LIC's Stake Sale: Step in the right direction, but inadequate
TL:DR: The proposed minority stake sale while a step in the right direction, is inadequate to reform the financial system and protect policyholder's interests completely. While the government will benefit because it will meet its disinvestment target, have some liquidity for its holdings and policyholders will have transparency, LIC still has the risk of ending up like the PSU banks - poorly managed and a drag on the economy.
I make no pretense of having a deep understanding of macro-economics or predicting growth rates. I however do have a strong interest in finance and its related fields. The Budget has provided me with ample material to talk about its effects on the insurance market, banking sector and capital investment in India.
The Minority Sale of LIC
The proposed minority stake sale while a step in the right direction, is inadequate to reform the financial system and protect policyholder's interests completely. While the government will benefit because it will meet its disinvestment target, have some liquidity for its holdings and policyholders will have transparency, LIC still has the risk of ending up like the PSU banks - poorly managed and a drag on the economy.
LIC: A short history
LIC was among the first businesses to be nationalized in India. In 1955, after Feroz Gandhi an MP from Rae Bareli, (and Jawaharlal Nehru's son in law) showed large amounts of insurance fraud happening in the private sector, and got Parliament to pass the Life Insurance of India Act in 1956, which nationalized 245 insurance companies across India. After enjoying monopoly status from then till August 2000 when life insurance was opened up to the private sector. Today LIC has a market share of 66% (according to Tijori) in new life insurance premiums making it the market leader in the sector, which is slowly losing3 to the private insurers.
That's not just it.
LIC: The unofficial lender of last resort
LIC is among the largest investors in the public markets, owning ₹ 26.4 trillion worth of stocks. But LIC plays a far larger role than that. It has served as the owner of a failing bank, of various government companies and part owner in large private sector companies. The LIC has long been a medium for the government in the to finance its own expenditures using policyholders' money.
Take the case of IDBI bank. A quarter of its loans went bad, it was 0.045% above failing regulatory capital requirements and was in need of help. The bank was failing. Its stock fell a third from 2018 to 2019 and in 2019 LIC used its policy holders' money to bail the bank out.
None of this is new for LIC. After India's largest shadow bank failed, it was looking likely that LIC was going to bail it out, again, using policyholders' money. Even before that it owned a quarter of the company and didn't pay any attention to two RBI reports that indicated fraud in the company.
LIC has time and again invested in government schemes when the commercial rationale seems suspect.
It invested in the National Infrastructure and Investment Fund, even after it was overweight railways and other infrastructure. It invested ₹30,000 crores (0.3 trillion rupees) of its investment portfolio into railway bonds at close to no premium over the prevailing G-Secs. It also bought around 27% of all state government bonds issued in 2015-16 and bought over 50% of all Public Sector Bank's offerings in the same year.
While none of the decisions individually would lead to suspicion about LIC's investment mandate, all together they build a strong case that commercial interests are coming second to a mandate to finance the government's schemes.
The IPO is an opportune moment for LIC to change its ways. The market scrutiny and changed incentives for LIC managers can lead to them making decisions on a purely commercial basis. The increased transparency can lead to informed decision making by new policy holders and above all a move towards profit maximization over funding government projects.
The government too benefits from this to a large extent. The projected fiscal deficit for this year is 3.8%*, just because of an emergency clause in the FRBM Act that allows the government to breach the deficit limits by 50 basis points. It also gives some cushion to bond investors and rating agencies, who are concerned about the large borrowings of the government along with slowing growth.
But the alternative pathway is clear here. LIC can continue to finance government interests at the cost of policyholder interests, acting as unofficial the lender of last resort, and walk its way to ruin.
I don't mean to imply that the policyholders won't get paid at all. I do however say that LIC is getting a substandard return on its investments because of its implicit mandate of financing the government.
TL:DR: The proposed minority stake sale while a step in the right direction, is inadequate to reform the financial system and protect policyholder's interests completely. While the government will benefit because it will meet its disinvestment target, have some liquidity for its holdings and policyholders will have transparency, LIC still has the risk of ending up like the PSU banks - poorly managed and a drag on the economy.
*The on balance sheet deficit (the one the government shows to the public) is 3.8%. But it borrows via PSUs like the Food Corporation of India, SBI, etc. That adds up to the government's liabilities regardless of what the accounting rules say. My estimate is that you can multiply the reported fiscal deficit by a factor of between 1.5 and 2 to get the actual central fiscal deficit. This comes from the fact that in the last 3 years, the actual deficit is between 1.5 and 2 times the reported deficit. Source: Subramanian et. al 2019, Pg 18. Then add the states' deficits to get a true picture of the total sovereign backed debt in the country.