ICICI Lombard Rating: reduce Ban on health product would dent income

As per media reports (Times of India, 4 December 2020), regulator IRDAI has proposed a ban on group health policies, such as critical illness, that are bundled with mortgages. The regulator may be thinking of such a move to avoid such products being bought on a standalone basis rather than being purchased along with a health insurance cover.

Credit-linked health accounted for c1.3-2% and c5-6% of the industry’s and ICICI Lombard’s gross premiums, respectively, in FY20. Until October 2020, group health accounted for 15% (FY20: 13%) of the industry’s gross premium and 16% (FY20:16%) of ICICI Lombard’s gross premium. As per the media report, the IRDAI’s intention is to have all such policies withdrawn by the end of this month.

Regulation could raise combined ratio by c100bps and dent net profit by c6%: Credit-linked group health usually has lower retention ratios, and insurers earn ceding commissions apart from lower loss ratios. If there were a ban on credit-linked group health products, we estimate that ICICI Lombard’s combined ratio would rise by 100bps on a FY20 basis.

As a result, this could result in a cut in net profit by c6%, all else being equal. On a ROE basis, this move would result in a ROE compression of 1.2ppts again on a FY20 basis. We do not make any changes to our estimates in this note as we wait for the regulation to be notified and then passed.

Maintain Reduce and target price of Rs 1,065: We derive our target price based on a Gordon growth model. We do not make any changes to our estimates in this note and our target price remains unchanged. We calculate a target P/B multiple of 6.7x by assuming an average ROE of 23.7%, cost of equity of 10% and growth of 7% (all unchanged).

We then apply our target P/B multiple to our year-end BV estimate of Rs 161.8 (unchanged) and discount it back to the present at the cost of equity to arrive at our target price of Rs 1,065 after adding unrealised gains. Our target price implies 27.3% downside. We maintain our Reduce rating on the stock. Upside risks: (i) better-than-expected loss ratio; (ii) increase in OD prices; and (iii) increase in third-party prices.