A little bit of IDBI Bank in my LIC policy

For the more than 25 crore policyholders of Life Insurance Corporation of India (LIC), the LIC-IDBI Bank headlines are very upsetting. LIC will use up to 13,000 crore of policyholder money to buy up to a 51% stake in IDBI Bank, an asset nobody wants to touch. With stressed assets of 55,588.26 crore and bad loans a huge 28% of the total loan book, IDBI Bank is probably the worst of the bad banks of India. With its own paid-up capital at just 100 crore as on 31 March 2017, LIC will use policyholder money entrusted to it to make this equity investment.

LIC has been the gilt-edged long-term safety net for most of post-Independence middle India. “LIC kara lo” is a refrain heard in Indian homes the minute the first salary of the young adult of a family begins to come in. There is public anger when this security of savings comes under threat. There are lots of reasons the policyholders are worried. They are worried about the safety of their money—what if the entire money goes down the drain. They are worried about this being a precedent to more such toxic asset purchases. They are worried about the haste with which the insurance regulator has interpreted a rule to allow this sale—insurance firms are not allowed to hold more than a 15% equity stake in a single firm to prevent concentration of risk.

Should you really worry? Step back and see that ₹ 13,000 crore is 0.57% of the ₹ 23 trillion assets under management by LIC as on 31 March 2017. Even if the entire money was to vaporize, there is little risk to policyholder money from this one investment. But policyholders fear that such an action can get repeated, as it has in the past when LIC has been called in to bail out other government issues from devolving, putting at risk their money. People of a certain age pull out the memory of the Unit 64 fiasco when some of middle India lost its savings to the mismanagement of their money by UTI mutual fund. Will a Unit 64 happen in LIC?

While Unit 64 was a market-linked mutual fund that was not marking its assets to the market, LIC has a hybrid portfolio with some of its policies market linked and others carrying a guaranteed return that is backed by the central government. What is the worst that can happen? The entire ₹ 13,000 crore, or less than a 1% of the entire investment war chest of the insurance behemoth, vaporizes. In that case, the impact on different categories of policyholders will be different. LIC policies broadly fall into two categories—traditional and unit-linked.

There are two kinds of traditional products—non-participating (non-par) and participating plans (par). A non-par plan gives the investor a guaranteed return on his investment along with a risk cover. On death, the nominees get the sum assured, on maturity the policy gives the guaranteed return. The non-par is the most basic bundled life insurance policy that is most like an FD with a life cover. A par policy provides returns that are partly guaranteed (sum assured and guaranteed additions) and partly discretionary. The discretionary element is called “bonus”, which gives the investor a share of the profit earned by the insurance company due to fund management. If the entire investment of LIC in IDBI Bank goes bad, there is no change in the life of the guaranteed part of the policy benefits. The par plans’ bonus will get reduced a notch.

Ulips are market linked products that invest policyholder money according to asset choices—in equity, bonds or both. Those investors who have bought the equity fund in an LIC Ulip will see a marginal dip in the NAV if the entire investment goes bust. But few LIC investors buy Ulips, they buy the guaranteed traditional plans partly due to the comfort of having the central government giving a guarantee to the policy benefits.

What LIC policyholders need to understand is this: there is a cost to the sovereign guarantee that you crave. If the government is giving you a guarantee, it is taking the risk upon itself to pay back your money. What it does with the money is really not your problem. LIC policyholders actually need to worry about poor disclosures that mask real returns and hide the real cumulative impact of a series of such investment decisions by LIC.

The larger question in the LIC-IDBI Bank acquisition story is around the asset liability numbers of LIC and who has oversight of them. There is also a question on whether the central government reports this guarantee in its contingent liabilities in the budget.