CRISIL has assigned its 'CRISIL AAA/Stable' rating to the Rs 600 crore subordinated non-convertible debentures of HDFC Life Insurance Company Limited (HDFC Life). The proposed subordinated non-convertible debenture issue of Rs.600 crore is subject to the receipt of approval from the Insurance Regulatory and Development Authority of India (IRDAI) pursuant to the provisions of IRDAI (Other Forms of Capital) Regulations, 2015. HDFC Life has applied to IRDAI for the same and is awaiting approval.
 
The rating factors in the strategic importance to, and expectation of support, if required, from its parent, Housing Development Finance Corporation Limited (HDFC; rated 'CRISIL AAA/FAAA/Stable/CRISIL A1+') both on an ongoing basis and in the event of distress, HDFC Life's established market position within life insurance industry, its well diversified distribution network, healthy persistency and operating profitability, robust risk management in non-participating segment and adequate capital position. These rating strengths are partially offset by high operating cost as compared to peers and relative disadvantage as compared to leading peers in the bancassurance channel due to lack of exclusive partnership with group company, HDFC Bank Ltd. CRISIL also believes that in a downward interest rate environment, there may be potential challenges in growth of savings products.
 
While, from day to day operations perspective, HDFC Life has been managed independently and is a self-sustaining entity, strong linkage with HDFC driven by ownership (currently holds 50.15%) and a shared brand name, adds to its strength. HDFC group's presence in the life insurance sector is through HDFC Life, which is, therefore, one of the critical entities for the group. Additionally, HDFC and HDFC Life have common members on the Board with three members of the Board of HDFC Life being from HDFC. HDFC has provided HDFC Life access to its network of branches and customers for selling insurance products. In the case of HDFC Bank, while it has embraced an open architecture life insurance distribution, HDFC Life continues to garner a significant share of business. The foreign promoter, Standard Life (Mauritius Holdings) 2006 Limited (a unit of Standard Life Aberdeen Plc) holds stake of 10.26% as on date.
 
The rating also factors in established market position of HDFC Life within life insurance industry. HDFC Life has been among the top 3 players within the private sector space. HDFC Life's market share in terms of new business premiums (both individual and group) stood at 21.5% during fiscal 2020 as against 19.1% during fiscal 2018. In terms of overall premiums (including renewal premium) it stood at around 5.8% as on March 31, 2020 (around 5.1% as on March 31, 2018). Further, within private insurers, it continued to maintain healthy market share of around 17.7% during fiscal 2020 (16.8% during fiscal 2018). It also continues to benefit from its extensive industry expertise, as it has been in operation for nearly two decades and has a presence across all the states and union territories in India.
 
The rating also takes into account the adequate capital position reflected in the healthy solvency margin. HDFC Life has maintained solvency margin in the range of 180%-195% during last 5 fiscals (184% as on March 31, 2020) which is comfortably above the regulatory requirement of 150%. The solvency margin has been maintained at above 180% entirely through internal accruals, without any capital infusion from the shareholders, over the last nine years. CRISIL expects the solvency margin to be maintained at similar levels over the medium term.
 
The rating also factors in healthy persistency and profitability metrics maintained by HDFC Life.The 13th month persistency based on individual total premium stood at around 88% in fiscal 2020 as compared to 84% in fiscal 2019. In terms of profitability, the return on equity has consistently been above 20% during last five fiscals. Additionally, the value of new business (VNB) margin has also steadily increased over the years and stood at 25.9% during fiscal 2020 improving from 19.9% during fiscal 2016.
 
The rating further factors in diversity in business sourcing channels. HDFC Life has high diversity in its sourcing channels within bancassurance, agency, direct and online channels. In bancassurance, HDFC Life has been the first to successfully embrace open architecture, while continuing to diversify its distribution network with 270+ partners comprising traditional partners such as NBFCs, MFIs and SFBs, and includes more than 40 new ecosystem partners. HDFC Life has always tried to maintain a well-diversified distribution mix, with bancassurance accounting for 55%, 14% contribution by Agency, 22% by Direct including online, 9% by Broker channels. With channels too, each has focused on a profitable product mix with no major concentration. HDFC Life has developed and nurtured each channel, while ensuring business diversification. The company has achieved long term sustainable and profitable growth by balancing the product mix across various channels of distribution. However, CRISIL notes that HDFC Life does not have an exclusive partnership with group company, HDFC Bank. This puts them in a relative disadvantage as compared to leading private peers who have exclusive tie-ups with their parent banks.
 
The operating cost structure of HDFC Life has been relatively higher as compared to some of the large peers. The operating costs (excluding commission) as proportion to net premiums¹ has remained in the range of 13-13.5% during last 3 years. However, CRISIL notes that the company has been working to ensure balanced portfolio mix, strengthening its distribution mix and make efficient use of technology to ensure ease of purchase for the customers. Hence, the operating cost ratio is expected to be relatively higher than peers.
 
CRISIL notes the recent directive by Reserve Bank of India (RBI) dated May 16, 2020 that mandates HDFC to reduce its shareholding to 50% or below by December 16, 2020. On June 3, 2020, HDFC sold shares in open market to reduce stake to 50.15% from 51.44% earlier. HDFC expects to comply with the regulations within specified timelines. CRISIL understands that HDFC will continue to remain the single largest stakeholder in HDFC Life and will also retain Board control. Further, CRISIL also understands that there will not be any change in stance of support (both financial and Board oversight) provided by HDFC. In addition, HDFC will also continue to consolidate HDFC Life fully within its financial reporting due to management control. 
 
In the aftermath of covid-19 break-out, a number of regulatory relaxations have been extended to the policyholders. Insurance Regulatory Development Authority of India (IRDAI) announced an extension for paying the renewal premiums due until March 2020 across all life insurance policies till May 31, 2020. Also for renewal premiums due in month of April 2020, an additional grace period had been announced by IRDAI. Furthermore, the restrictions on physical movements imposed by the government during the different phases of lockdown has also affected the growth in new business for the life insurance industry.
 
For April and May 2020, the overall new business premium (NBP) for the private sector players de-grew by 30.7% as compared to similar period last year. With the lifting of lockdown restrictions taking place in a calibrated manner, thereby impacting field operations, the onus on insurance companies to expand digital mode of acquisition remains high. Further, there are likely to be operational challenges in undertaking full-fledged medical tests and hence large ticket size protection policies may not see closure in the near term. In the savings segment, CRISIL believes that the need to maintain liquidity with flexibility of withdrawal may mean that offtake of savings is also impacted in the near term. Consequently, CRISIL expects new business to be impacted during first half of fiscal 2021. The manner and extent of resumption in economic activity and operations will determine the growth outlook for the second half of fiscal 2021. However, at a structural level, we do believe that the pandemic has increased awareness for the need for life insurance products - especially protection segment. This should help the industry increase penetration over the medium term.

For arriving at the rating, CRISIL has first assessed the corporate credit rating of HDFC Life. CRISIL has factored in HDFC Life's business, financial, and management risk profile and the company's strategic importance to, and expectation of strong support from, Housing Development Finance Corporation Ltd (HDFC) - for arriving at the corporate credit rating. Additionally, the extent of cushion that HDFC Life intends to maintain in the solvency ratio over and above the regulatory stipulation on a steady state basis is taken into consideration for arriving at the rating on the subordinated debt instrument.

Strengths
* Strategic importance to, and expectation of support from HDFC
HDFC Life is strategically important to its parent, HDFC, which is reflected in sizeable representation of its directors on HDFC Life's board, commonality of chairman and its oversight of HDFC Life's functioning. HDFC Life also benefits from common branding with HDFC, which is the largest housing finance company in India with a strong retail presence, solid brand image, established franchise, and large customer base. CRISIL believes that HDFC will continue to support HDFC Life's growth plans and will contribute to any incremental capital requirement whenever needed. Furthermore, HDFC Life being the life insurance arm of HDFC group makes it a key element of the group's suite of financial service offerings.
 
CRISIL has also taken note of the directive issued by the Reserve Bank of India (RBI) to HDFC on May 16, 2020, instructing the latter to reduce stake in HDFC Life to 50% or below. In the above context, CRISIL believes that HDFC will continue to exercise control on HDFC Life and, will continue to extend support to HDFC Life, as and when required, in-line with regulatory guidelines.
 
* Established market position with balanced portfolio mix
HDFC Life is expected to maintain its market position as one of the top players within life insurance industry. HDFC Life has maintained its market position and consistently improved its market share in each fiscal year. HDFC Life's market share in terms of new business premiums (both individual and group) stood at 21.5% during fiscal 2020 as against 19.1% during fiscal 2018. In terms of overall premiums (including renewal premium) stood at around 5.8% as on March 31, 2020 (around 5.1% as on March 31, 2018). The company has been in operation since 2001 and has a presence across all the states in the country. Within private insurers, it continues to maintain healthy market share of around 17.7% during fiscal 2020 (16.8% during fiscal 2018). HDFC Life has been able to diversify its sourcing channels over the years which has led to strong business growth. Further, strong brand image and direct access to large customer base of HDFC group, provides critical support to the business growth of HDFC Life. Furthermore, low insurance penetration and other supportive macro factors are expected to drive growth.
 
With the intent of maintaining customer centric, balanced and profitable suite, HDFC Life maintains a balanced portfolio mix with focus on sourcing through multiple channels. This is reflected in the product mix for fiscal 2020, with ULIPs and conventional products accounting for 28% and 72% respectively of the individual annual premium equivalent (APE). The company also continued its focus on protection business, wherein its contribution to individual new business APE increased to 8%, up from 7% in the previous year. In terms of total new business premium received, the protection segment (only term) contributed 27.6% in fiscal 2020, compared to 27.0% in the previous year.
 
* Well diversified distribution network
HDFC Life has been the first to successfully embrace open architecture in bancassurance, while continuing to diversify its distribution network with 270+ partners including 40+ partners within the non-traditional ecosystem. HDFC Life has always tried to maintain a well-diversified distribution mix, with bancassurance accounting for 55%, 14% contribution by Agency, 22% by Direct including online, 9% by Broker channels. With channels too, each has focused on a profitable product mix with no major concentration. HDFC Life has developed and nurtured each channel, while ensuring business diversification. The company has achieved long term sustainable and profitable growth by balancing the product mix across various channels of distribution.
 
* Healthy persistency and profitability metrics
HDFC Life has maintained healthy persistency in its overall product portfolio. The 13^th month persistency based on total individual premium stood at around 88% in fiscal 2020 as compared to 84% in fiscal 2019. The persistency at 61^st month basis improved to 54% in fiscal 2020 from 51% during fiscal 2019. Improvement in persistency across cohorts led by focus on better quality of business and leveraging technological capabilities to provide a superior customer experience. The healthy persistency also reflects the company's ability to hold on to its policyholders for longer duration.
 
In terms of profitability, HDFC Life has been generating healthy accruals which has also supported its capital position. The return on equity has consistently been above 20% during last 5 fiscals. Additionally, the value of new business (VNB) margin has also remained healthy at 25.9% during fiscal 2020 improving steadily over the years from 19.9% during fiscal 2016. In absolute terms, the VNB margin have improved to around Rs 1,919 crore during fiscal 2020 from Rs 739 crore in fiscal 2016 (representing CAGR growth of around 27%). Additionally, the company has also shown healthy growth in its Embedded Value to Rs 20,650 crore as on March 31, 2020 as against Rs 18,301 crore as on March 31, 2019.
 
* Adequate capital position
HDFC Life maintains adequate capital position which is reflected in healthy solvency margin of over 180% maintained for last 10 years. The absolute net worth was Rs 6,800 crore as on March 31, 2020 (Rs 5,656 crore as on March 31, 2019). While CRISIL expects capital support from HDFC to be forthcoming if required; HDFC Life has been maintaining its capital position through internal accruals, not necessitating any such support. Although, there has been no incremental capital infusion during last nine years, HDFC Life has maintained solvency margin of above 180%.
 
HDFC Life reported embedded value of Rs 20,650 crore as on March 31, 2020. The ratio of embedded value to networth stood at close to 3 times as on March 31, 2020 which was in line with its peers. The embedded value can be seen as a representation of actual capital position since it includes the future profits that company is expected to receive from the business it has underwritten till valuation date. The steady increase in internal accruals enables the company to maintain capital position while achieving healthy business growth.
 
* Robust risk management in non-participating segment (non-PAR)
HDFC Life has a robust risk management framework across all its product segments. The products offered under non-par segment are typically those wherein the minimum returns are guaranteed to the policyholders. Given HDFC Life has grown substantially within non-par segment during the last 2 years, HDFC Life follows a fairly comprehensive approach to financial risk management, targeting duration matching on the Annuity business and cash flow matching on the non-par savings business. The company also follows a strategy of prudent pricing and dynamic repricing of new business. A judicious mix of multiple instruments is used to hedge interest rate and renewal premium reinvestment risk.
 
These include, firstly, aggregation of non-par savings and credit life cash flows. The relative scale at which these businesses have been written allows them to achieve close ALM at an aggregate level. Secondly, investing in partly paid bonds of high-rated issuers, which complement the cash flow profile of these products and also offer attractive yields. Thirdly, they also use GSec STRIPS to improve the efficiency of the cash investments, improve asset-liability management and reduce interest rate risk. Finally, they also use external hedging instruments such as Forward Rate Agreements to lock in interest rates for future premiums of the non par savings portfolio.
 
A combination of the above allows them to be in a positive net assets (policyholder assets minus policyholder liabilities) position under base case and stress scenarios (very low interest rates and 100% persistency). The result of all the above is visible in low interest rate sensitivity for Embedded Value and VNB margin. CRISIL understands that their risk management approach has also been validated by a leading external actuarial consultant.
 
Weaknesses
* High operating cost as compared with peers
The operating costs (excluding commission) has been modestly higher as compared to some of its large competing peers. The operating costs as proportion to net premiums¹ has remained in the range of 13-13.5% during last 3 years. However, CRISIL notes that the company has been working to ensure balanced portfolio mix, strengthening its distribution mix and make efficient use of technology to ensure ease of purchase for the customers. Hence, the operating cost ratio is expected to be relatively higher than peers.
 
*Relative disadvantage as compared to leading peers in the bancassurance channel
HDFC Life does not have an exclusive partnership with HDFC Bank, the second largest bank in India with an impeccable track record of profitable growth. This puts them at a relative disadvantage as compared to leading private peers who have exclusive tie-ups with their parent banks, who are among the top 5 banks in India. While the business generated from HDFC Bank stood at 85-90% of the bancassurance channel, CRISIL notes that HDFC Bank embraced open architecture model over last 2-3 years. Consequently, as a percentage of overall life insurance business sold by HDFC Bank, HDFC Life's share has reduced.
 
Nevertheless, HDFC Life has significantly ramped up their corporate distribution tie-ups including new ecosystem partners with over 270+ partners as on March 31, 2020. The reduction has helped the company de-risk its sources of generating business. This has helped the company to generate sufficient business volumes from bancassurance channel. However, at this juncture, the share of individual new business sourced from non-HDFC Bank partners is still limited. HDFC Life's ability to ramp up business from other partners will be a key monitorable.
 
*Potential challenges in growth of savings business
During fiscal 2019 and fiscal 2020, the company had launched two customer centric products ' Sanchay Plus and Sanchay Par Advantage that had become the top selling products of the company. HDFC Life's majority of the business, within traditional segment, was contributed by these two key products during this period. These products have helped HDFC Life to increase their proportion significantly within traditional business (particularly with Sanchay Plus in non-par segment) during last two years. The non-PAR products come with guaranteed returns over a longer policy tenure. The guaranteed returns (in Sanchay Plus) have already trended lower from 6.5% to around 5% over the last few years. CRISIL believes that demand for these products will compete with traditional fixed deposits and debt mutual funds; although, on post-tax basis, these products remain attractive. However, in a downward interest rate environment and with the uncertainty on account of covid-19, the overall future demand and consequently growth in the short term may remain a challenge.

As on December 31, 2019, HDFC Life had total non-linked policyholder investments of Rs 65,595 crore. The company had debt investment (non-ULIP) book value of Rs 61,792 crore (non-linked policyholder investments of Rs 57,610 crore); of which 95.6% were in sovereign instruments and 'AAA' rated instruments. The major outflow for the company is benefits to claimants (net of reinsurance) which was at Rs 18,173 crore for fiscal 2020.Since life insurance inherently is highly granular and stable business, CRISIL expects liquidity to remain comfortable on an on-going basis.

CRISIL believes that HDFC Life will continue to derive strong financial support and oversight from HDFC over the medium term, both on an ongoing basis and in the event of a financial distress, and that it will maintain comfortable level of cushion in its solvency ratio over and above regulatory minimum on a steady-state basis.
 
Rating Sensitivity Factors
Downward Factors
* Revision in rating or outlook of the parent HDFC, resulting in similar action on HDFC Life
* Significant reduction in cushion in the solvency ratio taking it below 170%.

Established in 2000, HDFC Life is a leading long-term life insurance solutions provider in India, offering a range of individual and group insurance solutions that meet various customer needs such as Protection, Pension, Savings, Investment, Annuity and Health. As on March 31, 2020 the Company had 37 individual and 11 group products in its portfolio, along with 6 optional rider benefits, catering to a diverse range of customer needs. HDFC Life continues to benefit from its presence across the country with 421 branches and additional distribution touchpoints through several partnerships.

¹Operating expense ratio is calculated through operating expense/total net premiums.

Any other information: Not applicable