IPO for Indian Life Insurers

In October 2010, the capital market regulator, Securities and Exchange Board of India (SEBI), approved life insurance companies to issue IPOs. India’s insurance regulator, Insurance Regulatory and Development Authority (IRDA), has been planning to come up with guidelines for IPOs of life insurance companies for quite some time; an announcement is expected within the next few months. Current regulations allow only those insurers that have been in business for at least 10 years to go for an IPO. The government is likely to bring this down to five years; however, a final call is yet to be taken. Another such pending proposal is raising the limit of foreign ownership in a joint venture life insurer to 49% (currently capped at 25%). After an IPO, foreign promoters will have to bring down their stake to ensure Indian promoters hold a majority. An insurer opting for a public offering must also offer at least 25% of the shares to the public. Like any other IPO, pricing of an insurance IPO is an area of concern. This is more so for two reasons. First, insurance is a key sector of the economy with a large number of stakeholders; this sector is being allowed to participate in fund-raising from the capital market for the first time. Therefore, overly optimistic valuation may be detrimental to the sector in the long run. Second, in light of the recent events in Japan, it has become critical that all relevant factors affecting the insurance industry are priced in appropriately. The IRDA is likely to spell out appropriate guidelines regarding valuation accordingly. Insurance IPOs are expected to gain traction in the medium to longer term; however, this will also depend on the evolution of the markets and regulatory landscape. The Indian capital market seems to have hit a roadblock in recent months due to high inflation threatening growth prospects. The insurance sector in particular has been adversely affected. New policy sales by private firms took a hit in 2010, and margins are also under pressure. The Direct Tax Code (DTC), scheduled to implementation in 2012, is another cause for concern. This may remove some tax advantages for certain insurance products and raise the tax burden on insurance companies, which is likely to have an adverse impact on sales and profits. Several private sector insurers, including the likes of ICICI Prudential Life, Reliance Life Insurance, SBI Life Insurance, and HDFC Standard Life, are planning to tap the capital market. However, their expected times of offering may differ. While some may go for IPOs in the very near term, others may wait for some time. For example, Reliance, which has been supporting the reduction of the 10-year operations rule to five years, can be expected to raise money from the public in the short term. On the other hand, SBI Life is not in a hurry and wants to wait and watch as the regulations evolve. So even if IPOs do not pick up in the near term, they are likely to become popular in the medium to longer term.

IPO Pricing Issues in India

One of the most important issues in floating an IPO is the pricing aspect. Different forces, often in conflict with each other, are at play here. Issuers would ideally like to maximize the proceeds from the process. Investors would want the offer to be under priced at best and to be (near) correctly valued at worst. Underwriter gets a portion of capital raised as fee, and they would want to maximize their income. But if an IPO is overpriced, there may not be sufficient demand from the market and as a result the issuer may not be able to sell all the shares it had planned. The reputation of the underwriter is also at stake here. It has been observed from empirical data that historically IPOs have been under priced. However, the trend regarding pricing of IPOs seen in India over the last one year has followed an opposite pattern. It has been observed, 70% of the 55 firms that went for IPO during the period April, 2010 to March, 2011, are trading below their offer price. Moreover, 70% of the same 55 firms traded at premium on their listing days, but price fell on subsequent trading days. This implies only very short term investors have actually benefited from these offerings. This is even more surprising when one considers IPO performance in conjunction with overall market performance. In August 2009 BSE created an IPO index that tracks the value of companies for two years after IPO starting from the third day of trading. The graph shows the movement of this BSE IPO index along with that of the SENSEX. It is noteworthy, while the two moved in tandem initially, they have diverged from each other since September, 2010. Thus while the SENSEX gained over 10% during April 2010 to March 2011, BSE IPO index fell over 15% during the same period. This implies overall market condition is not to be blamed for the poor performance of the newly listed firms. This does not augur well for the markets. Retail investors, most of whom invest with medium to long term objectives and are not very sophisticated or well informed, suffered heavy losses and may lose interest in the IPO segment. The pricing of IPOs has come under scrutiny from a number of market participants and the capital market regulator, Securities and Exchange Board of India (SEBI), has taken note of the situation. In the past SEBI had expressed its displeasure regarding overpricing of IPOs and asked the underwriting banks to be more prudent regarding IPO pricing. Recently SEBI proposed that underwriting banks must disclose to investors the performance and track records of their earlier issues in their prospectus and on website. The regulator is also concerned about hyping of public issues through misleading advertisements and media reports and could propose strict penalty if underwriters are found to be involved in such activities. Moreover, SEBI has expressed its displeasure over investment banks, vying among each other to bag deals, quoting very low fees from issuers, thereby promoting issuer interest above investor interest.