There is a lot of coverage to the LIC's investment in ONGC's share auction. So I thought will just explain it in the simplest possible way.
*What was reported/what happened
ONGC was auctioning its shares. Since the oil marketing company is in losses and is expected to remain in losses, so the investor community didn't show enthusiasm. The government sprang in action and called the LIC's big boss. The boss (at LIC) told his minions to buy ONGC in the auction. The minions also followed their orders.
Now the investment has been screwed: LIC bought the share around either INR 392 or INR 303.67 (this is a new controversy, I havent fig out the discreparency either), but the current price of the ONGC Share is INR 282. So either way the company LIC has made poor investment.
*Insurance?
The idea of insurance is to protect one self against an unforeseen problem. Most of the time the company takes into account that only 10-20% of the people taking out an insurance will file claim. If there is a risk of more people filing for claims then the premium amount will rise.
*Business model for an insurance company
Roughly, the insurance company invests 60-80% of the money collected in business from where it can get higher returns. Only a part of the money is kept with the insurance company so that it can give out claims and run its day-to-day activity. For this the company claims a service charge and all money made out of the investment remains with the company/shareholders.
(The exact business is more complicated but in simple terms we can state as above)
*The twist
In India LIC sells insurance product which guarantees a return at the end of the tenure. This return is linked to the performance of stock market, which is based on the number of units. So if LIC makes a bad investment then it is the policy bearer who will register the losses.
*The noon robbery
LIC is making poor investment knowingly because the Govt has directed its Chairman to do so. This hurts the company from a business sense but also because it is doing against the best interest of its policy investors.
*The biggest problem
Years ago, there was a mammoth company called UTI which used to collect money and invest. But it failed because it came out with a product with guaranteed return and it invested in stocks but around the same time stock market collapsed and hence it didnt had enough money to meet its obligation.
LIC may not have to share the fate of a govt bail-out now but if its decision making is not give the due freedom then it will go the Air India way and face the prospect of being bankrupt.
