II China report: insurance. Ping An and China Life take different routes to growth

Institutional Investor, September 2009

China  report– insurance

There are few sectors of the Chinese economy that look as promising as the insurance industry. Use of insurance tends to grow dramatically in any country experiencing rapid urbanization and wealth creation; the pace of economic growth and individual wealth is rapid in China and there are more potential customers – a 1.3 billion population – to aim at than anywhere else in the world.

Already, growth is impressive. The industry received RMB597.55 billion in premium revenue in the first half, a 6.4% year on year increase, according to the China Insurance Regulatory Commission. Property insurance in particular rose 15.84% year on year.

But it’s the headroom for future growth that is most exciting. Surveys tend to put life insurance penetration in China at around 2.5 to 3%, compared to around 7.5% for the insurance industry globally and 12% in developed markets such as the UK. That’s the potential.

“In the near term, the industry will still be undergoing all sorts of challenges, but over the longer term the room for expansion in China’s insurance market is immense,” says Louis Cheng, executive director and group president of Ping An Group. “As the level of personal income rises, the demand for integrated financial services will grow. The potential for growth in China’s domestic market is exponential.”

While this is partly about rising wealth and awareness of insurance, there is also an age demographic to consider. “We will start to have an ageing population by 2015,” notes Ning Ma, an analyst at Goldman Sachs. “I think insurance is one of the most promising industries in China. In fact, we think long term the insurance sector will have better growth than the banks.”

Cheng says that at Ping An, the average age of customers is below 40. “As their income levels increase over time, accumulating more wealth along the way, so will their needs for financial products.”

It’s interesting to see how China’s major insurers have gone about this opportunity in different ways, particularly the two biggest, China Life and Ping An. China Life, which has around a 40% market share in life insurance, has stuck exclusively to that line of work. It has done very well from doing so: gross written premium and policy fees were RMB135.33 billion in the 2008 financial year, a 20.9% year on year increase despite a global financial slowdown. It does own a 20% stake in Guangdong Development Bank, but so far appears to have been a passive investor and has not become involved in its management.

Ping An, by contrast, has set out very clearly to become, as Cheng describes it, “a leading integrated financial group in the world.” In insurance, it covers not only life insurance but property and casualty (P&C); and beyond that, it is increasingly active in asset management and banking. Today, Cheng says, insurance is about 80% of group revenue, and asset management and banking 10% each. In five years time, though, Cheng would like to see insurance account for 50% and the other two 50% between them. “And then we hope to achieve in the following decade the balanced development of our three pillar businesses – insurance, banking and asset management.”

Achieving this ambition has involved some serious headwinds along the way, none more so than the acquisition of a 4.99% stake in Fortis, a deal that had originally involved Ping An acquiring half of Fortis’s asset management unit. That part of the deal was subsequently unwound, but the decline in value of the Fortis stake required a write-down that almost wiped out Ping An’s 2008 full-year profit: it incurred almost RMB23 billion in impairment write-downs, reducing full-year profit to just RMB873 million – a 94.4% decline in what would otherwise have been an exceptional year.

Ping An’s domestic acquisitions have been far more successful, and earlier this year it announced a two-stage deal that will conclude with it owning 29.95% of Shenzhen Development Bank. SDB is not huge – it is the 11^th largest joint stock bank in China, with total assets of RMB521.9 billion at the end of 2008 – but it gives Ping An banking scale in its home market of Shenzhen and is a clear statement of intent. Cheng calls it “a win-win transaction that offers key benefits in a number of areas,” including an improved capital base for SDB and a platform for long term development of banking for Ping An.

Ping An believes in this multi-pillar approach because it is committed to the idea of cross-selling. Its results demonstrate there is some merit in this approach: for example, when it entered the credit card business, 83.3% of sales in 2007 and 50.5% in 2008 came through cross-selling. In 2008 RMB 3.86 billion of property and casualty insurance premium income came from cross-selling, 14.2% of the total.

One of the curiosities of Ping An is that it is almost unique in being permitted to build a business across different areas of financial services. Generally, insurers, brokers and banks are kept apart: the only other obvious example is Citic, which has powerful banking and securities arms, although there too they are housed in separate legal entities. Victor Wang, a China banks analyst at UBS, believes Ping An is something of a test case. “I think the regulators will allow deals on a case by case basis,” he says. “They will allow specific names to buy into relatively smaller players. But I don’t think in the next two years we are going to have a major merger of big players in different business areas.” For one thing, there is too much inequality in the relative size of the industries: as he points out, ICBC, with about RMB10 trillion in total assets, is more than twice the size of the entire insurance industry at RMB4 trillion, which in turn is far bigger than the total securities industry.

The biggest short term impact on the health of insurers will be the performance of the stock market. That’s because all insurers invest their policy premiums, and in China the local stock markets tend to account for 10 to 15 per cent of those investments (see table). So, when the A-share market drops 65%, as it did in 2008, that hits overall earnings badly; when it then increases 62%, as it did in the first half of 2009, it boosts them considerably. “Market movements should have a positive impact on 1H09 earnings for all of the listed China insurance companies reflecting capital gains on equity assets,” says Mark Kellock at Macquarie Research. Kellock expects China Life’s equity exposure to have gone from 8% to 12% between December 31 and June 30; Ping An from 10 to 15%; and PICC, the third largest insurer, from 8 to 11%.

Christopher Esson at Credit Suisse sees similar positives. “What a difference six months can make,” he says. “After a dismal 2008 as far as investment returns go, the 62% rebound in the Shanghai Composite Index should provide a tailwind for the insurers in terms of earnings, book value and EV [embedded value] in the [first half] results.” Further ahead, he argues, “equity market gains should provide improved flexibility for insurers to realize investment gains in future results, paving the way for a solid reported earnings profile.”