HDFC Life Insurance Company Ltd.

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Initiating Coverage ICICI Prudential Life Insurance Company Ltd.

27-October-2020

Initiating Coverage HDFC Life Insurance Company Ltd.

HDFC Life Insurance Company Ltd.

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Industry LTP Recommendation Time Horizon

Life Insurance Rs.580.4 SIP Buy for 10-12% CAGR 2-3 Years

Our Take: We believe India’s highly underpenetrated life insurance space is still at a nascent stage and is attractively positioned to capture the huge growth opportunity. Large private players especially sponsored by banks are in better place to take advantage of this opportunity given their ability to push protection business by leveraging strong brand and existing network. The life insurance companies have access to adequate capital and can invest in online platforms. Also, insurance industry’s inherent nature of long gestation period to break-even (9-10 years) and need for bancassurance partnership provides a very bleak visibility for a new entrant which in turn is extremely positive for well-established larger bancassurance players. We feel that this COVID-19 situation could be blessing in disguise over the medium term for the industry as it will create renewed push for insurance coverage by Government and increase need for coverage felt by the general public.

We feel that HDFC Life is a long term compounding growth story. The company’s focus on superior product mix with greater focus on high margin business, diversified distribution mix and high technology focus puts company ahead of the curve. Share of low margin ULIP business (as a % to total APE) has been consistently contracting from 46% in FY17 to 23% in FY20. At the same time, high margin pure individual protection business share (as a % to total APE) has grown by 2x from 4% in FY17 to 7% in FY20 and further 8.5% as on H1FY21. On the back of consistent performance, we feel that the company can continue to fetch higher multiple compared to other listed peers.

Valuations & Recommendation: Life insurance stocks took a beating following Budget announcement making benefit u/s 80C optional followed by lockdown in the peak period for insurance companies. However they recovered fast as the impact of the two factors were not expected to last beyond 2-3 quarters. Within Insurance companies HDFC Life rose the most (except Max due to expectations of Axis deal) even as it gained incremental market share from other players. We expect FY21E to be a challenging year for HDFC Life. We expect the company to deliver 13% CAGR for New Business Premium (NBP) and a growth of 11% in Value of New Business (VNB) over FY20 to FY22E. Embedded Value (EV) is estimated to grow by 16% CAGR over the same time frame. We have incorporated VNB Margin improvement by 60bps between FY20-22E. For FY22E the company is trading at 4x Embedded Value. We feel that investors can SIP buy HDFC Life for a 10-12% CAGR over next 2-3 years.

HDFC Scrip Code HDFCLIFEQNR BSE Code 540777 NSE Code HDFCLIFE Bloomberg HDFCLIFE CMP Oct 26, 2020 580.4 Equity Capital (Rsbn) 20.2 Face Value (Rs) 10 Equity Share O/S (mn) 2019 Market Cap (Rs bn) 1172 Book Value (Rs) 35 Avg. 52 Wk Volumes 5047207 52 Week High 647.50 52 Week Low 339.15

Share holding Pattern % (Sep, 2020)

Promoters 60.40 Institutions 30.72 Non Institutions 08.88

Total 100.0

Fundamental Research Analyst Nisha Sankhala Nishaben.shankhala@hdfcsec.com

HDFC Life Insurance Company Ltd.

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Financial Summary Particulars (Rsbn) Q2FY21 Q2FY20 YoY-% Q1FY21 QoQ-% FY19 FY20 FY21E FY22E

NBP 58.8 39.8 48 26.2 124 149.7 172.4 178.1 220.2

APE 21.4 14.9 21 12 78 60.5 71.6 77.4 89.2

VNB 5.5 4.5 22 2.9 90 15.4 19.2 20.1 23.6

VNB Margin (%)

24.6 25.9 26.0 26.5

EV 182.9 206.5 238.1 277.3

P/EV (x) 6.4 5.7 4.9 4.2

P/BV (x) 20.7 16.7 15.3 13.5

P/E (x) 91.6 78.5 103.6 69.2

(Source: Company, HDFC sec) Recent Developments Q2FY21 highlights: HDFC Life posted strong Net premium income growth of 34.86% YoY. Single premium, first year and renewal premium grew by 66%, 15% and 21% YoY respectively. Overall APE grew by 21% YoY in Q2Q21 (mainly led by PAR). New Business Margins improved to 25.6% during current Quarter compared to 24.3% in the last quarter on the back of improvement in product mix and cost efficiency. Overall, shareholders’ PAT grew ~6% YoY to INR3.3b during 2QFY21. AUM growth was 18% YoY to Rs 1.5tn, with Debt:Equity mix of 67:33 (about 97% of debt investments were in G-Secs and AAA bonds). During the quarter the company entered into banca partnership with YES Bank and Bandhan bank. HDFC Life reported solvency ratio of 203% as of Sep-20 vs 190% as of Mar-20. On the persistency front, 13th month persistency improved by 380 bps QoQ while 61st month persistency declined by 200 bps. In spite of a steep rise in the share of bancassurance channel to ~60% of distribution mix (vs. ~50% in FY20), the share of ULIPs stood at ~23%, whereas savings products grew to ~66% (vs. ~60% in FY20). Its overall market share for the quarter of total new business expanded by 90 bps YoY to 23.3% v/s 22.4% in Q2FY20. Superior execution and product leadership have helped maintain business growth and margins. High margin individual protection business grew 28% yoy, partially offsetting 32% decline in group protection. Due to rising reinsurance rates, the company will try to keep premium rates competitive, which could pressurize VNB margins, but expected growth in business volume is expected to offset margin pressure and drive earnings. The company has a comfortable solvency position at 203% as of Q2FY21 compared to the regulatory requirement of 150%. There has been no capital infusion in the company during the last eight years and the solvency was supported by internal accruals.

HDFC Life Insurance Company Ltd.

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Past pandemics show increased sales and lower persistency trends. A study of past pandemics such as SARS (CY 2002-04) and MERS (CY 2013-14) demonstrates increased sales of health and life insurance during the pandemics and life insurance post the pandemics. We expect similar trends to play out in India. Long term Triggers India is an underpenetrated market with favorable demographics India has highly underpenetrated insurance market compared to the other parts of the world with a life insurance penetration of less than 3%. This presents immense opportunities to expand the life insurance business given the favorable demographics, rising prosperity, growing household income and the increasing awareness of the need for financial protection. Protection is the most profitable part of business; and this market could double in 5 years as penetration of protection is low at 10% of addressable population. Long gestation period to break-even and strict regulatory requirements restricts the entry of new players. Established players especially those who have promoters from the banking industry will continue to lead the sector because of its wider distribution reach at a lower cost. In the private space top 3 players take out majority of the pie. Protection and retirement annuity are two big positive triggers for India life insurance industry. Market Leader The company has a vast experience of almost 2 decades in the business. Through consistent product innovation, the company has consistently been able to maintain its market position and consistently improved its market share in each fiscal year. The second largest private player-HDFC Life's market share among private players in terms of new business premiums stood at 21.5% in FY20 and 23.3% in Q2FY21. While in the overall industry level it stood at around 6.86% as on Sep, 2020. By focusing on better quality of business, HDFC Life has also been able to maintain best in-class VNB margins of 26%, ROEV of 18% with healthy persistency in its overall product portfolio. The 13th month persistency has improved every year since last 5 years. It stood at around 88% in FY20 as compared to 84% last year. The persistency at 61st month basis improved to 54% in FY20 from 51% last year.

HDFC Life Insurance Company Ltd.

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Diversified distribution mix On the distribution front, the company continues to add partners at a good pace to strengthen diversified distribution and reduce dependence on HDFC Bank. Apart from HDFC Bank, it also has recently tied-up with RBL Bank, Bandhan Bank and IDFC First Bank for bancassurance partnership. HDFC Life has been constantly expanding its distribution reach and been reducing its dependence on Bancassurance which at 55% of FY20 of Individual APE v/s 72% in FY17. Currently, it works with over 250+ partners ranging from traditional banks to NBFCs to SFBs. It is also developing alternative channels of distribution; 50+ partnerships in emerging eco-systems such as Ecommerce, Fintech etc. are done. The management is also focusing on proprietary channels – Agency, Direct and Online channels. These channels registered 26% growth in FY20, and management has indicated that this will continue to grow through strategic interventions. The company is intending on expanding share of business from customers less than 30 years indicating increasing awareness and early adoption of life insurance via these channels. Product Mix- greater focus on high margin business The company has a diversified business model which helps it in balancing risk across business cycles. As of H2FY21, saving products such as ULIP, Par, Non Par and group contributes 20%, 28%, 26% and 9% respectively in Total APE. While protection products like Term and Annuity are 12% and 5% respectively. The savings business grew by 18%, whilst overall protection business grew by 22% in FY20. The company’s conscious focus on high margin business such as Term, Non-par in savings and Annuities, has led to improve product mix by increase its share of these products to 57% in FY20 from 29% in FY17 in total new business premium. The share of pure protection (the highest VNB margin business in life insurance) for HDFC Life is at 17% of total APE. This is higher than listed peers ranging between 10-15%. New Business Margins has been on a rising trend since last 5 years. The company has also disrupted the market with some innovative products in FY20 i.e. Sanchay Plus – a savings plan with guaranteed returns and an option for lifelong income; Sanchay Par Advantage – a participating plan with lifelong regular income, payout flexibility and whole life cover; as also life insurance bundled with partners’ products or services, for example life insurance with pre-paid mobile recharge.

HDFC Life Insurance Company Ltd.

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High Technology Focus Technology has been a key differentiator for the company, as it has continued to invest in technology to transform the business model from a product-centric to a customer-centric model. Mobile application “Insta suite” comprising various sub modules helps facilitate sales teams to onboard customers efficiently. In addition to the on-boarding process, the company have also taken various initiatives to provide a simple and fast journey reducing policy conversion TAT from 2 days in FY15 to less than 4 hours in FY20. During FY20, 99.9% of new business was initiated through digital platforms. Around 85% of the renewal payments came through online modes. 210+ bots were deployed across internal processes and 60% of post sales verification calls were completed through InstaVerify (a video-based authentication mobile app). This has helped the company in maintaining smooth business process during the time of social distancing. Technology focus will not only help the company in reducing operating expenses but will also allow it to drive away any threat of losing business to any new fintech companies or digital disruptors.

What could go wrong? We expect the savings business to face headwinds as lower business activity impacts savings levels. High dependence on ULIPs would

likely to be impacted. However, HDFC Life has relatively less dependence on these kinds of products. ~20% of individual Annualized premium equivalent (APE) comes from ULIP as of H1FY21.

Indian life insurers are witnessing a hardening of term reinsurance premiums. Companies are reworking rates for end consumers while trying to ensure the least impact on their margins.

Slow economic growth might impact the business both in terms of new business growth and persistency.

Any adverse change of regulations by IRDA or Income Tax authorities might impact the growth in revenues and profitability of the business.

Insurance business is highly competitive business. There has been intense competition from other private life insurers and since last few months, LIC has also become aggressive and has been gaining market share. Rising competition especially via digital disruptors poses pricing risk.

An increased share of the guaranteed return businesses can raise risk from volatility in interest rates. HDFC Life had ~26% share of Non PAR in APE mix as of H1FY21.

Adverse regulatory change in Bancassurance agreement with HDFC Bank can impact the low cost of sales and overall profitability.

HDFC Life Insurance Company Ltd.

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Slower tapping of/adoption by HDFC clients, slower adoption of digital sales and higher than expected mortality are other concerns faced by the company.

High margin Protection and Non-PAR saving products have been key growth drivers for HDFC Life. Any slowdown in growth trajectory of these segments can impact its overall earnings growth momentum.

HDFC Life currently pays tax @12.6% in FY20. Any increase in tax rates for Insurance companies could hurt its net profits. Company Profile: HDFC Life Insurance Company Limited (HDFC Life) (formerly HDFC Standard Life Insurance Company Limited) is a joint venture between HDFC Ltd. (50.14% stake), India’s leading housing finance institution and Standard Life (Mauritius Holdings) (10.27% stake), a global investment company. Established in 2000, HDFC Life is a leading long-term life insurance solutions provider in India, offering a range of individual and group insurance solutions that meet various customer needs such as Protection, Pension, Savings, Investment, Annuity and Health. As on June 30, 2020, the Company had 36 individual and 13 group products in its portfolio, along with 7 optional rider benefits, catering to a diverse range of customer needs. HDFC Life continues to benefit from its increased presence across the country having a wide reach with 420 branches and additional distribution touch-points through several tie-ups and partnerships.

Peer Comparison:

CMP Market Share as of Sep-20

VNB Margin

%

AUM (in Rs.

Bn)

EV P/EV P/E

FY20 FY21E FY22E FY20 FY21E FY22E FY20 FY21E FY22E

IPRU 405 3.6 21.7 1640 160 180 204 2.5 2.3 2.0 52.0 41.2 34.3

MAXF 576 2.0 21.0 735 268 214 234 2.1 2.7 2.5 48.4 44.6 41.8

SBILIFE 779 7.2 20.7 1588 276 313 357 2.8 2.5 2.2 57.5 39.6 31.1

HDFCLIFE 580 6.9 25.9 1273 102 118 137 5.7 4.9 4.2 78.5 103.6 69.2

HDFC Life Insurance Company Ltd.

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Under Penetration versus other Markets Product Portfolio mix% Distribution strength H1FY21

AUM Mix% Persistency Trend VNB Margin%

HDFC Life Insurance Company Ltd.

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Financials

Policyholder Account (in mn)

Shareholders account (in Mn)

FY19 FY20 FY21E FY22E

As at March FY19 FY20 FY21E FY22E

Total Premium earned 2,89,307 3,22,450 3,67,073 4,35,793

Transfer from policyholders' a/c 12,127 11,992 7,511 12,490

Income from investments and other income 92,025 (30,669) 1,04,966 1,21,306

Investment income and other Income 4,143 4,463 5,215 5,809

Transfer from shareholders AC 3,090 1,048 943 848

Total income 16,270 16,455 12,727 18,299

Total Income 3,84,422 2,92,828 4,72,982 5,57,947

Expenses 309 377 396 416

Commission 11,177 14,912 16,056 18,322

Contribution to policyholders' a/c 3,090 1,048 943 848

Operating expenses 38,136 42,669 41,626 47,270

Profit before tax 12,871 15,030 11,388 17,034

Provisions 4,304 9,207 9,667 10,150

Taxes 131 165 118 186

Total Expenses 53,616 66,787 67,349 75,742 PAT 12,740 14,865 11,270 16,848

Benefits Paid 1,39,898 1,82,451 1,58,484 1,88,603 Bonus paid - 8,484 10,181 12,218

Change in valuation of liabilities 1,75,075 24,408 2,30,603 2,70,476

Total 3,14,972 2,06,859 3,89,087 4,59,079

Surplus 15,833 19,182 16,546 23,127

Tax 2,268 1,490 934 1,552

Net Surplus 13,565 17,692 15,613 21,574

Transfer to shareholders AC 12,127 11,992 7,511 12,490

Source: Company, HDFC sec Research

HDFC Life Insurance Company Ltd.

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Balance Sheet ( in mn)

Performance metrics

FY19 FY20 FY21E FY22E FY19 FY20 FY21E FY22E

Sources of funds NBP (Rs mn) 1,49,715 1,72,385 1,78,127 2,20,214 Share capital 20,174 20,188 20,188 20,188 APE (Rs mn) 60,494 71,637 77,379 89,242

Reserve and surplus 36,282 49,798 56,302 66,560 VNB (Rs mn) 15,400 19,192 20,119 23,560

Net worth 56,456 69,986 76,490 86,748 EV (Rs mn) 1,82,900 2,06,500 2,38,106 2,77,304

Credit/debit balance in fair value a/c (30) (1,920) (1,920) (1,920) EVOP (Rs mn) 30,600 33,200 35,406 43,198

Policyholders' a/c 11,81,514 11,95,443 14,26,045 16,96,521 Rs/share

Funds for future appropriation 11,030 8,830 9,272 9,735 EPS 6.33 7.39 5.60 8.38

Total Liabilities 12,48,970 12,72,339 15,09,888 17,91,085 Book Value 28.06 34.79 38.02 43.12

Application of funds DPS 2.0 - 1.4 2.2

Shareholders' Investments 50,360 58,850 65,546 76,017 Growth (%)

Policyholders' investments 5,71,245 6,71,886 - - Premium growth 23.8 11.5 13.8 18.7

Asset to cover linked liabilities 6,33,774 5,41,821 14,44,310 17,14,786 Total income growth 19.3 (23.8) 61.5 18.0

Loans 796 2,991 2,991 2,991 Commissions growth 4.0 33.4 7.7 14.1

Fixed assets + DTA 3,339 3,307 3,557 3,807 Opex growth 20.7 11.9 (2.4) 13.6

Net current assets (10,543) (6,516) (6,516) (6,516) PAT growth 16.2 16.7 (24.2) 49.5

Total Assets 12,48,970 12,72,339 15,09,888 17,91,085 Efficiency ratios (%)

RoAA 1.1 1.2 0.8 1.0

RoE 24.6 23.5 15.4 20.6

ROEV return 22.5 12.7 17.1 18.1

Valuation

P/E (x) 91.6 78.5 103.6 69.2

P/BV (x) 20.7 16.7 15.3 13.5

P/EV (x) 6.4 5.7 4.9 4.2

Source: Company, HDFC sec Research

HDFC Life Insurance Company Ltd.

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Definitions, abbreviations and explanatory notes:

New Business Premium (NBP): Insurance premium that is due in the first policy year of a life insurance contract or a single lump sum payment from the policyholder.

Annualized Premium Equivalent (APE): The sum of annualized first year premiums on regular premium policies, and 10% of single premiums, written by the Company during the fiscal year

from both retail and group customers.

Renewal Premium: Life insurance premiums falling due in the years subsequent to the first year of the policy.

Embedded Value: Insurance is a long-term business. You buy a policy today but continue to pay premiums for several years. It is from this future income that the insurers make profits. So the

value of a life insurance company is assessed by future profits that the current business is able to generate. This is captured by the embedded value (EV) that represents the sum of present

value of all future profits from the existing business and shareholders’ net worth. Embedded value simply represents the value generated from the business sold by the company, if it were to

stop writing anymore business.

Value of New Business (VoNB): VoNB is the present value of expected future earnings from new policies written during a specified period and it reflects the additional value to shareholders

expected to be generated through the activity of writing new policies during a specified period.

Value of New Business Margin / VoNB Margin: VoNB Margin is the ratio of VoNB to New Business Annualized Premium Equivalent for a specified period and is a measure of the expected

profitability of new business.

Solvency Ratio: Solvency ratio means ratio of the amount of Available Solvency Margin to the amount of Required Solvency Margin as specified in form-KT-3 of IRDAI Actuarial Report and

Abstracts for Life Insurance Business Regulations.

Persistency: The proportion of business renewed from the business underwritten. The ratio is measured in terms of number of policies and premiums underwritten.

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Disclosure:

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