93, ♦ ---------♦ 94.3% in 2011 – 12, ♦ 91.3% in 2012 – 13 and ♦ 91.4% in 2013 – 14.
15) So, the actual yield will be higher than 9.63%. Even this is a slight understatement. The assets would not have increased uniformly from Rs.15,159,222m to Rs.17,382,270m during the year. It would have increased very slowly during the first three months, April, May and June and very fast during the last three months, January, February and March. The life insurance companies in India therefore determine the amount invested at the end of each month and take the weighted average of these amounts during the year. This average will always be less than Rs.16,270,796 million, the average arrived at earlier. But, this information is not available in the public domain and would be available only with the companies and the Regulator (IRDAI). So, for the year 2014 – 2015, the actual yield on investments would have been higher than even 9.65%. Let us determine the yield on investments for a few more years. 16) This is given in Table-2, on the following page. It can be seen from this Table that, while the yield on assets increased from 8.91% in 2012 – 13 to 9.15% in 2014 – 15, it registered a sharp decrease in 2015 – 16 and ended up at 8.44%. What can be the reason for this decline? The (Net Profit/(Loss) on Sale/Redemption) which had been increasing year after year, registered a sharp decline in 2015 – 16. It was 1.14% of Average assets in 2014 – 15 and just 0.62% in 2015 – 16. Equities which used to constitute less than 3% of the total assets, about 25 years ago, now constitute about 20% of the total assets. Since increases in market value of assets will not be recognised unless the profit is actually booked, when the equity portfolio constitutes a significant proportion of the assets, it is essential to ensure that the actual profit booked maintains an increasing trend.
TABLE – 2 Investment Performance of LIC of India Yield on Investments during a Four Year Period All Amounts to the nearest Rupees (million) Within India Interest, Dividend, Rent Net Profit/(Loss) on Sale/Redemption Total Investment Income Policy Liabilities Insurance Reserves Total Assets Average Assets during the year
2011 - 12
2012 - 13
2013 - 14
2014 - 15
2015 – 16
842,038
973,041
1,119,047
1,299.741
1,454,621
63,798
119,802
152,172
189,448
114,806
905,836
1,092,843
1,271,219
1,489,189
1,569,427
11,300,993
13,106,728
15,076,662
17,300,463
19,725,860
61,484
59,409
82,560
81,907
81,798
11,362,477
13,166,137
15,159,222
17,382,370
19,807,658
---
12,264,307
14,162,680
16,279,796
18,595,014
8.91%
8.98%
9.15%
8.44%
9.38%
9.45%
9.65%
8.88%
Yield on total Assets
---
Yield on total Investments
---
• Note 1: The values of (Interest, Dividend, Rent) and (Net Profit/(Loss) on Sale/Redemption) have been taken From the Revenue a/c given in the Annual Reports of each year • Note 2: The values of (Policy Liabilities) and (Insurance Reserves) are to be taken from the Balance Sheet given in the Annual Report of each year. • Note 3: Average assets during the year = [(Assets at end of previous year + Assets at the end of current year) / 2]
• Note 4: Yield on total investments is obtained by dividing yield on total assets by 0.95, on the assumption that only about 95% of the assets can be invested.
The results given in the above Table will show that yields on investments obtained by the Corporation are quite reasonable. Different Classes of Investment Organisations 17) A life insurance company performs two basic functions. The primary function is to cover the risk to human life and the secondary function is to invest the premium received, net of expenses and charges for the risk cover. So, it can also come under the classification of “Investment Organisation”. There are two other major investment organisations in the country, Mutual Funds and Banks. 18) Mutual funds do not give any guarantee regarding the return on amounts deposited with them. They only promise to try their best to maximise the returns and so enjoy a high degree of freedom of investment. 19) Banks give guaranteed return, but only for short durations. The terms of most of the Fixed Deposits with the banks will be for three years or less. They invest a significant proportion of the fund entrusted with them, in short and medium term loans. The recovery of the loans granted is the major problem that the banks face. 20) The life insurance companies give guaranteed returns over long periods. In the case of life annuities, the period of guarantee may even extend beyond 50 years. Consequently, they have to exercise extreme caution while investing the funds entrusted with them. The Regulations that govern the investment activities of life insurance companies are also very stringent.
21) When security of long term investment is of primary concern, the yield will become correspondingly less. Very few writers on Finance & Investment understand these basic differences between different classes of investment organisations and the impact of these differences on the yield that can be obtained. Still lesser number of persons are able to appreciate the significance of long term guarantees and the difficulties involved in giving such guarantees. 22) In an environment of falling interest rates, unable to give long term guarantees, many life insurance companies in other countries began switching over to Unit Linked products. These products provide risk cover, but give no guaranteed returns and, in this respect, are similar to mutual fund products. For more than a hundred years, life insurance products were synonymous with guaranteed returns and risk cover. The
life insurance regulators round the world, turned a Nelson’s eye to this aspect while granting permission for Unit Linked Insurance Plans (ULIP) and the Indian Regulator too was too eager to copy the same, without any application of mind. It did not even take the elementary precaution of controlling operational costs, but gave a free run to the life insurance companies. When, with stock market crash of 2008, the policyholders lost millions of rupees, it did not even apologise for the glaring mistakes committed. 23) Napoleon Bonaparte once said that, “Peoples’ memory is short”. By 2015, people have forgotten what happened in 2008 and, the private insurers have started to market, more vigorously, the Unit Linked products. However, the agents of the LIC appear to have a better memory and are scrupulously avoiding the marketing of ULIP products.
Segments of the Life Fund of the LIC 24) The Life Fund of the LIC can be divided into three segments on the basis of investment patterns permitted by the Regulator. • Annuity Fund • Group Employee Benefit Fund and • The Balance Fund The investment operations of life insurance companies are strictly controlled by the Insurance Regulatory & Development Authority of India (IRDAI) and different sets of regulations are applicable to the above three segments. On the basis of investment pattern permitted, the yield on investment can be the highest under the Annuity Fund. The yield, in the case of Group Employee Benefit Fund, may come next. Cash Accumulation Scheme 25) A significant proportion of the Group business of the LIC comes under Cash Accumulation Schemes. The employee benefit funds (pension, gratuity and leave encashment funds) come under this Scheme. 26) In the case of funds under Cash Accumulation Scheme, only mortality charges are explicitly deducted. The operational expenses do not get explicitly deducted. If the yield on the funds under this scheme is, say y%, interest credited to the fund will be x%, where x will always be less than y. The difference between y and x will be taken as the charge towards expenses. Higher the fund size, lesser will be the value of (y – x). For very large fund, the value of (y – x) can be as low as 0.25%. 27) TABLE-3 on the following page gives the rate of interest credited during the years 2013 – 14 and 2014 – 15 for funds of different size.
Since yield on investments has to be higher than rate of interest credited, the figures in this TABLE will give an idea of the yield obtained on investments in the case of Group Employee Benefit funds. TABLE – 3 Rate of interest credited in the case of Group Employee Benefit Funds
Fund Size
Interest Credited (as % of the Fund) 2013 – 14
2014 – 15
Below Rs.100 million
8.75%
9.00%
Rs.100m or more but less than Rs.500m
8.85%
9.00%
Rs.500m or more but less than Rs.1 billion
9.00%
9.10%
Rs.1 billion or more but less than Rs.4 billion
9.05%
9.15%
Rs.4 billion or more but less than Rs.6 billion
9.20%
9.30%
Rs.6 billion or more but less than Rs.8 billion
9.30%
9.40%
Rs.8 billion or more but less than Rs.10 billion
9.35%
9.45%
Rs.10 billion or more but less than Rs.20 billion
9.40%
9.50%
Rs.20 billion or more but less than Rs.50 billion
9.45%
9.52%
Rs.50 billion or more
9.50%
9.55%
28) The Annual Report of every organisation will give a wealth of information. To understand fully the information contained in these Annual Reports, one should have good domain knowledge of that organisation. Before the formation of the IRDAI (Insurance Regulatory & Development Authority of India), the LIC’s Annual Reports used to give much more information in a simpler format. The value of an asset was being taken as the lesser of the book value and market value. A
statement was being given in Form AA, showing the book value and market value of each class of asset. For example, in the year 1992 – 93 (Page No. 119 of the Annual Report), the book value of Shares of Companies is given as Rs.14,598 million, with the corresponding market value, Rs.69,534 million. There was no “Fair Value Change Account”, giving in an opaque manner, just a single figure for the difference between the (sum of market value of all assets) and the [sum of the (lesser of the market value and book value) of all assets. The Revenue Account gave only details of Income & Outgo. This simple format has been changed by combining with the Revenue Account a part of the Valuation Balance Sheet and that too, in an unsatisfactory way. In those days, one need not even be a student of commerce, to understand the Revenue Account and Balance Sheet of the LIC. Now, with the so called globalisation, simple things have been needlessly made more complex.
28th December 2016
R.RAMAKRISHNAN (Actuary)
