Are The Tides Turning For China’s Insurance Titans?

For China's largest insurers, 2016 proved to be a challenging year on several fronts as profitability was weighed down by intense competition, more stringent capital rules and weak investment income amidst a low interest rate environment. China Life Insurance (HKEX.2628) was a case in point. The leading life insurance company, which commands about a fifth of China's insurance market, saw its net profit last year decline for the first time in four years by a steep -44.9%. Its competitor, New China Life Insurance (HKEX.1336), also reported a lacklustre set of full-year results, as earnings swooned -42.5%. However, against the current backdrop of an improving macroeconomic environment, the slew of disappointing earnings is unlikely to be a harbinger of grimmer things to come. In this article, we take a deeper look at China's insurance industry, and assess if the tides are turning for the country's insurance titans.

Expected Rate Rise And Regulatory Support Boon For Larger Insurers

A series of rate cuts by the central bank to inject life into China's slowing economy has posed major challenges to the insurance industry. As insurers derive a portion of their revenues from the interest generated by their bond portfolios, low interest rates have reduced the interest earned from their fixed income investments, while matured assets have to be reinvested at lower rates than before. Consequently, existing policies become more expensive to fund, and that has hampered the ability of insurers to honour the guaranteed returns of products that were sold in the past when rates were higher. In search of higher yields, insurance companies moved into stocks and other riskier assets, only to see returns hit by stock market volatility. The industry's woes were further compounded by a rule change last year that required insurers to discount liabilities based on market rates, and low interest rates meant that insurers were forced to ramp up on their reserves, which had a negative impact on earnings. With the central bank shifting from an easing bias towards a more neutral monetary policy stance, a further rise in interest rates would bode well for China's insurers, whose share prices usually move in tandem with interest rates (Chart 1).

Chart 1: Interest Rate Rise Bodes Well For China's Insurers

Besides low interest rates, China's listed insurers also had to grapple with intense competition in the industry. The country's largest insurers have been steadily ceding territory to newly emerged unlisted rivals, many of which have been expanding aggressively through the sale of universal life insurance products that offer generous returns, short premium terms and low fees. Beijing's Anbang Insurance Group was one such company that has benefitted hugely from sales of universal life insurance products. It went from near-obscurity a few years ago to the fourth largest insurer last year in terms of gross written life premiums, leapfrogging state-backed New China Life Insurance (HKEX.1336). The riskiness of such short-term high-yielding policies, however, has caught the attention of regulators, who have stepped in to clamp down on these products. While the new curbs are likely to bring an end to the fairy-tale run of smaller players that have been dependent on sales of universal life insurance products, they are positive for the larger insurers whose main products are longer-term insurance policies.

High Growth Potential In China's Insurance Market

China's insurance industry has experienced rapid growth over the past decade, with total written premiums from insurance products increasing from RMB 493.2 billion in 2005 to RMB 2,428.3 billion in 2015, representing a compound annual growth rate of about 17.3%. Despite being the third largest in the world, China's insurance market remains largely underpenetrated, according to a recent study conducted by Allianz. Its insurance depth (measured by total insurance premiums as a percentage of gross domestic product) and density (measured by total insurance premiums per capita) remains low relative to that of developed economies such as the US, Japan and the UK (Table 1). The fact that China has the largest population in the world while having such a low insurance depth underscores the growth potential of its insurance market. Its low insurance density also suggests immense room for further market expansion, as insurance spending per capita grows closer to that of developed markets. Moreover, a rising middle class and an aging population are demographic trends likely to boost demand for insurance products.

Table 1: Top 10 Insurance Markets In 2016 By Total Gross Written Premiums

Quality Picks For Insurance Sector Exposure

While the long-term case for investing in China's insurance industry is compelling, not all insurance stocks are created equal. With a total of about 12 insurance companies listed on the Hong Kong exchange, investors will do well to be selective in the names that they invest in. As the leading life insurer with a market share of about 19.9% (Table 2), China Life Insurance (HKEX.2628) is certainly a blue-chip candidate to consider for investors who may want to include some insurance stocks in their portfolios. Despite delivering a disappointing set of earnings last year, due in large part to unfavourable macroeconomic conditions, its bottom line belied the strong sales growth of its insurance business. Backed by the rapid expansion of its agency sales force, which stood at about 1.5 million agents in 2016 and is the largest in China, the insurer managed to rake in a record-high RMB 426.2 billion in net premiums earned in 2016 – an 17.6% increase from the previous year.

Table 2: Largest Life Insurers In China By Market Share In 2016

The stability of China Life's insurance business can be observed from its performance since 2008 (Chart 2), during which its net premiums earned and embedded value have grown at compounded annual growth rates of 6.1% and 13.3% respectively. As the company continues to expand its agent headcount and shifts its focus towards longer-term protection-type policies with payment periods of at least ten years, which typically have higher margins, its future growth in net premiums earned is likely to pick up further. Moreover, the ongoing uptick in bond yields, along with a stabilisation in China's stock market, are expected to improve the returns on its investment portfolio, which will in turn contribute to a likely profit recovery this year. Since the release of its full-year results on 23 March 2017, market participants have slowly turned positive over the prospects of China Life, reflected in the 2.1% upward revision in its estimated earnings for 2017 (as of 10 April 2017), and further upgrades could prove to be a potential catalyst that will drive the company's stock price (Chart 3).

Chart 2: Business Performance Of China Life Insurance Since 2008

Chart 3: Earnings Revision Trend Of China Life And Ping An Insurance

With an impressive track record of delivering growth, Ping An Insurance (HKEX.2318) is another quality insurance stock that investors should consider for their portfolios. The second-largest life insurer in China has seen its net profits and embedded value grow remarkably at compounded annual growth rates of 28.4% and 26.7% respectively since its initial public offering in 2004. Despite a challenging operating environment, Ping An reported a better-than-expected 15.1% increase in its bottom line – the only major insurer to have posted a profit growth in 2016, topped off by a generous dividend boost of 41.5% compared to 2015 that puts the stock at a 2.1% trailing dividend yield (as of 10 April 2017). While Ping An has similarly been grappling with weak investment income and intense competition, factors that were faced industry-wide by most listed insurers in China, the company's diversified business model has contributed to its resiliency. Besides its staple insurance business, Ping An also derives profits from its banking, asset management and internet finance operations (Chart 4).

Chart 4: Ping An's Diversified Business Model Aids Resiliency

Another interesting thing to note about Ping An is its increasing emphasis on internet finance, the business segment it deems to be a key source of growth in the future and a point of differentiation that separates the company from other traditional financial service providers. Its online platforms, which offer a wide range of services including peer-to-peer lending, medical services and mobile payments, have been effective in the acquisition of new customers, boosting cross-selling opportunities for its insurance, banking and investment products. A further rise in interest rates is also expected to benefit not only its insurance business, but also its banking operations as well. Moreover, a possible initial public offering of its online peer-to-peer lending platform, Lufax, could potentially be another catalyst that will further lift the valuations of Ping An.

Further Room To Manoeuvre For Insurance Stocks?

While market sentiment towards mainland Chinese insurers has slowly turned positive in recent times, current share prices are still below the May 2015 highs seen before the sharp sell-off that eventually precipitated (Chart 1). When looking at a generic price-to-book ratio valuation measure, all major listed insurers, with the exception of PICC Group (HKEX.1339), are currently trading at premiums to their book values (Table 3). Their embedded value per share, however, paints a rather different picture. The embedded value of an insurance company is an actuarial construct that represents the present value of its future profits from existing policies sold, plus its net assets adjusted to market value. As it encompasses everything belonging to shareholders, a company's embedded value per share can be compared to its share price for a rough gauge of its valuation. When compared to its embedded value per share of HKD 25.97, China Life Insurance looks undervalued, with its current share price suggesting a further 11.5% potential upside. Meanwhile, Ping An's shares appear overvalued, but it must be noted that its embedded value per share takes into consideration only the value of its insurance profits. The value of its banking, asset management and internet finance operations, when factored in, could imply further upside potential for Ping An.

Table 3: Valuations Of Major Listed Insurers

A Growing Slice Of A Growing Pie

The long-term investment case for China's largest insurance companies remains attractive. Insurance blue-chips, such as China Life Insurance (HKEX.2628) and Ping An Insurance (HKEX.2318), appear undervalued based on their embedded values per share. While 2016 has been a challenging year for most insurers, their bottom lines should see improvements this year. They are also expected to benefit from a rising interest rate environment in China and enjoy a policy tailwind that is likely to be a heavy blow to their newly emerged unlisted rivals. After all, China has the largest population in the world, but its huge insurance market remains largely underpenetrated. Even for the largest players in the industry, there is still plenty of room for growth.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.