Indian Insurance Industry Focus Max India

September 2011 TABLE OF CONTENTS

I. Industry Analysis 1. Overview (Nationalized Era) 2. Deregulation 1997-2010 3. IRDA Regulations 2010-2011 4. The Market Today i. Demographics ii. Competitive Landscape iii. Products and Product Mix iv. Ongoing Concerns and Developments Max India 1. Overview 2. Life Insurance Business i. Pre Regulation ii. Post Regulation 3. Comparison with Competitors 4. New Strategies 5. Other Key Information i. Management of MNYL ii. Stock Metrics and Performance Valuation 1. Value of Life Insurance Business 2. Value for FY12 i. Key Assumptions ii. Valuations iii. Scenario Analysis Conclusions 1. Key Positives 2. Key Risks 3. Overall Conclusions Appendix 1. IRDA Regulations 2. Definitions of Policies 3. Details on Proposed DTC 4. Shareholding of Max India 5. Broker Estimates 6. Alternate Analysis 7. Key Management of Max India

II.

III.

IV.

V.

I.

Industry Analysis

Overview (Nationalized Era): On January 1956 the Indian government nationalized the Life Insurance Industry by merging 250 companies into one large organization named the Life Insurance Corporation of India (LIC). However, LIC failed to increase insurance penetration in India (remained below 1% till the late 1990s), and the premium underwritten grew at a meager CAGR of 10.6% between 1956 and 2000. Furthermore there was little to no product innovation as LIC had no incentive to do so as it had full control of the market. Deregulation 1997-2010: In Dec97, Insurance Regulatory and Development Authority (IRDA) Act was passed, paving the way for the entry of private players. New licenses were given to private players with a cap of 26% on foreign equity share capital. As of 31st March 2011, there are 22 private players and one public company. Most private companies have a foreign partner with 26% equity stake. The deregulation period was marked by rapid expansion of private players, the growth of Unit Linked Products (ULIPS), and Policy Holders aiming for quick market gains. Growth in the sector: The insurance sector grew at a CAGR of 25% from 2001-10 (after the sector was open for private investment). The growth rates for Private Players and LIC however have been starkly different. Sector Growth over Time

Private Players LIC Consolidated

1956-2000 10.6% 10.6%

2001-2010 185.0% 20.0% 25.0%

*growth rates are based on the insurance premium underwritten

LIC losing share: Owing to the mammoth growth shown by the Private Life Insurance companies during the deregulated period, LIC steadily lost market share to the private players. LIC vs. Private Market Share

Indian market dominated by saving products: During this period the Indian Insurance market was primarily driven by savings oriented products with negligible share of pure protection, annuities and pensions. Among the savings oriented products unit linked products account for 42% of the savings products premium underwritten in FY 2010. For the private players, ULIPs account for 86% of the savings products premium underwritten in FY2010. Saving Products Dominate Sales (FY10) Private Player Product Mix (FY10)

Strong correlation between industry performance and capital markets: As a lot of the craze for ULIPs (products where performance is linked to public markets) was driven by strong capital markets, it was natural that the Life Insurance Industry did well when capital markets were in a bull phase. Policy Holders were hooked on to short term gains and were attracted to the aggressive structure of ULIPs. However the subsequent drop in markets resulted in a drop in First Year Premiums (FYP).

Correlation between Industry and Markets

IRDA Regulations 2010-2011: With the fall of the markets in late 2008, several ULIP policy holders saw their investments wash away and began to cash out. Furthermore sales of new policies diminished (see chart above) as market conditions made ULIPs unattractive. However Insurance companies continued to make money as ULIPs came with heavy surrender charges which had ample PnL built into them. The bifurcation of the interests and profits between insurance companies and policy holders led to the IRDA stepping in and make sweeping regulatory changes with regards to ULIPs (this is after the courts decided that the IRDA was indeed the regulatory body responsible for these products and not SEBI). The IRDA felt that mis-selling of the product instigated by high agent commissions, the one-sided profit structure, and overall arrangement of the product was unfair to policy holders. In July 2010 the IRDA announced the following changes. For full details on the regulations below please see the Appendix. IRDA Regulation and Effect on various Industry Participants
IRDA guidelines Insurer Agent/ Distributor Lock in period of Negative as short term in- More difficult to find vestors would not invest in buyers for the policies minimum 5 years ULIPS. Long term might lead to better persistency ratios Rationalization of distributors commission Cap on charges Minimum sured Surrender Negative Negative Policy Holder Deterrent but mixed feelings as this is coupled with cap on ULIP charges and surrender charges Would magnify the returns

Negative

Would magnify returns

sum

as-

Negative as higher solvency requirements

Mixed effect. Policy holders would lose out because of age Magnified returns Returns will increase if more value created

Capping of ULIP charges FDI stake and IPO norms

Would hit margins Would unlock value

Post regulation the life insurance industry as a whole recorded a 15% growth in new business premium during FY11. While LIC grew by 22% during FY11, private players witnessed medium growth of 2.6% due to new regulations set by the IRDA. Some industry experts have stated that the new regulations have pushed the market back three years (in terms of Annual Premium Equivalents).

The Market Today: Demographics: There are several key demographics and figures which make the Indian Industry highly attractive. With the new focus on long term savings, insurance products already suit the needs for many policy holders. Long term Investment is a function of the savings rate of the country and with one the highest savings rate (more than 35% of GDP) in the world, India is one of the most attractive markets for long term savings. It is predicted that in the future a vast proportion of growth is likely to come from change in allocation of wealth by Indian individuals. A large proportion of the savings is routed to the bank deposits rather than more efficient long term saving instruments like insurance and mutual funds, predominantly due to limited financial knowledge. However with financial literacy improving it is expected that the proportion of mutual funds and life insurance will improve, given most of the Indian population is still young and with a higher risk profile. Savings Distributions in India

Furthermore Indias insurance density (Insurance premium per capita) is amongst the lowest in the world. With a young population, increasing risk appetite, growing financial knowledge, and a high GDP growth rate, the density numbers are poised to increase rapidly. Insurance Density

Competitive Landscape: The private market has 22 players with most of the leading companies being promoted by private sector banks. While LIC still dominates the market, these private players have made signifi-

cant headway over the last decade. The market share composition has changed significantly between FY10 and FY11 due to the change in regulations, and companies that were able to adapt have won out (at least in the short run). Market Share by New Business Annual Premium Equivalent (APE)

However over the last few years there are clear winners in terms of the size of AUMs, with bank promoted companies doing well by leveraging their branch distributions to capture market share and total premiums. AUM Growth & Size of Top Players

Products and Product Mix: There are several variations of products (albeit minor), being offered by the various companies however the core types of products are broadly categorized into five types; Term Insurance (Pure Protection), Endowments, Unit Linked Polices, Single Premium Products, and Pension polices. Term Insurance, Endowments, and Pension policies are commonly known as Traditional Policies. A full definition of the products can be found in the Appendix. Product Metric Comparisons

Due to the changes in regulations and the drop in profitability of ULIPs most Indian Insurers have significantly altered their product mix. It is likely that the industry as a whole will settle at a 50:50 product split between Traditional and ULIP products. Product Mix (Jan Sep 2010)
MYNL Bajaj Allianz Tata AIG Aviva Life Birla Sunlife

Product Mix (Oct - Jun 2010)

MYNL Bajaj Allianz

75%
63% 85% 95% 92% 92% 85%

25%
37% 15% 5% 8% 8% 15%

15%
50% 55% 57% 60% 60% 75%

85%
50% 45% 43% 40% 40% 25%

Tata AIG Aviva Life Birla Sunlife

ICICI Pru
HDFC Life SBI Life

ICICI Pru
HDFC Life SBI Life

97%
ULIP Traditional

3%

85%
ULIP Traditional

15%

Ongoing Concerns and Developments: The New Direct Tax Code (DTC) proposed by the Income Tax department of India poses significant risks to the sector. While there is not clear timeline for when the DTC would be implemented, several executives in the industry have hinted that its implementation would bring down overall profit and valuations of Indian Life Insurance business (from 7-10%). Full details of the DTC proposed changes are in the Appendix.

DTC Impact
DTC guidelines Tax rate (From 12.5% to 25%) MAT Insurer Would hit margins Policy holder Higher share of surplus

Would hit margins and push away breakeven Would reduce takers for policy

Would erode the returns

Taxation on Individual (Transfer from EEE to EET)

Policy holders might then choose other tax exempt schemes

The IRDA is also meant to come out with clarifications on the following: Guidelines for IPO of Insurance businesses. This will unlock value and allow promoters to monetize their investments. No firm deadline on when the regulations are to be released, however the industry expects these to come out by March 2012. The IRDA may also allow FDI investments to increase to 49%, however this is still in the discussion phase.

II.

MAX India

Overview: Max India Limited (Max) is involved in the Life Insurance, Health Insurance, Healthcare services, and Clinical Research businesses. It has several group companies which specialize in one of the above verticals. Overall its businesses have had revenue CAGR of 32% from FY07-FY11. Max New York Life (MNYL): A 74:26 JV with New York Life. 89% of the revenues of Max are derived from MNYL Max Bupa: Maxs health insurance business, which is a 74:26 JV, but with Bupa Finance PLC. Max Healthcare Institute Limited: A healthcare provider of standard, seamless, integrated and international class healthcare services. It provides primary, secondary, and tertiary care with 8 healthcare facilities across the country. Max Neeman Medical International: Provides clinical research services across the entire value chain of new drug development to pharmaceutical, biotech and clinical research customers. Max Specialty Films: Manufactures a range of sophisticated barrier and packaging films.

Key Metrics
INR (cr)

Op. Rev Tot. Rev

growth %

FY08 3,244 3,611 3,671 -60 3,575 2,693

FY09 4,508 4,891

35.45%

FY10 5,575 7,661

56.63%

FY11 6,668 7,891

3.00%

Tot. Expenses
growth %

5,224
42.30%

7,747
48.30%

7,859
1.45%

PBT LI AUM
growth %

-333 5,405
51.19%

-86 10,121
87.25%

32 13,836
36.71%

Total Premium
growth %

3,856
43.21%

4,860
26.04%

5,812
19.59%

Due to most of the value of the stock being derived from the Life Insurance business, Max is the only appropriate proxy for the Life Insurance business which can be accessed through public markets. Life Insurance Business: Pre-Regulation: Max New York Life Insurance Company Ltd. is a joint venture between Max India Limited, and New York Life International, the international arm of New York Life, a Fortune 100 company. Incorporated in 2000, Max New York Life started commercial operation in April 2001.Prior to the IRDA regulations Max took a more conservative approach to the business compared to its competitors. Its management chose not to be aggressive on Bancassurance (using banks to distribute policies), and chose to build out their own agency force instead. Furthermore Max was late to the game with regards to ULIPS and was one of the last of the private players to enter this space. However once it did enter the space it did so aggressively and moved its ULIP mix as high as 75% of the total, and expanded into 384 cities in the country. Post-Regulation: Post regulation, like all other life insurance players MNYL has changed its mix from a predominantly ULIP heavy business to a more traditional focus business. However as illustrated previously, Max has moved into this mix significantly quicker than any of its rivals. This is due to the fact MNYL had moved into the ULIP business significantly later, and still maintained much of their infrastructure for selling traditional products. This allowed MNYL to grow 9% in FY11 when the Industry fell 20%, and allowed Max to de-grow only 14% in Q1FY12 when the rest of the industry de-grew 44% yoy. However MNYL realized that it had missed a few things, and let their costs get out of hand, and currently have the highest operating expenses amongst the top seven players.

Expense Ratios (Opex to Total Premium)

Comparisons to Competitors: MNYL has done exceedingly well in continuing to grow their business despite an adverse market and regulatory environment. Their growth in Total Premium and APE is significantly above the averages.

Company MNYL ICICI Pru Birla SunLife Bajaj Allianz HDFC SL Kotak Old Mutual SBI Life Reliance Life Average
New Strategies:

Total Premium Growth FY10 FY11 26.0% 19.6% 7.6% 8.1% 20.4% 3.1% 7.5% -15.8% 25.9% 28.5% 22.4% 3.7% 40.1% 27.8% 33.9% 21.4% 13.6%

APE Growth FY10 FY11 3.0% 8.1% -4.8% -6.2% 5.5% -30.4% -9.9% -33.7% 31.7% 9.4% -14.2% -19.1% -2.1% -16.6% 21.1% 1.3% -8.4%

MNYL has undertaken a series of new initiatives in order to revamp their business. Along with McKinsey the management of MNYL undertook a study to help them understand the industry better. This led to a reorganization and a focus on Long Term Savings Products (LTSP), a focus on the Mass Affluent Market (incomes of Rs. 2 lakhs or higher), and various other strategies. This could mean higher productivity and more sticky business. Move away from mass customers to mass affluent customers with focus on long term savings protection products (LTSP): Its focus shifted in the latter part of the decade due to high competitive pressures but now it

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has achieved critical mass in business so it is realigning its focus on mass affluent customers only. It has historically focused on LTSP which helped it to nullify the impact of ULIP regulation. It will concentrate on LTSP with minimum 10 year tenure and 20 times sum insured. This measure also makes future earnings less volatile since it reduces the companys dependency on new business premiums. Transform the current agency to a platinum standard: It decided to recruit well educated agents who have focus on Insurance as full-time employment. It also reduced the span of control which will ensure higher accountability and better performance. MNYL is renowned to have one the best agent force in the business. While most agents train for 50 hours MNYLs agents train for a minimum of 300 hours. There are also a minimum of two trainers per office, which means agents constantly go through re-training. Lastly, agent compensation is now tied to long term earnings instead of sales, which helps to explain MNYLs higher persistency ratio (see below). Maintain overall persistency at least at 75% to 80%: The high quality agency channel and products should be able to help meet the targets on persistency. Its current persistency levels are higher than industry average. Persistency Ratio of Indian Insurers

Build a multichannel distribution network with bancassurance: MNYL entered into agreement with Axis Bank which is in line with its strategy of concentrating on mass affluent market, given the high quality customer base of Axis. For this agreement, Max has given a 4% stake to Axis Bank in MNYL. Post this agreement Maxs stake in MNYL came down to 70%. Going forward Max expects nearly a quarter of its distribution to go through bancassurance from a meager 4% in FY10. This strategy will also help to reduce costs and boost margins. Currently on a ULIP distributed through its agency MNYL makes ~5% margin, however when distributed through bancassurance the margin jumps to nearly 15%. Focus on cost management: The management has decided to make a leaner company by cost savings of Rs.4bn during FY11 (from FY10). This has largely been done by cutting down its presence from 384 cities to 135 cities and by cutting their number of agents by nearly 30,000 to 43, 692 in FY11. MNYLs expense ratio is expected to fall to 18% from FY12 onwards.

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Proactively try and shape the regulatory agenda: The insurer has launched products confirming with DTC and hence avoid any discontinuity after the tax changes. Moreover, Max it is one of the best placed insurance companies to cope up with ULIP regulation given its low dependency on these products. Going forward MNYL expects to maintain a 60:40 Traditional to ULIP mix. Due to these changes MNYL has managed to turn profitable in FY11 with all product lines also turning profitable. For the future MNYL management has indicated that they will focus on the following Keep check on costs New Product Designs to boost margins Keep distributors happy (grow bancassurance, and reduce overall cost of distribution) New Business Margins will come down to around 13-14% but meant to stabilize at 15-16% within a years time

Other Key Information: Management of MNYL: MNYL has a professional management team with a depth of experience. Rajesh Sud: CEO & Managing Director - Appointed CEO and Managing Director with effect from November 1, 2008. Prior to this was responsible for setting up distribution strategy for individual life business. Worked with ANZ Grindlays prior to joining MNYL. Rajit Mehta: Executive Director & Chief Operating Officer - He is also on the board of the company. Has been appointed as the Chief Transformation officer, to facilitate the organization through its transformation over the next 2-3 years. Ashish Vohra: Senior Director & Chief Distribution Officer - He is instrumental in maintaining the companys distribution footprints across the nation and acquiring key partnership and bank distribution alliances. Prashant Tripathy: Director - Strategic Planning, Business Development - Prashant looks after the strategic initiatives of the company and works closely with cross functional teams for business development developing long-term strategy His role is to identify and develop new opportunities, initiatives and assist in the support of new and existing external relationships. V Viswanand: Director & Head-Products and Persistency Management- Set up the companys Agency distribution channel in South & East India, and thereafter launched the Bancassurance and Direct Sales Distribution channels. Over the past six years, both channels have evolved to become significant strategic contributors to Max New York Lifes growth. Stock Metrics and Performance:
Key Numbers Shares CMP Outstanding (m) 205 257 Mkt Cap (m) 52,595 Free Float (m) 26,320 52 Week High/low 132 / 214

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Max India Stock Performance

IRDA regulations and subsequent underperforman ce of the industry Max share price has help up exceedingly well despite market downturn

Start of the Financial Crisis

What Analysts Are Saying: Stock analyst generally have a bullish view on Max India, with most recent reports putting the price target anywhere between 220-250.
Date of Px at time Upside From Report of report Target Current Px 28-Aug-11 176 222 8.29% 16-Aug-11 185 234 14.15% 01-Jun-11 167 248 20.98% 18-Mar-11 144 190 -7.32%

Broker BoAML Sharekhan Execution Noble Goldman Sachs

III.

Valuation

Value of a Life Insurance Business: The value of a Life Insurance company is driven by its outstanding business and its potential future earnings (Appraisal Value). Thus most analysts value Indian Life Insurers on the following formula:

Appraisal Value = Embedded Value + NBAP * Capitalization Factor

where: Embedded Value = Net worth + Value in Force NBAP (New Business Achieved Profit) = APE * New Business Margin Capitalization Factor = Multiple Allocated to future earnings (Typically between 9-14x) Value in Force = Present Value of the profits that will emerge from a block of life insurance policies over time APE (Annual Premium Equivalent) = First Year Premium + 10% of Single Premium

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We will value the business of MNYL based on this formula, analyst expectations, and guidance from management. Value for FY12: The below assumptions are taken after considering conversations with management from MNYL and analyst estimates. Key Assumptions:
Key Assumptions Value Notes Embedded Value (Rs. crore) 3764 Analyst Average + Mgmt Guidance APE (Rs. crore) 1775 Mgmt Guidance No. Shares (Rs. crore) 23 Max India Stake 70% After Axis Deal Holding Co. Discount 10% Analyst Average Margin Range 10-15% Mgmt Guidance Multiple Range 9-14 Analyst Average Value/Share of Other biz. 26 Analyst Average

*FY12 APE is assumed to be flat to slightly higher than FY11 APE as per management guidence Valuation: Step 1) Appraisal Value Sensitivity
MNYL Appraisal Value for FY12 (Rs. crore)
NBAP %/Cap Factor

9 5362 5522 5681 5841 6001

11 5717 5912 6107 6303 6498

13 6072 6303 6533 6764 6995

14 6249 6498 6746 6995 7243

10% 11% 12% 13% 14%

Step 2) Discounted for Maxs shareholding, addition of value of other business, application of Holdco discount
Max Target Price
NBAP %/Cap Factor

9 169 173 177 182 186

11 178 184 189 194 200

13 188 194 201 207 213

14 193 200 206 213 220

10% 11% 12% 13% 15%

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Scenario Analysis:
Cases of Evaluation Pessimistic case New Business margin Capitalization factor Price of Max India 12% 9 177 Base case 13% 11 194 Optimistic case 15% 14 220

*These values do not take into account the impact of DTC. If this were taken into account each of the scenario price targets would drop by ~4%.

IV.

Conclusions

Key Positives: Conservative Approach to Risky business: MNYLs new product line is focused on long term savings and mass affluent clients to focus on stable future business. They have stayed away from particularly risky ULIPs that their competitors are offering. First Mover into New Paradigm: MNYL was the quickest to move into the new product mix where ULIPs share is to come down. This has allowed them to grow when the industry has fallen. Other competitors are to follow suit. Cost Consciousness: While they still maintain one of the highest cost ratios in the business, the company has taken drastic measures to reduce their costs, and is making strong progress. Strong Management: The Management teams of Max and MNYL are made up of seasoned professionals who have solid track records in the financial industry. Strong Agent Force: MNYL is renowned for having the strongest agent force in the business, and the new compensation patterns are conducive towards supporting and building the firms new strategies. This force has also been trimmed down, and is now leaner in terms of costs to the company. Key Tie-Up with Axis: While they may have been late to the game in this aspect, the new Bancassurance tie-up will help to boost margins, increase distribution channels, and reduce costly agent base. No New Capital Needed: MNYL is well capitalized; they are running a 322% Solvency Margin compared to the 150% required. There may however be a ~Rs. 400crore need by Max to fund their healthcare and health insurance businesses. All Policies Generating Surplus: As per FY11, all policy verticals have turned profitable and are now generating a surplus Marquee Investors: Max has the backing of key investors such as Warburg Pincus, Goldman Sachs, IFC, and Temasek (see Appendix)

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Key Risks: Valuations: Max seems fairly valued at the moment with a price of Rs. 205/share. Furthermore if DTC is taken into account current valuations might actually be on the higher side. Net Margins (ROE) to remain lower than Competitors: As MNYL has just broken even the ROE of Max will remain lower than competitors. However the gap should continue to close as all product lines are now adding to the surplus. New York Life Agreement: Under the agreement with NYL, if the FDI limits are increased to 49%, NYL has the right to buy an additional stake of 23% at a 10% discount to Fair Market Value. While this would mean additional cash for Max, it could result in reinvestment risk if the money is not invested in assets which yield as much as MNYL. DTC: If DTC comes into effect it will affect the entire industry on two fronts. Tax on the company itself will increase, and the tax benefits derived from buying policies will be reduced. This will be a big negative for the industry, which could have an impact of 7-10% on embedded values. Macroeconomic / market conditions deteriorating: India is currently in a high interest rate and high inflation environment, and this coupled with economic weakness in, Europe and the United States provides for an unstable horizon. As the financial crisis in 2008 illustrated, when Indian markets fall, most (if not stocks) follow suit due to the high amount of embedded correlation. However, the share price of Max has held steady during the recent turmoil, illustrating its resilience and investor confidence. Regulations have set Industry back: The new IRDA regulations have set the industry back three years. This has impacted margins, new business, and it will take some time before these metrics return to a steady state. Overall Conclusions: Over the long term most analysts would agree that Max is one of the most well placed Indian Insurance companies. Its new strategies, tie-ups, and cost cutting should help it continue to gain market share in the industry. However the stock price has run up quite a lot recently (perhaps a reward for a solid performance), which makes it difficult to see any value left on the table. However considering the strength of the company it would make sense to purchase the price on corrections. Due to potential DTC implications, setbacks from regulation, and low margins for the next year, a price of Rs.170-180/share would make this scrip very attractive.

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V.

Appendix

1. IRDA Regulations Solvency Margins: Have been reduced recently and this should favour insurers capital requirements

Cap on ULIP charges: In July 2009, IRDA introduced a ceiling of 300 bps on ULIP charges for contracts up to 10 years and 225 bps for contracts over 10 years, effective Sept 2010. Most private players ULIP charges in FY09 were in excess of this limit.

The cap is likely to reduce NBAP (new business achieved profits) margins of private life insurers. In addition, IRDA has also capped the fund management charge (FMC) at 150 bps for a policy up to 10 years and at 125bps for a policy with more than 10 year tenure. FMC for debt funds used to be typically in the range of 0.8-1.5%, and for equity funds it was 1.5-2.5%. Capping Surrender Charges: IRDA has stipulated that no surrender charge can be levied by an insurer for policies rendered from the fifth policy year (i.e. the policyholder would be entitled to receive the full fund value on surrender after five years, albeit in annuity). This makes the policy more attractive for policyholders but caps margins and reduces cash flow for insurance companies. If however the Policy holder chooses to surrender before five years following charges will apply. If the premium is less than Rs. 25,000: Lower of 20% of the Annual Premium/Fair Value of the Policy up to a maximum of Rs. 3000

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If the premium is greater than Rs. 25,000: Lower of 6% of the Annual Premium/Fair Value of the Policy up to a maximum of Rs. 6000

Lock In period of minimum 5 years and Minimum Paying term of 5 years: New IRDA guidelines require lock in period of minimum 5 years (previously 3 years). Thus it is a negative for investors who were looking at ULIPs over a short term investment horizon. This would reduce the amount of policies being sold by the insurer. Rationalisation of distributors commission: The commission being paid to distributors has been capped, and the commission will not be completely charged in the first year, instead spread over five years. Thus the distributors would have to ensure higher persistency rates for the policies. Minimum Guaranteed return of 4.5% for pension products: This regulation has lead to most of the insurers dumping the product as this regulation made the product highly unattractive for the insurers. This regulation does not make much of a dent as the pension products formed a miniscule portion of total premium underwritten by private insurers. Minimum sum assured: Change in this regulation has lead to insurers maintaining more capital as reserves. Before 5x AP After Age < 45 years: higher of 10x AP or 0.5x tenure X AP Age > 45 years: higher of 7x AP or 0.5x tenure X AP

Regular premium

Single premium

Tenure < 10 years: 125% of SP Tenure > 10 years: 110% of SP

Age < 45 years: 125% of SP Age > 45 years: 110% of SP

Foreign Direct Investment: The government proposes to raise the foreign ownership ceiling for private sector insurance companies from 26% currently to 49%. A rise in foreign ownership limit is directionally positive for the insurance industry. Such a step will facilitate access to international capital, in turn enabling players to enhance their capital base for business expansion and aid value unlocking in the sector. No regulation has still been passed. 2. Definitions of Policies Term Insurance: Term insurance is the simplest form of insurance policy which covers only the risk of the insured. The policy has no maturity value and the insurance company is liable to pay any amount only in the event of death of the insured. This policy is not very popular in India, owing to a) Indian mindset of getting something back at the end of the term b) Lack of awareness as LIC never marketed such kind of policy c) Agent dont push it aggressively as commissions are low on such policies

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However these kinds of policies are more profitable for insurance companies as the NBAP (New Business Achieved Profit) margins for such policies are around 43%. The upside for an insurance company for such policies comes from the mortality savings and the higher return on investments as the entire AUM belongs to the insurance company. Endowment: Endowment policies were the most popular form of insurance in India before Unit Linked products. These policies combine the risk element with the savings elements making it a more attractive proposition to market. Agents also aggressively market such policies as the commission rates of such policies are the highest and it requires less effort to sell compared to term insurance. Profitability on these policies is also high with NBAP margins ranging from 30%-35%, depending on the nature of the policy (participating v/s non participating) and the actual returns on the AUM. In case of an endowment policy insurance companies deduct charges from the premium amount (the deduction is largely adhoc and is based after factoring in a level of expected mortality and economies of scale) and the balance is invested. In case of participating policies 90% of the return made on the invested is given to the policyholder while in case of non-participating policies the insurance company declares bonuses depending on the actual return (typically range from 50-90%) The revenue stream for insurance company in endowment policy comes from mortality gains, economies of scale and the surplus return on investments. Unit Linked policies: ULIP are called as non-traditional policy, as its been introduced only after the private players entered the market. However it has seen a sharp growth in demand and accounts for 80-90% of the incremental market share. While initially the ULIPs generated significantly high NBAP margins for insurance companies, the margins have since then come down, owing to rising competition and increasing awareness. ULIP NBAP margins now, range around 20%. Unlike endowment policies, insurance companies have to upfront mention the load charges that will be deducted from the premium income towards risk premium, operating expenses and agents commission. Also any return on investment on ULIP would accrue fully to the insured. Thus the revenue stream for the insurance company in such policies comes from the 1-2% asset management fees and the savings from mortality gains (very limited as typically sum insured is very low) and c) economies of scale (again very limited as large economies of scale is already priced in by most of the insurance companies) Single Premium Policies: Single Premium policies have also gained significant traction in the past 12-18 months, however, largely in the ULIP space. Single premium policies are least profitable from NBAP margin point of view (as all the income is received upfront) and NBAP margins range from 3-4%. Single premium policies could be endowment or ULIP, however require only one premium to be paid upfront. Pension: Pension policies form a miniscule portion of the total premium income as the pension sector in India is not fully opened up. Pension policies involve a series of annual payments by the insured over the term of his employment, which is invested by the insurance company and which cumulatively (including the return) is returned to the insured on his retirement either by way of bullet payment or by annuity. Group Insurance: Group insurance is an insurance coverage plan that covers a group of people who are the employees of a common employer, group of professionals or society members, etc; under one master policy. A common feature in most of the group insurances is that the premium cost is not based on the risk. In fact, the premium paid by every member is the same. For example, in case of group health insurance plan of a company, all the employees are under the same coverage and pay the same premium amount. They receive the same bene-

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fits irrespective of their age or other factors. Group Insurance plan allows the members to purchase or renew coverage during their association with the group subject to fulfillment of specific conditions. The payment of premium for a group insurance policy is managed by payroll department of company where certain portion of employee salary can be deducted towards premium payment or in some other cases company itself bears the entire cost of policy as a means of benefit for employees.

3. Details on Proposed DTC Tax rate: Currently, insurance companies are subject to a 12.5% tax rate and most have priced their products using this tax rate in their calculation. The new direct tax code proposes to increase this tax rate to 25%, which would hurt the profitability of insurance companies. The new DTC also proposes to allow companies to carry forward losses to set off against future profits for an unlimited period, compared with 8 years currently. This will enable insurance companies to set off losses even if breakeven gets delayed by a couple of years. However, given that a large chunk of these losses were incurred over FY06-09 (which means set-off available till FY1417), most insurance companies would have been able to set off losses within 8 years. Hence, the extension of the setoff period may not have a significant implication. Taxation on maturity: The new DTC also proposes to tax the maturity proceeds of all savings, including insurance policies. Currently, maturity proceeds of an insurance policy are tax-free. Increasing tax incidence on investments would discourage savings in general but the impact on insurance savings is likely to be more severe, as insurance products would lose its relative tax arbitrage vis--vis other financial-savings products. Minimum Alternate Tax: The new DTC also proposes minimum alternate tax (MAT) at 2% on policyholders assets, which, if passed on to the policyholders, can lower investment returns further. Minimum sum assured: For the annual premium to be eligible for deduction under 80C, the minimum sum assured should be 20x annual premium. This regulation if effective might act as a deterrent for investors choosing between insurance policies and other financial instruments.
Till the time of compiling of this report , no formal word was out on DTC

4. Shareholding Structure of Max India

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5. Broker Estimates
FY12 Estimates (rs. crore) Execution Noble Embedded Value Appraisal Value 3,770 6,477 Goldman Sachs 3,744 6,929 BofAML 3,780 6,118

6. Alternative Valuations
P/EV Multiples Europe Prudential PLC CNP Assurance Old Mutual Legal and General Standard Life St. James Place Average China China Life Ping An CPIC Average Hong Kong AIA Group CTIHC Average India Bajaj Finserv Aditya Birla Nuvo Reliance Cap Max India Average 1.644 1.720 3.463 1.315 2.04 1.397 1.420 1.41 1.420 1.510 1.690 1.54 0.81 0.53 0.58 0.72 0.61 0.84 0.68

P/EV Multiples: This table illustrates that insurance companies in developed markets typically trade at a P/EV of less than 1, where as in developing markets this multiple is typically greater than 1. This difference implies that in developed markets much of the value of a Life Insurance Company is driven by EV rather than the New Business multiple as business have matured. However in developed markets where the businesses are quite new, the new business multiple makes up most of the value. Local Comparisons: Max tends to have a lower ROE than some of its competitors due to it just breaking even, however this should move up steadily as all product lines are now in surplus. Furthermore the Implied multiple used for Maxs valuation seems in line with the rest of the industry.

Local Comaprisons (Analyst Averages) Implied Multiple for Company ROE FY11 LI Biz. Max India 9.78% 11.33 Bajaj Finserv 50.37% 13.00 Aditya Birla Nuvo 23.57% 11.00 Reliance Cap 1.03% 11.00 Average 21.19% 11.58

7. Key Management of Max India Analjit Singh: Executive Chairman - The driving force behind Max Groups sustained growth and success in the early 80s. Is an alumni of the Doon School and Graduate School of Management, Boston University. Rahul Khosla: Managing Director Expertise developed over 27 years in financial services having worked in India and Singapore with organizations such as Visa, ANZ Grindlays, Bank of America, and American Express.

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Is a Fellow Member of the Institute of Chartered Accountants of India and holds a Bachelors degree with honors in Economics from St Stephens College, Delhi. Mohit Talwar: Director, Corporate Development 31 years experience with the Oberoi Hotels, Bank of Nova Scotia, Grindlays and Standard Chartered. Post Grad in Arts and Hospitality management. Sujatha Ratnam: CFO 22 years experience in Jubilant Organosys and Tata Motors. CA qualified.

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