Section 1: Understanding Health Insurance Business in India
The number of lives covered has increased from 22% of the population in FY15 to 40% (~55 Cr) in FY22.
Government sponsored schemes (including RSBY Rashtriya Swasthya Bima Yojana) accounted for 68% of the total lives covered as of FY22; Group Business (i.e., employer provided coverage) 22% and Retail 10% (5.5 Cr lives).
Retail has over 40% MS by value i.e., 5.5 retail lives contribute over INR 30,000 Cr to the overall INR 73,000 Cr health insurance premium.
Health Insurance is provided by standalone health insurance (SAHI; Care, Niva Bupa, Star Health, etc.), multiline (ICICI Lombard, Bajaj Allianz, etc.) and public sector insurance companies (New India Assurance, National, etc.)
SAHI companies are retail focused; more than 50% of retail customer premium goes to them. SAHI companies derive 80% of their premium from Retail.
Retail Health insurance is an agent assisted product. Retail customers rely on agents, web aggregators and advisors like Ditto Insurance to guide them towards purchasing the right policy.
𝐒𝐨 𝐰𝐡𝐲 𝐢𝐬 𝐫𝐞𝐭𝐚𝐢𝐥 𝐬𝐞𝐠𝐦𝐞𝐧𝐭 𝐚𝐭𝐭𝐫𝐚𝐜𝐭𝐢𝐯𝐞?
- 𝐋𝐨𝐰 𝐩𝐞𝐧𝐞𝐭𝐫𝐚𝐭𝐢𝐨𝐧: As of FY22, only ~17% (from 10% in FY17) of India’s population outside of govt plans is penetrated with health insurance. There is certainly scope for more penetration.
- 𝐇𝐢𝐠𝐡 𝐨𝐮𝐭-𝐨𝐟-𝐩𝐨𝐜𝐤𝐞𝐭 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬: Over 60% of spends are out-of-pocket in India – highest in the developing countries.
- 𝐀𝐠𝐞𝐧𝐭 𝐚𝐬𝐬𝐢𝐬𝐭𝐞𝐝 𝐩𝐫𝐨𝐝𝐮𝐜𝐭: Health insurance can be a complex product for customers to understand. As mentioned previously, agents guide customers to purchase policies suited to their needs. IRDAI norms allow individual agents to sell policies of three insurers – one life insurance company, one non life insurer and one standalone health insurer. 75% of the total premium of retail business came from individual agents in FY20. There is high co-relation between growth in number of agents and individual health insurance premium. Insurers with a growing and productive network of agents stand to benefit.
- 𝐏𝐫𝐨𝐟𝐢𝐭𝐚𝐛𝐢𝐥𝐢𝐭𝐲: Higher retail premiums (than public and group, which has corporate customers with high bargaining power) lead to higher profitability (pre-COVID Claims ratio: SAHI 59%; Multiline 67%; Public sector 92%). Lower the claims ratio the better.
All these are key reasons behind the enormous potential in this segment.
𝐒𝐨 𝐰𝐡𝐢𝐜𝐡 𝐜𝐨𝐦𝐩𝐚𝐧𝐲 𝐢𝐬 𝐬𝐞𝐭𝐭𝐢𝐧𝐠 𝐮𝐩 𝐢𝐭𝐬𝐞𝐥𝐟 𝐟𝐨𝐫 𝐬𝐮𝐜𝐜𝐞𝐬𝐬 𝐢𝐧 𝐭𝐡𝐢𝐬 𝐬𝐞𝐠𝐦𝐞𝐧𝐭?
Section 2: Star Health is a health insurance leader in the retail business segment
Being a StandAlone Health Insurance (SAHI) company (others being Care, Niva Bupa, Aditya Birla HI etc), its singular focus on health insurance has led to new and innovative products (aided by IRDAI’s use and file regulation) aligned to specific health conditions.
SH clocked gross premiums of ~INR 11,500 Cr in FY22 (from 3,000 Cr in FY17).
It has the 𝗹𝗮𝗿𝗴𝗲𝘀𝘁 𝗺𝗮𝗿𝗸𝗲𝘁 𝘀𝗵𝗮𝗿𝗲 𝗼𝗳 𝟯𝟯% 𝗶𝗻 𝗿𝗲𝘁𝗮𝗶𝗹 (3x higher than HDFCERGO and NIA; 4x higher than Care and Niva Bupa) and draws 90% of its premiums come from this segment (higher than any other company)
The market share gains have come due to an enormous network of 13k+ hospitals, 5.5 lakh agents (3x higher than the closest SAHI) with the highest premium / agent of INR 180,000 in the industry.
But this growth has not come without some not-so-pleasant developments –
- Claims: For customers getting their accepted and settled on-time is paramount. SH has one of the highest claim repudiation rate of ~14% i.e., 14% of claims over the last 4 years were rejected. Aditya Birla and Niva Bupa are in a close ballpark.
In FY21, CARE Health closed ~100% of claims in one month followed closely by ICICI Lombard that settled 99.7% of claims made during this period within a month
Among the SAHI players, SH had the last spot with 94.4% claims settlement in one month. Public companies have lagged in claims payments - Regulation: IRDAI has proposed to cap the tenure and age of MDs/CEOs of insurance firms at 15 and 70 years resp. SH CEO is past this cap.
- Management Compensation: If you are a value investor, you would like overall comp to not exceed 2-5% of PAT and expect comp to increase with PAT. But credit needs to be given where it is due. The management has built a good business from the ground up and they have very adequately compensated and rewarded themselves with ESOPs, which is typical for a growth company.
SH is the only listed SAHI. It has a market cap of INR 43,000 Cr i.e., 9.5x book value and 3.7x FY22 premium. For some context, multiline insurer ICICI Lombard trades at 6.5x book value and 3.4x FY22 premium.
No matter how attractive a business is, one wants to get in at a reasonable price!
So would you invest? What price will you be willing to pay?
“Bhav Bhagwan hai”
Rakesh Jhunjhunwala
Section 3: Bhav Bhagwan hai!
No matter how attractive a business is, one wants to get in at a reasonable price.
Like other insurers, SH has two profitability streams – underwriting profit and income from investments.
Underwriting profit/(loss) is defined as gross premium less 1. re-insurance, 2. risk reserve, 3. net incurred claims (claim ratio) and 4. net commissions and other operating expenses (expense ratio)
SH has been able to increase investment assets more than 5x from 2,000 Cr in FY18 to 11,000 Cr in FY22, which is 2.4x book equity. This is a key metric they track; higher this metric, higher is their interest income
Going back five years pre-COVID, with a 7-8% yield, interest income from investments have been 2-6x UW profit pre-COVID”
Only in FY19, Cash Flow from Operations was enough to fund their investments. Other years, they have relied on raising equity, debt and existing cash to fund investments – necessary to generate an interest income (and in turn supplement the UW income/loss)
Moving forward, assuming less reliance on external capital and existing cash (~INR 550 Cr), there is more reliance on CFO i.e., profitable growth to fund investments. In the absence of that there is a danger to maintain solvency (since losses causes a double whammy – they erode equity value and increase regulatory required solvency margin) and generate interest income.
After two unprofitable years, FY23-Q1 seems to be on the way to recovery with a combined ratio (claims + expense ratio) of 98% from 118% in FY22
As of FY22, only 17% (~5.5 Cr retail and ~12 Cr group lives) of Indian population outside of govt plans is penetrated with health insurance policies
SH has covered ~1.6 Cr of the 5.5 Cr retail lives. With increasing awareness, rising incomes, retail segment may very well more than double in a decade to 13-14 Cr as per industry estimates.
My key assumptions in valuing SH:
- Growth: With growing hospital and agent network, SH covers 1/3rd retail lives (from ~30% today) in a decade. This translates to a premium CAGR of 15%
- Profitability: Combined ratio improves to 96% in FY24 and owing to operating leverage continues to gradually improve to 94% over the decade
- Hygiene: Profitable growth eliminates reliance on external cap and leads to a. maintenance of regulatory solvency margin and b. increase in investment assets (to 2x of networth; consistent with history), which in turn well supplements UW profit
With these assumptions, I valued SH at INR 27,000 Cr i.e., 5.7x book equity. As of 9/9, SH was trading at 9.5x book. As stated previously, for context, ICICIL is priced at 6.5x book (There is no listed SAHI player yet for a peer-to-peer comparison)
Clearly, at 9.5x book, the market is assuming a much higher growth – perhaps for both retail segment and SH market share – and/or profitability. This is my conclusion based upon my analysis and assumptions (stated above). If you are more optimistic than I am, then you may find SH to be reasonably (or even under) valued.
Does it mean, I will give SH a pass? For the moment, Yes!
Even if I get in at this the current price, in the long term I’d be okay, but I’d like to buy growth at a reasonable price (and I am not going to speculate on a target price). Remember, every normal year it is going to add earnings and may command a higher valuation.
What do you think?
PS: Not a Recommendation
EDIT: As of 14/03/2023, SH is trading at 6.9x book and ICICIL at 5.6x book. My fair valuations of SH and ICICL are largely the same at 5.5-5.7x and 5x book respectively. I will keep on waiting on the fence and take positions (if and) when they fall within my margin of safety