This industry will emerge as a long-term winner, thanks to China’s older and wealthier population

As China gets older and wealthier, the insurance industry is expected to benefit from these demographic trends. Given their dominance in China’s insurance market, we believe China Life Insurance (HKEX:2628) and Ping An Insurance (HKEX:2318) will be the two main beneficiaries as China transforms itself into the world’s largest insurance market.

Ferlyn Tan
|
Published on 05 Feb 2020

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• The Chinese insurance industry is on track to double its market share by 2029, and investors who are looking for an alternative way to tap into the financials sector should pay more attention to this industry.

• China’s ageing population and its rising middle-class population will serve as major growth drivers for this industry.

• China has the largest health protection gap in the world. Coupled with its lower-than-average insurance penetration and insurance density, we see huge potential for Chinese insurers to gain more market share.

• Investors can consider investing in China’s two domestic insurance giants – China Life Insurance (HKEX:2628) and Ping An Insurance (HKEX:2318).

• We have a target price of HKD 25.0 for China Life Insurance (HKEX:2628) and HKD 107.3 for Ping An Insurance (HKEX:2318), which translates to an upside potential of 31.5% and 20.0% respectively.

Financial institutions provide a wide range of financial products and services to consumers. Given the diversity of these services, it is unsurprising that numerous types of financial institutions exist.

While most people tend to associate financial institutions with the banking industry, the financials sector encompasses a broad range of businesses that extend way beyond traditional banks. Besides banks, another important industry within the financials sector is the insurance industry.

Similar to banks, insurance companies are critical to the financial stability of a country’s economy due to the following reasons:

1) They are large investors in the financial markets.

2) They ensure the financial stability of individuals and groups/corporates by insuring their risks.

The US is currently the largest insurance market in the world, but with the ongoing shift in the global insurance business to Asia, China has been slowly climbing up the ranks. It is the second-largest insurance market globally as of 2018 and is on track to double its market share by 2029E (Chart 1).

Chart 1: China is on track to double its market share by 2029E

China is home to one of the world’s most dynamic and fastest-growing insurance market. According to Swiss Re, China is forecasted to contribute almost half of the growth in the global insurance market over the next two years.

As the leading players in this market, we believe China Life Insurance (HKEX:2628) and Ping An Insurance (HKEX:2318) will be amongst the main beneficiaries as China continues to transform itself into the world’s largest insurance market.

How the insurance industry works

The insurance industry offers risk management products to its customers in the form of insurance contracts. Insurance companies are typically categorised as either property and casualty (P&C) or life and health (L&H). P&C insurance provides protection against loss of property, damage, or other liabilities. On the other hand, L&H insurance provides protection against death, disability or retirement.

Under both categories, the insurance companies earn primarily from the premiums paid by the purchaser of insurance products and the investment income earned on the float, which refers to the amount of premiums collected and not yet paid out as benefits. In other words, the insurance companies will take the money earned from the premiums and put them in low-risk investments, helping them to earn the spread between their investment return and what they have to pay out as benefits to the insured.

As a result, the primary asset category for insurance companies is “investment assets”, which are mostly made up of fixed income securities. Their liabilities are mainly “insurance contracts”, which are the estimated future insurance benefits to be paid out to policyholders.

Another important characteristic of insurance companies is their distribution channels. The main bulk of an insurer’s revenue depends on its ability to write premiums, which is in turn determined by the extensiveness of its distribution channels. While other functions are certainly important to the success of an insurance company, the process of reaching out to a prospective customer and delivering the policy product to him/her has is certainly one of the top key functions.

In the insurance industry, there are several distribution channels that insurers can tap on – agency, bancassurance, group insurance, digital and other distribution channels. The agency channel refers to the selling of insurance policies through individual sales agents, while the bancassurance channel refers to arrangements with major banks where sales will be conducted by the respective banks’ staff.

On average, the agency channel contributes approximately 85% of total premiums written by major Chinese insurers, followed by the bancassurance channel, which contributes about 9%. The remaining are taken up by digital, group insurance and other distribution channels (Chart 2).

Chart 2: Distribution channels breakdown

Since insurance was first introduced in China, the industry has always been dominated by its domestic players, which collectively took up 92% of the market share in 2018. China Life Insurance (HKEX:2628) and Ping An Insurance (HKEX:2318) dominate the market with almost 40% of the total market share (Table 1).

Table 1: Market share breakdown of China’s life insurance industry based on gross written premiums

	Description
China Life Insurance	20.4%
Ping An Insurance	17.0%
China Pacific Insurance	7.7%
New China Life Insurance	4.7%
PICC Life Insurance	3.6%
Others	46.6%
Source: Bloomberg Finance L.P. Data as of February 2020

Turning the silver segment into ‘gold’

Even as the second-largest insurance market, there is still a lot of room for development in China’s insurance market. Firstly, the growing ageing population in China represents a major opportunity for insurers. The number of Chinese above the age of 65 has reached 166.6 million in 2018, which represents 11.9% of the national total population (Chart 3). The proportion of elderly has been increasing steadily for the last decade and this figure is expected to continue its growth in the next few decades, highlighting two main concerns – having enough savings after retirement and having long-term care for their medical expenses in the future.

Chart 3: Increasing proportion of the ageing population over the last decade

Household savings and public insurance coverage may help to cover a portion of an elderly’s healthcare expenses, but significant out-of-pocket payments are still required. This, in turn, suggests that cash from savings and public insurance coverage may not be the appropriate long-term solution.

That being said, the ageing population is still very reliant on government and family support for their expenses across developed countries, while insurance continues to be overlooked as a solution, accounting for only 5% of total expenses. In China, insurance accounts for a mere 2% when it comes to elderly care (Chart 4).

Chart 4: China stands out in terms of family support for the elderly

With the lingering effects of the one-child policy exacerbating the problem of an ageing population, we believe this will place further economic strains on families with elderly members. In fact, the ratio of the number of working adults to each person over 65 was at 7.7 in 2015, but this figure is expected to fall to just 3.4 over the next two decades.

Besides, people are also living longer, and this increases the potential for more years of poor health and higher medical expenses. In light of these challenges, insurance can potentially take on a bigger role in retirement planning, and this clearly represents a great opportunity for insurers to grow their market share.

China's rising middle class will boost insurance demand

As mentioned in our previous articles, China has a huge and fast-growing middle-class population and their consumption habits are set to change the world of consumerism. As consumers get wealthier and living standards in China improve, the demand for better medical care should increase as well.

A survey conducted by Ernst & Young concluded that wealthier Chinese consumers tend to purchase more private insurance plans as public insurance coverage remains insufficient to cover their climbing healthcare costs. As evident from Chart 5, we can observe that as disposable income per capita increases, the amount spent on insurance premiums generally follows suit.

Therefore, we believe that China’s growing middle class will spur demand for insurance, particularly long-term insurance products that will protect and help plan for their future wealth needs.

Chart 5: Amount spent on insurance premium increased as disposable income increases

According to Swiss Re forecasts, China’s insurance premiums are expected to grow at a double-digit rate in 2020, significantly higher than the expected growth rate of 3% globally (Chart 6). Hence, this should translate to strong revenue and earnings growth for the Chinese insurers as well.

Chart 6: China insurance premium forecasts

Health protection gap in China remains large

While the abovementioned sociodemographic trends suggest that demand for insurance is rapidly increasing, readers will be surprised at the fact that many citizens in China remain severely underinsured. Overall, the health protection gap in emerging markets stands at about USD 448 billion, and of which, China has the largest health protection gap at USD 169 billion.

Health protection gap is defined as the difference between the amount of insurance coverage that is economically beneficial and the actual premium purchased. While China’s health protection system has improved over the years, the country’s enormous population size and increasing health protection needs suggest that its health protection gap will continue to be a problem in the coming years.

On top of the growing protection gap, the level of insurance penetration and insurance density in China also remain low as compared to its other international peers (Chart 7). Insurance penetration measures gross written premiums as a percentage of a country’s GDP, whereas insurance density indicates how much the people in a country spends on insurance in terms of premium. As measured by life premiums per capita, the insurance density of China stands at only USD 250, almost ten-folds smaller than the average insurance density of its peers at approximately USD 2,000.

Chart 7: Level of insurance penetration remains low in China

This large protection gap and low insurance penetration in China clearly signals a significant amount of unmet demand for insurance. Therefore, we believe there is a huge potential for Chinese insurers to take up more market share.

The great unknown – novel coronavirus outbreak in China

At this juncture, the greatest unknown risk is the severity of the novel coronavirus outbreak in China. The nationwide death toll has risen to over 400, and the World Health Organization (WHO) has officially declared the outbreak to be a global health emergency.

While it is inevitable that the insurance industry will have to deal with increasing business interruption, hospitalisation and death claims under such circumstances, we believe that the strong balance sheets of Chinese insurers should be able to withstand any massive spike in claim payouts. As of 1H 2019, the core solvency ratio of the Chinese insurance industry stood at 234.8%, which is significantly higher than the minimum requirement of 100%.

The solvency ratio indicates whether insurers have enough capital to pay any claims, dividends or other liabilities. As such, the high solvency ratio of the Chinese insurance industry suggests that most insurers are well-capitalized and they generally have a huge margin of safety in the event of a massive claim payout is required. This is especially so for China Life and Ping An Insurance, both of which have set aside large amounts of reserves for their liabilities, as evident from their strong solvency ratios of 258.6% and 224.4% respectively.

Two domestic giants to ride on the long-term growth in the Chinese insurance industry

For investors who are willing to look beyond the short-term volatility caused by the novel coronavirus, we believe China’s top two domestic insurance giants – China Life Insurance (HKEX:2628) and Ping An Insurance Group (HKEX:2318) – are good picks that investors can consider to gain exposure to this fast-growing industry.

Using a fair PB ratio and sum-of-the-parts (SOTP) methodology for China Life Insurance and Ping An Insurance respectively, we arrived at our target prices of HKD 25.0 for China Life Insurance (HKEX:2628) and HKD 107.3 for Ping An Insurance (HKEX:2318). This represents an upside potential of 31.5% and 20.0% respectively (Table 2) based on their last traded prices.

Table 2: Valuations of China Life Insurance and Ping An Insurance Group

	China Life Insurance (HKEX:2628)	Ping An Insurance (HKEX:2318)
Methodology	Fair PB	SOTP
Current share price (HKD)	HKD 19.0	HKD 89.4
Target price (HKD)	HKD 25.0	HKD 107.3
Upside potential	31.5%	20.0%
Source: Bloomberg Finance L.P., iFAST estimates Data as of 4 February 2020

Over the next few weeks, we will be publishing more articles related to the two domestic giants in China’s vast insurance industry. Do stay tuned.

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.

All materials and contents found in this site are strictly for general circulation and informational purposes only and should not be considered as an offer, or solicitation, to deal in any of the funds or products found/identified in this site. While iFAST Financial Pte Ltd ("IFPL") has tried to provide accurate and timely information, there may be inadvertent delays, omissions, technical or factual inaccuracies and typographical errors. Any opinion or estimate contained in this report is made on a general basis and neither IFPL nor any of its servants or agents have given any consideration to nor have they or any of them made any investigation of the investment objective, financial situation or particular need of any user or reader, any specific person or group of persons. You should consider carefully if the products you are going to purchase are suitable for your investment objective, investment experience, risk tolerance and other personal circumstances. If you are uncertain about the suitability of the investment product, please seek advice from a financial adviser, before making a decision to purchase the investment product. Past performance is not indicative of future performance. The value of the investment products and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. In respect of any matters arising from, or in connection with the said research analyses or research reports, recipients of the report are to contact IFPL at 10 Collyer Quay, #26-01 Ocean Financial Centre Building, Singapore 049315, or by telephone at +65 6557 2853. Where the report contains research analyses or research reports from a foreign research house and if the recipient of such research analyses or research reports is not an accredited investor, expert investor, institutional investor or an ex-accredited investor, IFPL accepts legal responsibility for the contents of such analyses or reports to such persons only to the extent as required by law. Please note that only certain security(ies) herein are available to all investors, while the rest are only available for certain persons to invest in, such as Accredited Investors (as defined in the Securities and Futures Act) or one who invests at least S$200,000 (or its equivalent currency) per transaction. To qualify as an Accredited Investor, one needs to submit a declaration form and certain relevant supporting documents, according to iFAST’s prevailing policies and procedures.

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This industry will emerge as a long-term winner, thanks to China’s older and wealthier population

Ferlyn Tan

Published on 05 Feb 2020

Chart 1: China is on track to double its market share by 2029E