Mumbai: HDFC Standard Life Insurance Co. Ltd, Max Financial Services Ltd and its unit Max Life Insurance Co. Ltd on Friday announced merger talks that may lead to the creation of an insurance giant with Rs.1.1 trillion in assets and herald the start of consolidation in the industry.
A combination of the entities would become India’s largest private sector life insurer, overtaking ICICI Prudential Life Insurance Co. Ltd. It will be second only to state-run Life Insurance Corporation of India (LIC), which has a 70% share of new business premiums in the country.
“HDFC Life, Max Life and Max Financial Services, at their respective meetings held today, approved entering into a confidentiality, exclusivity and standstill agreement to evaluate a potential combination through a merger of Max Life and Max Financial Services into HDFC Life by way of a scheme of arrangement,” Housing Development Finance Corp. Ltd (HDFC), the parent of HDFC Standard Life, said in a statement.
“The agreement provides for a mutually agreed exclusivity period for due diligence and discussions between the parties in relation to a proposed transaction,” HDFC said.
If the merger indeed goes through, it could trigger long-awaited consolidation in an industry with assets under management of Rs.22.4 trillion, of which the share of India’s 23 private sector insurers is only Rs.4.61 trillion, according to the Insurance Regulatory and Development Authority of India (Irdai).
The insurance industry, including LIC, earned Rs.3.28 trillion in premiums last year, of which the private sector’s share wasRs.88,433 crore.
Parliament in 2015 voted to increase the amount foreign investors can own in insurers to 49% from 26%, allowing overseas firms to expand their presence.
India’s insurers could attract as much as $5 billion (aroundRs.33,600 crore today) of fresh capital from investors, Mumbai-based Shashwat Sharma, partner for financial services at KPMG, estimated in April.
“Joint venture agreements with foreign entities and the scope to raise private equity (PE) seemed in the offing (when the cap was raised) but we haven’t really seen strategic moves on that count,” said Aarthi Sivanandh, a partner at law firm J Sagar Associates.
“For PEs, biting off small chunks of insurance companies with selective risk and control, coupled with high valuations, is not enticing. The Irdai control regulations still require the companies to be India-owned and controlled, and control is a very broad definition as per the regulations. So, I think we will see strategic M&A (merger and acquisition) in life insurance in line with the global trend,” Sivanandh added.
Shares of Max Financial, with a market value of about $2 billion, rose as much as 20% in intra-day trading, the most since Max Group restructured into three companies in January, before closing 10.3% higher at Rs.472.80 on BSE. HDFC Standard Life and Max Life may merge, The Economic Timesreported on Friday, citing three people whom it didn’t name.
HDFC shares gained 2.2% to Rs.1,227.80 apiece on a day the benchmark Sensex advanced 0.38% to 26,625.91 points.
HDFC last year sold a 0.95% stake in its insurance unit to PremjiInvest, a fund set up by billionaire Azim Premji, in a deal that valued the insurer at about Rs.20,950 crore, data compiled by Bloomberg shows. Edinburgh-based Standard Life Plc boosted its stake in the Indian venture to 35%, from 26%, in a deal completed in April.
Max Life is a joint venture between Max Group and Mitsui Sumitomo Insurance Co. Ltd.
HDFC Standard Life had assets under management of Rs.74,247 crore as of 31 March. The insurer, whose business primarily comes from unit-linked insurance policies, collected premiums worth Rs.16,313 crore in the year ended 31 March.
Max Life had Rs.35,824 crore of assets under management as of 31 March. The company, which mainly sells traditional life policies, collected Rs.9,216 crore in premiums during the fiscal year.
“I think the fact that both the insurers have very different businesses mean a scope for greater synergies,” said Sanket Kawatkar, principal and consulting actuary, life insurance (India) at Milliman India Pvt. Ltd.
A merger “will involve short-term disturbances as integration of the two entities will involve expenses”, Kawatkar added. “However, in a successful merger, the operating expenses are expected to come down over time, as fixed costs are expected to get spread over a larger base of business. The cost synergies will definitely outweigh the short-term disturbances and costs.”
Max Financial owns a 68% stake in Max Life. Axis Bank owns a 5.99% stake in the life insurer and Mitsui Sumitomo the remaining 26%.
“A merger with HDFC Life will not only make the combined entity the No.1 private life insurer, but also is the best option for growing the business further at this juncture,” said Max Group founder Analjit Singh.
Many details of the proposed merger are not yet clear. It is not known how the deal will impact the shareholder capital of HDFC Life, Max Life and Max Financial Services.
It is also not clear whether Japan’s Mitsui Sumitomo will remain a shareholder if and when Max Life and Max Financial Services are merged into HDFC Life.
According to the plan, Max Life will be first merged with Max Financial Services and subsequently Max Financial Services, which is a listed firm, will be merged into HDFC Life.
“The existing shareholders of HDFC Life have agreed to the planned merger. Standard Life will continue to be a shareholder in the merged entity,” said HDFC chairman Deepak Parekh. “Similarly, the shareholders in Max Life too have given a thumbs-up for the deal. However, the final shareholding pattern post the deal will depend on the swap ratio, which is yet to be decided. Depending on the swap ratio everyone, including Standard Life and Mitsui Sumitomo, will get a share of the pie. Post the deal and the listing of HDFC Life, shareholders may decide whether they want to continue to be in the venture or exit.”
HDFC Life has been preparing to go public. In April, the board of HDFC approved a proposal to sell shares in HDFC Life through an initial public offering (IPO). “The plan is to do this divestment in the second part of the calendar year,” Keki Mistry, vice-chairman and chief executive officer of HDFC, told Mint after the board’s decision on 20 April.
HDFC had announced plans to sell up to a 10% stake in HDFC Life through the IPO.
“HDFC Life has been keen to get listed, we have been working on it and had appointed a dedicated team for it. But two weeks back, a banker came up with the proposal of this merger and we agreed. The potential merger will result in an automatic listing of HDFC Life, since Max Financial Services is already listed,” Parekh said.
According to a person familiar with the proposed merger, a deal has been under discussion for some time and is being seen as a way to scale up the operations of HDFC Life.
“The deal puts HDFC Life in the No. 1 position in the private insurance industry. Also, Max Life Insurance has a strong distribution network and there are a number of product synergies as well,” said this person, who didn’t want to be identified.
Max Life distributes its policies through Axis Bank, while HDFC Standard Life sells products through HDFC Bank. Combined, the distribution network of the two would be among the largest in the sector.
“The branding of the eventual company would be under the HDFC umbrella,” said the person cited above.
Since the life insurance business primarily involves selling long-term contracts with annual premiums, and income estimates are based on the assumption that a large portion of these contracts will get renewed every year, the valuation method for M&As in the business is different from that used in other conventional businesses.
Additionally, every life insurer needs to factor in life mortality assumptions to create sufficient reserves for future payouts on account of death, maturity or surrender of policies.
Life insurance companies are typically valued using the appraisal value method, which is a combination of embedded value and structural value of the company. The embedded value is based on the business written till date while the structural value is based on the potential of the company to generate new business. Typically, a younger company will have a higher structural value and a lower embedded value. As the company matures and its in-force business expands, the embedded value starts becoming higher than the structural value.
Often, the actual deal value is largely driven by market share, new business growth rates, product portfolio, parentage and the strength of distribution network. Insurers with distribution tie-ups with banks, which can generate significant volumes, will have better valuations.
If the deal achieves fruition, it will mark the first merger in the life insurance space since 2005, when AMP Sanmar Life Co. Ltd was acquired for at least Rs.100 crore by Anil Ambani’s Reliance Group. Following the deal, both AMP and Sanmar exited as shareholders.
In March 2012, Tokyo-based Nippon Life Insurance acquired a 26% stake in Reliance Life Insurance for $680 million. In October 2015, Nippon Life increased this stake to 49%, following the hike in the foreign investment limit.
In 2012, New York Life Insurance Co. exited its life insurance joint venture with Max India by selling its stake to Mitsui Sumitomo, valuing the company at around Rs.10,500 crore.