LIC’s triple blow

Rs14,000 cr hole; loss at LIC MF; govt scrutiny

LIC’s problems echo those at Unit Trust of India a decade ago when its assured return scheme ran into trouble

Tamal Bandyopadhyay, Baiju Kalesh & Anirudh Laskar, Mint 16/11/10

Life Insurance Corp. of India (LIC), the country’s largest financial institution with an asset base of Rs12 trillion, is running a valuation deficit of around Rs14,000 crore in three plans of its guaranteed-return annuity policies—Jeevan Dhara, Jeevan Suraksha and Jeevan Akshay. Not all plans under these three brands are affected.

There are at least 1.3 million customers of these three plans, but none will be affected.

In a parallel development, all investments made by LIC during fiscals 2007-08 and 2008-09 are under the government’s scanner, following complaints made about its investments in a few companies.

The finance ministry is also closely looking at the exposure of its subsidiary, LIC Mutual Fund Asset Management Co. Ltd (LIC MF), to liquid and money market schemes that led to a loss of Rs120 crore. “The unitholders have nothing to worry. We’ll fix the responsibility and take stern action (against those responsible),” said a ministry official familiar with the development, who asked not to be identified.

Another person, who also did not want to be identified, said “heads will roll” in LIC MF.

While LIC MF has disclosed its loss in its half-yearly earnings and reported this to the capital market regulator, the notional loss or valuation deficit of LIC’s three guaranteed return pension schemes is not mentioned in its balance sheet as the insurer does not disclose its profits or losses across segments.

These plans were launched in the 1980s and the 1990s with assured returns of 11-12%, but with the drop in interest rates the actual yield on investments is much less than what investors have been earning. They were launched under the Jeevan Dhara, Jeevan Suraksha and Jeevan Akshay brands. Subsequent schemes launched under the same brands are not suffering from any notional losses.

These three loss-making old schemes are annuity plans, offering periodic payments after the retirement of a policyholder. They address the longevity risk and in some cases, inflation risk in a limited manner.

As the payout phase is usually long and uncertain, such schemes require the matching of assets and liabilities over a fairly long period.

“The valuation gap varies according to the movement of interest rates. In future, it can widen or even shrink. At the current interest rate scenario, the net present value of the deficit for these schemes, which will expire after a few decades, is around Rs14,000 crore,” said an LIC official, who asked not to be named.

Apart from the interest rate trend, the mortality rate will also have a bearing on the actual loss that LIC will suffer eventually. Mortality rates have been progressively coming down and this means longer payouts to the investors. The LIC official said that there is no plan to discontinue these schemes and added that LIC has a solvency margin of Rs46,000 crore and this is being used to take care of the valuation gap. “We’re using surpluses to make good this gap and not using other policyholders’ money,” he said.

A senior Insurance Regulatory and Development Authority (Irda) official said the regulator would not have approved these LIC schemes had it been in existence when they were launched. “There is indeed a deficit… This is not a good practice. We’d not have cleared such products if they were to come to us for approval,” the Irda official said, asking not to be identified.

“It would be unwise for LIC to build up such losses in their accounts. Pension funds are required to be handled very carefully,” he added.

If interest rates keep falling and the people covered under these LIC policies do not claim their incomes, the losses could build up further. “If it calls for a corrective action, we’d certainly act,” said Irda chairman J. Hari Narayan. Irda came into being in 1999.

The schemes

LIC introduced two personal pension plans, a deferred pension plan by name Jeevan Dhara and an immediate pension plan by name Jeevan Akshay in 1987-88, offering 1% assured return per month. The government had allowed premium on these two plans up to Rs40,000.

Both plans had managed to attract millions of customers due to tax incentives offered. Investments in such schemes were exempted from one’s income while computing tax. Demand for the schemes continued till 1992, when the government withdrew the tax incentive.

In 1996, once again, LIC introduced a deferred pension plan, Jeevan Suraksha. The government allowed premium of up to Rs10,000 for the policy.

The latest data available for these schemes shows that till March 2003, LIC had nearly 1.3 million customers covered under them.

The arithmetic

The premium money collected under annuity and pension plans is predominantly invested in government securities and highly-secured corporate bonds; some portion is also invested in equity.

Interest rates in India were regulated until 1997–98, when the medium and long-term rates were approximately 12-13%. Since then they started falling and simultaneously, the mortality rates too fell as life expectancy increased. Currently, the yield on the government’s benchmark 10-year bond is about 8.1%.

When an insurer launches a guaranteed annuity product, it assumes that the securities where the premium money is invested are fairly long-term in nature and will mature roughly during the payout phase (the period when the annuitants start claiming their income).

If investments mature before the people covered die or start claiming their income, the insurer needs to reinvest the money in other securities. If the reinvestments fetch interest rates lower than the returns guaranteed by the insurer, it starts incurring huge losses. The losses keep multiplying year-on-year and if the interest rates keep falling, the company may be badly hit.

“The interest rates fell more steeply than we had expected and the life expectancy has increased to 90 years for the policyholders,” the LIC official said.

Solvency issues

In order to ensure that the life insurers in India are capable of honouring claims against any of their policies any time, Irda stipulates that firms must maintain a solvency margin. The solvency margin is simply the excess of the value of assets over the value of life insurance liabilities and other liabilities of policyholders’ and shareholders’ funds.

Irda also specifies that for pension schemes, an insurer is required to recognize the risk of decline in future interest rates.

LIC has an overall solvency margin of Rs46,000 crore currently. A member of the Institute of Actuaries of India, who had earlier worked with LIC, said solvency margins are prudential measures and may not be sufficient to handle an insurer’s overall liabilities. An insurer needs to ensure it has the right kind of reserves, reinsurance or derivatives to back its guarantees credibly as far as annuities are concerned, he added, asking not to be identified.

The valuation deficit at LIC is somewhat reminiscent of the infamous US-64, the assured return scheme of the erstwhile Unit Trust of India (UTI), the nation’s oldest MF that crumbled under the burden of assured payouts to the millions of investors in US-64. The government had bailed out UTI and bifurcated it into two separate entities—Special Undertaking of UTI for managing all the tax-free assured return schemes, and UTI Asset Management Co. Ltd for managing the assets under other MF schemes.

The LIC official said that “it’s not fair to compare (LIC’s schemes) with US-64” as investments made by the pension schemes are all held to maturity and LIC does not need to value them in accordance with their market price or follow the so-called mark-to-market (MTM) accounting practice.

Losses in MF

LIC MF has posted a Rs120 crore loss following a new norm of capital market regulator Securities and Exchange Board of India (Sebi) that directs all MFs to value their investment in all securities maturing 91 days and above on an MTM basis.

In its effort to enhance transparency in valuation of debt schemes, Sebi in February had ordered all MFs to value all money market and debt securities, including floating rate securities, with residual maturity of up to 91 days on the basis of their market value.

Nearly 60% of the MF industry’s assets are in debt securities. The Rs7.13 trillion industry invests money under income schemes, liquid and money market schemes in such securities. At the end of September, LIC MF’s average assets were Rs19,726.97 crore and Rs16,911.18 crore of this was in debt funds, says Value Research, a Delhi-based MF tracker.

“We’ve a substantial holding in long-dated securities under our mutual fund business. We’re now strengthening our mutual fund team. Actions are being taken,” the LIC official said.

Sushobhan Sarkar, who used to head LIC’s MF business, has recently been made the head the insurer’s international operations, and Mohan Raj, an executive director, is now heading the MF business.

Govt investigation

A three-member panel constituted by the finance ministry is closely looking into all investments made by LIC in 2008 and 2009. Tarun Bajaj, joint secretary (insurance and banking), department of financial services; Sanjeev Kumar Jindal, director, department of financial services, and Ravneet Kaur, joint secretary (banking and insurance) are the members of the panel.

R. Gopalan, financial services secretary, said: “This is a routine investigation. Millions of policyholders’ money is involved and we should act responsibly.”

“Whenever there’s any complaint, the government examines if there is any merit in it. If there are verifiable facts, the government questions and checks the investment books. One of the recent complaints regarding LIC’s investments involved four to five firms. The investigations are going on and we’re cooperating fully,” the LIC official said.

A series of discussions between Mint and a number of LIC officials disclosed that LIC’s equity investment portfolio includes investments in 475 unlisted firms of which 14 are strategic investments, including those in the National Stock Exchange and the Bombay Stock Exchange.

The book value of such investment is around Rs1,521 crore.

Currently, LIC holds equities of at least 1,000 companies and the market value of these investments stood at Rs3.75 trillion as on 30 September.

“Our holdings are fairly long term in nature. Naturally, there is always a possibility of companies getting delisted, turning the stock illiquid,” a second LIC official said last week, asking not to be identified.

He also said, “There is no loss-making investment and if required LIC can liquidate its stake (in such companies) at substantial profit.”

However, another person familiar with LIC’s investments in illiquid stocks said the insurer is trying to “dispose of such investment fast at best possible way”. This person, who doesn’t work for LIC and asked not to be named, said no new investment is made by the insurer in any firm unless it is listed and has a track record of paying dividends for three consecutive years.

The insurer has an investment committee that meets roughly once in six weeks. Gopalan is one of the members of the committee.

According to Irda rules, a life insurer is permitted to invest at least 50% in government securities, 15% in securities of infrastructure-related companies and projects, and the remaining 35% in equities, non-convertible debentures, commercial papers, certificate of deposits and MFs.

The insurer plans to invest nearly Rs2 trillion this fiscal, including equity and other instruments. LIC’s net profit went up by 11% to Rs23,478 crore during 2009-10 against Rs21,152 crore in the previous fiscal.

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