Star Health and Allied Insurance Company Ltd - Stock Valuation and Financial Performance

In a stock exchange filing dated August 14, Star Health disclosed that an unidentified individual had contacted the company, claiming access to sensitive data. The company immediately reported the incident to the cybercrime division in Tamil Nadu and the central cyber security agency, CERT-In. Recent news reports suggest that Star Health Insurance’s stolen customer data, including medical records, is being shared publicly via Telegram chat bots.

After the incident on 14^th August, Star Health stated that it has maintained adequate cyber security systems and controls, which are in accordance with IRDAI regulatory norms. Star Health announced it is investigating a potential breach that may involve a limited set of claims data. The company stressed its strong commitment to protecting customer privacy.

Regulatory Risk:

In terms of regulatory consequences, under the IT Act, entities handling personal data are required to implement adequate security measures. If a breach occurs, they are mandated to report it to CERT-In, a step Star Health has already taken. At this stage, there is no indication of any significant penalties unless it is revealed that Star Health’s cyber security systems were inadequate.

MoneyWorks4Me Opinion:

The full scope and source of the breach remain unclear as an official statement from Star Health is still awaited. Based on the information available, unless Star’s cyber security framework is found to be lacking, we do not expect any significant impact on business. We are closely monitoring the situation and will keep subscribers informed of any new developments.

As investor we should be looking for businesses which have long runway for growth combined with sustainable competitive advantage. We believe Insurance as a sector offers opportunities to invest in such decadal themes. We have invested in SBI life which is a dominant player in Life Insurance sector and ICICI Lombard which is amongst the best player in General insurance and we have made decent returns from these investments. The other compelling opportunity in this sector that we see is in the Health Insurance Sector through Star Health & Allied Insurance Ltd. 

Firstly, let us understand how an insurance company makes money in simple terms. A health insurance company remains profitable by collecting more in premiums from policyholders than it pays out in claims and operating costs. This is called as underwriting profitability. Premiums are collected at the start of the policy issuance and the company effectively manages float money over the year. It further earns investment income by investing these premiums in low-risk debt instruments. Most companies do not make underwriting profits in India. These companies attain profitability majorly on account of investment income. 

Over the past few days, we have released various blogs on the Insurance Sector: 

General Insurance Explained  

Life Insurance Explained

To read Initiating Coverage on Star, Click here

What is exciting about Star is that it is the only major health insurance company in India which has been able to generate operating profits consistently over the years. That along with a stable investment income has helped it to generate a significant Return on Equity. 

Underwriting profitability depends on business segment companies cater to. Health insurance is dividend into two major segments, Retail health which is consumers buying individual or family policies and Group segment which caters to employers and government. Health insurance in general is competitive. Group health is fiercely competitive while retail health is the most profitable. This is due to competitive dynamics as retail consumers do not have significant bargaining power. This characteristic is exactly opposite in group segment where there is cutthroat competition and premium per person is significantly low. Star has focused itself on the Retail health insurance segment where claim expense is the lowest but the premium per policy is the highest.

Health insurance is highly underpenetrated and growing sector in India; further most health insurance policies are under covered in (Sum insured lower than required). This presents a dual engine for growth coming from increase in number of people covered under insurance as well as increasing sum insured of existing policies.

Retail health insurance is a push product and is majorly sold by Individual agents. Star has been able to grow consistently in this segment by empaneling more than 7 lakh agents and consistently growing this number. For Agents, the most sellable point in health insurance is that how big is the network hospitals the insurer has. Network hospitals can process cashless claims within hours thus reducing patient struggle. Star stands out in this regard with its extensive reach of 14,000+ network hospitals across all major pin codes in the country. Hospitals are also interested in empaneling with Star as it is the biggest player in the market. This creates a fly wheel effect that results in visibility of sustained market share and earnings growth. 

Star consistently commands a whopping 30-35% market share in the Retail health insurance and is ~14% of the overall health insurance market which includes retail, group and government. 

(GDPI-Gross Direct Premium Income, Source: Niva Bupa DRHP)

Catalyst:

There are two triggers that we see which can add to further profitability and rerating opportunity for Star: 

1. IFRS Implementation: Accounting standards for Insurance are to be changed from Indian Standards (IGAAP) to International Financial Reporting Standards. Under these rules, costs on acquisitions of customers like commissions can be amortised over the period of the policies, thus reported profits will be higher by ~20%. What it also does is that it increases the available solvency margin thus insurers can do more business with the same capital requirement.
2. EOM Regulation: IRDAI Expense on Management (EOM) Regulations puts a cap on management expenses at 35% of Gross return premium (GWP) for health insurers. Insurers need to comply on the regulations by Mar’26. Star Health is the only Standalone health insurer (SAHI) compliant with the current EOM at 30%. Niva Bupa which was the fastest growing SAHI operates at EOM of 39% due to higher commission expenses. We believe that the recent growth for Niva driven by higher commissions isn’t sustainable, and Star should be able to regain its recent market share loss to Care and Niva Bupa.

Management path to sustainable ROE:

Anand Roy was recently promoted as CEO after retirement of Founder V Jagannathan. Anand has been in the company for 18 years now. Management in its July Investor presentation laid out the path for the next 4 years. Company targets to maintain its market share in Retail health at 33-35%. It would also look to expand the group business by focusing on SMEs. SMEs though come under the Group segment; its profitability is a bit higher. Thus, it offers a decent mix of scale as well as profitability. Management aims to Double GWP to Rs. 30,000 Cr and Triple PAT to Rs. 2,500 Cr by 2028. This shall be driven by improvement in combined ratio and higher investment income.

No investment opportunity comes up without its fair share of risk within it. Star health too isn’t an exception. 

1. Composite License: At present, life insurance companies can sell only fixed benefit health plans and pay a fixed amount, which is the sum insured, following a claim. After getting composite license, Life insurance companies will be able to sell all types of health insurance products. This can increase competition in this space. However, Management is keenly tracking this development as it might also be advantageous to Star Health wherein it can sell other insurance products due to its extensive agency network. 
2. Low claim settlement ratio: A consistent question asked about Star is its low claim settlement ratio. (86% for FY24 as against industry average of 91%). Our analysis suggests that this is mainly because of business mix between retail and group health. This will be a key trackable for us and we will change our opinion on the company based on this development.

Valuation:

Star could be doing about Rs. 1,250 Cr of PAT for FY25 (As per IFRS) with an ROE of ~18%. We value Star using DCF method, considering a CAGR growth of 17% in net earned premium and 19% CAGR in PAT over the next 5 years on account of improvement in combined ratio. We value Star at P/E multiple of 30x FY25e to arrive at MRP of Rs. 621.

Star Health Insurance is a leading health insurance company in India that offers a range of insurance products to its customers. The company was established in 2006 and has since grown to become one of the largest standalone health insurance companies in the country.

Industry

Indian Health insurance premium has grown at CAGR of 19% from 11Bn in FY11 to 73Bn in FY22, yet there is still ample room for further expansion in the underpenetrated health insurance industry in India. Out of pocket expenditure on healthcare is higher at 63%, indicating that most households and individuals either do not have health insurance or do not have adequate cover.

The number of lives covered under the health insurance sector is 52 crore (i.e. 37% of India’s population), of which 70% accounts are from government business (36 crore), while group business accounts for 20% (10 crore) and retail accounts for 10% (5 crore).

Another aspect to consider is the relatively lower health insurance density in India. Health insurance density refers to the ratio of health insurance premiums to the total population. India's health insurance density at 5, relatively low compared too many developed countries, indicating that there is significant untapped potential for the expansion of health insurance coverage in the country.

Business

Star Health is a Standalone health insurer (SAHI), offering a range of health insurance products and services to individuals, families, and corporate clients. Company focuses solely on writing health insurance policies; under this segment company has 32% market share in Health Insurance business & 34% in Retail health segment. Star has higher focus on retail segment as this segment has lower claims ratio than group business.

Distribution- Health insurance business usually conducted through agents, who explain these policies to clients. Star Health distributes their health insurance policies primarily through individual agents, which accounted for 82% of their FY23 GWP. It has agency force of 626,000 agents as of FY23; in FY22 the insurer had 550,000 out of 963,593 agents with Standalone health insurers & 1,116,177 agents in private sector. Star has 14.7% agent’s exclusive to its business in FY23 from 11% in FY20. The company has built one of the largest health insurance hospital networks in India, with more than 14,200 hospitals as of FY23.

Product -

The products target a variety of customer segments, as well as persons with pre-existing medical conditions across the broader middle-market customer segment. The products include family floater products. In these products, the sum insured covers the entire family on the payment of a single annual premium. The individual products are tailored to the needs of the individual. And specialized products focus on customers with pre-existing conditions after taking into account the associated risks, Specialized Products accounted for 15.5% of Retail Premium Mix in FY23.

Star health creates its competitive edge by pursuing retail health than other health products which has a lower claims ratio, its hospital network and agent force.

Business Performance

Competition

 Star faces competition from various Private Insurers like ICICI Lombard, HDFC ergo, as well public insurers like New India, Union and other SAHI like CARE, Aditya Birla.

Risks

Rise in claims in a bad year can lead to large losses to be funded from investment or capital raise.

Increasing competition can reduce the profitability.

Investment income is a product of interest rates and fixed income products.