Tag: Dena Bank | Vivek Kaul

21 April, 2016

Why It’s Best to Stay Away from Buying LIC Policies

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.

Year	Income from investments (In Rs crore)	Investments (In Rs Crore)	Return (%)	Average returns on 10 year govt bond	Difference
2014-2015	1,35,483	19,462,49	7.0%	8.3%	130 basis points
2013-2014	1,18,097	16.846,90	7.0%	8.4%	140 basis points
2012-2013	1,03,882	14,864,57	7.0%	8.2%	120 basis points
2011-2012	90,267	13,495,32	6.7%	8.5%	180 basis points
2010-2011	77,667	12,665,39	6.1%	7.9%	180 basis points
2009-2010	67,198	10,958,41	6.1%	7.3%	120 basis points
2008-2009	56,583	8,15,484	6.9%	7.6%	70 basis points
2007-2008	47,999	7,56,891	6.3%	7.9%	160 basis points
2006-2007	40,572	6,13,267	6.6%	7.8%	120 basis points
2005-2006	35,479	5,24,017	6.8%	7.2%	40 basis points
Source: LIC annual reports and www.investing.com

[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.

What does this tell us about a professional investment firm like LIC? It tells us that LIC is doing a terrible job of managing public money. Any investment firm should be able to generate average returns greater than the returns on government bonds, at least. It should also be able to beat the inflation. In fact, that is what it is paid a fee for. But that doesn’t seem to be happening in case of LIC.

The investment returns of LIC have been consistently lower than the 10-year government bond returns. First and foremost, this tells us that the investment management capabilities of LIC are very bad, given that its investment returns have been 120 basis points lower than returns on a 10-year government bond, over a period of ten years.

Further, LIC would be simply better off by buying government bonds and then holding on to them till maturity, instead of actively trying to manage money. It would probably end up earning higher returns than it currently does.

Second, what this also tells us is that the government is interfering too much in the functioning of the firm and getting it to make investments, which it shouldn’t be making in the normal scheme of things. The government regularly gets LIC to invest in shares of public sector enterprises which other investors are not willing to pick up.

In the recent past LIC has picked up stakes in public-sector banks to help them meet their capital requirements. As a March 29, 2016, news-report in The Indian Express points out: “Since the beginning of 2016, LIC has brought into preferential allotment of as many as six banks, supporting the fund-raising requirement of these banks in turn. Share prices of PSBs on an average have declined close to 11.7% so far this year.”

The public-sector banks are sitting on a huge corporate-debt time bomb. Many corporates they have lent to over the years are currently no longer in a position to repay their loans or have simply siphoned off this money. The question is why is LIC money being invested in these banks? This is because the government wants to continue owning these banks, instead of selling them out.

Also, LIC now owns 21.22% of Corporation Bank, 14.37% of IDBI Bank and 14.99% of Dena Bank. Again, the question, why should an investment firm managing public money be taking on such concentrated risk? In fact, the Securities and Exchange Board of India(Sebi) regulations do not allow a mutual fund to own more than 10% of a company.

Why doesn’t the same rule apply to LIC as well? Like mutual funds LIC is also in the business of managing hard-earned public money.

Unnamed LIC officials in various news-reports justify this buying by saying that they are buying value. Maybe they are, but buying value does not mean betting the house on one stock. When an institution is managing as much money as LIC is, some basic investing principles need to be followed.

Third, it tells us that individuals are better off putting their money somewhere else rather buying LIC policies. What is the point in investing money in order to earn a return of 6-7% on an average? Yes, investing in LIC policies helps people save on tax, but there are better ways of saving tax like the Public Provident Fund(PPF).

Between 2009 and now the returns on PPF have never gone below 8%. In fact, currently the rate of interest on PPF is at 8.1%. As far as an insurance cover is concerned, individuals can look at buying a pure term insurance policy, which just offers insurance against the premium paid.

Fourth, the government needs LIC to finance its fiscal deficit and to keep rescuing the public sector enterprises which aren’t a viable business anymore. Fiscal deficit is the difference between what a government earns and what it spends. LIC helps the government finance its fiscal deficit by buying government bonds and at the same time it also helps the government meet its disinvestment target by buying shares of public sector enterprises which other investors are not interested in. This money helps narrow the fiscal deficit.

In the process, the returns that LIC is able to generate on its investment portfolio get compromised on.

Fifth, when was the last time you saw an article analysing the returns on various LIC policies? Like is the case with other insurance companies, it is not possible to figure out which LIC plan has given what kind of return, over the years. Hence, it is best to stay away from investing in them.

The column originally appeared on Vivek Kaul’s Diary on April 21, 2016

15 May, 2012

LIC money: Is it for investors’ benefit, or Rahul's election?

Vivek Kaul

“We’re slowly learning that fact. And we’re very, very pissed off.”
—Lines from the movie Fight Club
The government’s piggybank is in trouble. Well not major trouble. But yes some trouble.
The global credit rating agency Moody’s on Monday downgraded the Life Insurance Corporation (LIC) of India from a Baa2 rating to Baa3 rating. This is the lowest investment grade rating given by Moody’s. The top 10 ratings given by Moody’s fall in the investment grade category.
Moody’s has downgraded LIC due to three reasons: a) for picking up stake in the divestment of stocks like ONGC, when no one else was willing, to help the government reduce its fiscal deficit. b) for picking up stakes in a lot of public sector banks. c) having excessive exposure to bonds issued by the government of India to finance its fiscal deficit.
While the downgrade will have no impact on the way India’s largest insurer operates within India, it does raise a few basic issues which need to be discussed threadbare.
From Africa with Love
The wives of certain African dictators before going on a shopping trip to Europe used to visit the central bank of their country in order to stuff their wallets with dollars. The African dictators and their extended families used the money lying with the central banks of their countries as their personal piggybank. Whenever they required money they used to simply dip into the reserves at the central bank.
While the government of India has not fallen to a similar level there is no doubt that it treats LIC like a piggybank, rushing to it whenever it needs the money.
So why does the government use LIC as its piggybank? The answer is very simple. It spends more than what it earns. The difference between what the government earns and what it spends is referred to as the fiscal deficit.
In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore. The expenses of the government have risen more than eight and half times faster than its revenues.
What is interesting is that the fiscal deficit numbers would have been much higher had the government not got LIC to buy shares of public sector companies it was selling to bring down the fiscal deficit.
Estimates made by the Business Standard Research Bureau in early March showed that LIC had invested around Rs 12,400 crore out of the total Rs 45,000 crore that the government had collected through the divestment of shares in seven public sector units since 2009. The value of these shares in March was around Rs 9,379 crore. Since early March the BSE Sensex has fallen 7.4%, which means that the LIC investment would have lost further value.
Over and above this the government also forced LIC to pick up 90% of the 5% follow-on offer from the ONGC in early March this year. This after the stock market did not show any interest in buying the shares of the oil major. The money raised through this divestment of shares went towards lowering the fiscal deficit of the government of India.
News reports also suggest that LIC was buying shares of ONGC in the months before the public issue of the insurance major hit the stock market, in an effort to bid up its price. Between December and March before the public offer, the government first got LIC to buy shares of ONGC and bid up the price of the stock from around Rs 260 in late December to Rs 293 by the end of February. After LIC had bid up the price of ONGC, the government then asked it to buy 90% of the shares on sale in the follow on public offer.
This is a unique investment philosophy where institutional investor managing money for the small retail investor, first bid up the price of the stock by buying small chunks of it, and then bought a large chunk at a higher price. Stock market gurus keep repeating the investment philosophy of “buy low-sell high” to make money in the stock market. The government likes LIC to follow precisely the opposite investment philosophy of “buying high”.
Estimates made by Business Standard suggest that LIC in total bought ONGC shares worth Rs 15,000 crore. The stock is since down more than 10%.
The bank bang
LIC again came to the rescue of the cash starved government during the first three months of this year, when it was force to buy shares of several government owned banks which needed more capital. It is now sitting on losses from these investments.
Take the case of Viajya Bank. It issued shares to LIC at a price of Rs 64.27 per share. Since then the price of the stock has fallen nearly 19%.
The same is case with Dena Bank. The stock price is down by almost 10% since allocation of shares to LIC. The share price of Indian Overseas Bank is down by almost 19.7% since it sold shares to LIC to boost its equity capital. While the broader stock market has also fallen during the period it hasn’t fallen as much as the stock prices of these shares have.
There are more than a few issues that crop up here. This special allotment of shares to LIC to raise capital has pushed up the ownership of LIC in many banks beyond the 10% mandated by the Insurance Regulatory and Development Authority of India, the insurance regulator. As any investment professional will tell you that having excessive exposure one particular company or sector isn’t a good strategy, especially when managing money for the retail investor, which is what LIC primarily does. What is interesting is that the government is breaking its own laws and thus not setting a great precedent for the private sector.
If LIC hadn’t picked up the shares of these banks, the fiscal deficit of the government would have gone up further. The third issue here is why should the government run so many banks? The government of India runs twenty six banks (20 public sector banks + State Bank of India and its five subsidiaries).
While given that banking is a sensitive sector and some government presence is required, but that doesn’t mean that the government has to run 26 banks. It is time to privatise some of these banks.
Gentlemen prefer bonds
As of December 31, 2011, the ratio of government securities to adjusted shareholders’ equity in LIC was 764%. This is understandable given that the subsidy heavy budget of the Congress led UPA government has seen its fiscal deficit balloon by 312% over the last five years. Again basic investment philosophy tells us that having a large exposure to one investment isn’t really a great idea, even if it’s a government.
The Rahul factor
But the most basic issue here is the fact that the government is using the small savings of the average Indian who buys LIC policies to make loss making investments. This is simply not done.
LIC has turned into the behemoth that it has over the years by offering high commissions to its agents over the years. It sells very little of “term insurance”, the real insurance. What it basically sells are investment policies with very high expenses which are used to pay high commissions to it’s the agents. The high commissions in turn ensure that these agents continue to hard-sell LIC’s extremely high cost investment policies to normal gullible Indians. The premium keeps coming in and the government keeps using LIC as a piggybank.
The high front-loading of commissions is allowed by The Insurance Act, 1938. The commission for the first can be a maximum of 40 per cent of the premium. In years two and three, the caps are 7.5 per cent, and 5 per cent thereafter. These are the maximum caps and serve as a ceiling rather than a floor.
The Committee on Investor Protection and Awareness led by D Swarup, the then Chairman of Pension Fund Regulatory and Development Authority, had proposed in September 2009 to do away with commissions across financial products. “All retail financial products should go no-load by April 2011,” the committee had proposed in its reports.
The National Pension Scheme(NPS) was already on a no commission structure. And so were mutual funds since August 1, 2009. But LIC and the other insurance companies were allowed to pay high commissions to their agents. “Because there are almost three million small agents who will have to adjust to a new way of earning money, it is suggested that immediately the upfront commissions embedded in the premium paid be cut to no more than 15 per cent of the premium. This should fall to 7 per cent in 2010 and become nil by April 2011,” the committee had further proposed.
Not surprisingly the government quietly buried this groundbreaking report.
While insurance commissions have come down on unit linked insurance plans, the traditional insurance policies in which LIC remains a market leader continue to pay high commissions to their agents. These traditional insurance policies typically invest in debt (read government bonds which are issued to finance the fiscal deficit).
This is primarily because the Congress led UPA government needs the premium collected by LIC to run LIC like a piggybank. The piggybank money can and is being used to run subsidies in the hope that the beneficiaries vote for Rahul Gandhi in 2014.
Is the objective of LIC to generate returns and ensure the safety of the hard earned money of crores of it’s investors? Or is it to let the UPA government run it like a piggybank in the hope that Rahul baba becomes the Prime Minister?
The country is waiting for an answer.
(This post originally appeared on Firstpost.com on May 15,2012. http://www.firstpost.com/politics/lic-money-is-it-for-investors-benefit-or-rahul-election-309545.html)
(Vivek Kaul is a writer and can be reached at [email protected])