Financials | Sector Update

NEUTRAL Key Factors Recently Affecting Sector Positive

Negative

Emerging investment opportunities in the bond market Curve of life insurance appraisal rate in the process of reversal Historical low valuation Lack of major improvements in insurance policy appeal; little change in bancassurance channel; slow sales personnel expansion; life insurance product sales facing difficulty Continued depression in stock market Relatively high pressure on solvency ratio

Source: BOCI Research

BOCI Research Limited Financials: Insurance

5 January 2012 

China Insurance Sector Winter sets in, spring awaited In 2011, insurers have been severely impacted by the life insurance doldrum and both the stock market and debt market depression. Only P&C insurance business has registered steady growth. Nevertheless, 2012 is set to become an even more challenging and complicated year to China’s budding insurance sector, given the peaking P&C insurance profit margins, persisting life insurance weakness, and unexciting equity investment return. We estimate that the major insurers will post continued deceleration in premium income and earnings growth in 2012, and will shift the focus to product mix adjustment and value upgrade. From a long-term perspective, however, the sector still has bright prospects. Moreover, its current valuation lies at a historical low level. As such, we reaffirm the NEUTRAL call on China insurance. „

2012 is set to pose multiple challenges to life insurers. On the demand side, the yield of insurance policies remain unattractive to the investment-oriented insurance customers, be it participation insurance or universal insurance. On the supply side, commercial banks’ craving for deposits remains unabated, whereas the bancassurance premium income would hardly rebound. In addition, the sales personnel’s income bottleneck has constrained new hire growth. Life insurers will put more emphasis on adjusting structure, developing medium/long-term installed payment insurance product and lifting value. In addition, the rising surrender rate also hinders the growth of renewal premium income. We expect the sector’s life insurance premium income growth in 2012 to continue on a downtrend from 2011. The full-year 2012 growth may come in at only 6-7%.

„

We anticipate that the P&C insurance profit margins will peak in 2012. The declining premium rates and rising combined ratio resulting from the liberalisation of auto insurance premium should become irreversible trends. We expect the future development of auto insurance to hinge on the increase in the number of vehicles. Also, the sector’s auto insurance premium income is likely to grow around 12-13%. As auto insurance accounts for approximately 75% and non-auto insurance can hardly ramp up in the short term, future earnings estimates on overall P&C insurance should be revised down as a result.

„

Given the high liquidity, the bond market should present better investment opportunities in 2012 than 2011, which should provide support for insurers’ earnings and solvency. However, stock investment should prove to be challenging still, especially in 1H12 when we expect insurance companies to take a larger blow from stocks. Besides, alternative investments in infrastructure, real estate and unlisted company equities should present vast opportunities.

„

Currently, the insurers’ solvency gives cause for concern. If their investment remains lacklustre in 2012, many insurers’ solvency ratios will hit the 150% minimum requirement. We anticipate the three major insurers need to raise RMB65bn-75bn of capital, in which two-thirds can be raised through bonds. Moreover, we do not rule out the possibility of insurers’ equity refinancing.

„

As a typical high-beta industry, the insurance stock prices have been adversely affected by the overall market depression in 2011. Currently, the P/E, P/B and the implied new business multiplier all lie at relatively low levels historically. The sector’s present implied new business multiplier is around 12x.

„

We estimate the respective 2011-12 earnings growth at -35.6% and -4% for China Life, -9.6% and 0.6% for Ping An, and 10.7% and 4.2% for CPIC. As for stock picks, we prefer insurers with integrated business, lower pressure on solvency and refinancing, and undemanding valuation. Our top pick is CPIC.

Sun Peng * (8610) 6622 9072 [email protected]

Yuan Lin, CFA (8610) 6622 9070 [email protected]

Yin Jinhua (8621) 2032 8590 [email protected]

_________

* Yao Yao made major contributions to this report.

BOCI research is available electronically on Bloomberg (BOCR ), thomsonreuters.com and www.bociresearch.com. 

 

Table of Contents LIFE INSURANCE TO ADJUST STRUCTURE AND SECURE GROWTH .............. 3 P&C INSURANCE PEAKING OUT ............................................................11 MAJOR INSURERS’ PREMIUM INCOME ESTIMATES ................................... 18 DEBT MARKET TO IMPROVE, STOCK MARKET TO STAY DEPRESSED ........ 23 BLEAK OUTLOOK ON SOLVENCY ........................................................... 28 VALUATION AND STOCK PICKS .............................................................. 29 APPENDICES. KEY MONTHLY INSURANCE DATA...................................... 32 LISTED COMPANIES IN THIS REPORT...................................................... 34

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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LIFE INSURANCE TO ADJUST STRUCTURE AND SECURE GROWTH In 2011, the premium income of the life insurance subsector has come under severe challenges. Given the continued deceleration in premium income growth in 2H11, the full-year premium income growth may be a mere 8% based on comparable data. In our view, the outlook on life insurance premium will remain bleak in 2012. From the perspective of insurance policy demand, the purpose of the insurance customers is mainly investment. The insured emphasise policy yield more than the safeguard provided by insurance products. Although the bond market should improve in 2012, the stock market uncertainty should pile relatively large pressure on the insurance policy yield. Given the unlikelihood of policy yield increase, the sales of insurance products should continue to face challenges. From the perspective of insurance policy supply, the bancassurance channel sales can hardly ameliorate in 2012, under the impact of banks’ wealth management products and other investment products. As for the retail insurance channel, the meagre growth in the number of retail sales agents persists. The expansion in the retail capacity is of particular importance to the various insurers. In our view, it will be difficult for the overall life insurance subsector to post double-digit premium income growth. We estimate life insurance premium income growth at 6-7% for full-year 2012.

I. Limited Upside for Insurance Policy Yield; Insurance Product Relatively Unattractive Based on the product sales mix of life insurers in recent years, we see all of them tend to expand the proportion of participation insurance and reduce the proportions of traditional life insurance and universal insurance. China Life and CPIC both see the predominance of participation insurance. Although Ping An Life still has a universal insurance proportion of more than 30%, the overall universal insurance sales continue to shrink and should hardly see changes in the short term, given the new accounting requirements and certain companies’ emphasis on product restructuring. The predominance of participation insurance has more strongly pegged insurance products to the interest rate, directly depressing premium income. Besides, fluctuations in a certain insurance business will also cause volatility in the whole life insurance market.

Figure 1. Three Major Life Insurers’ Product Mix (Mid-year 2011)

Figure 2. Ping An Life Insurance Product Mix (Mid-year 2008-11)

100%

100%

80%

80%

60%

60%

40%

40%

20%

20%

0%

0% China Life

Traditional Unit-linked

Ping An Life Participation Accident and health

Source: Company data, BOCI Research

5 January 2012

CPIC Life Universal Others

2008 Traditional Unit-linked

2009 Participation Accident and health

2010

1H11 Universal Others

Source: Company data, BOCI Research

China Insurance Sector This document may not be distributed in or into the PRC.

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In 2011, life insurance premium income growth has been slow. In particular, new policy growth has dropped quite significantly, largely due to the lower yield of insurance products than those of banks’ wealth management products and trust products. With a relatively high real-term market interest rate and large inflationary pressure, the negative interest rate has made it difficult for banks to attract deposits. Thus, life insurance policies continue to lose appeal. Meanwhile, the contractionary policy in 2011 has also led to serious tightening of bank liquidity. As such, banks are in dire need of deposits. Looking ahead into 2012, despite the fluctuating inflation rate throughout the year, CPI may stay above 4%, making it difficult for the negative interest rate problem to moderate. Without marked relaxation in liquidity, we expect insurance products to remain hard-pressed by banks’ wealth management products, despite the regulators’ sustained pressure on the latter products.

Figure 3. 1-year Treasury Bond Yield and 1-year Deposit Base Rate (Latest)

Figure 4. Monthly CPI YoY Change and 1-year Deposit Base Rate (Latest with estimates)

(% )

(% ) 10.0 8.0 6.0 4.0 2.0 0.0

1-yr treasury bond yield Source: WIND database, BOCI Research

1-yr deposit interest rate

(4.0)

02/02 08/02 02/03 08/03 02/04 08/04 02/05 08/05 02/06 08/06 02/07 08/07 02/08 08/08 02/09 08/09 02/10 08/10 02/11 08/11 02/12 08/12

(2.0) 02/02 08/02 02/03 08/03 02/04 08/04 02/05 08/05 02/06 08/06 02/07 08/07 02/08 08/08 02/09 08/09 02/10 08/10 02/11 08/11

4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50

CPI YoY

1-yr deposit interest rate

Source: WIND database, BOCI Research

(i) Weakening appeal of participation insurance yield relative to medium/long-term deposit rate In the current market, participation insurance is the major product of insurance companies. As the yield of participation insurance policies is not publicly disclosed, we can merely estimate such yield in recent years. Both the stock and debt markets have performed poorly in 2011, and the three insurers’ participation insurance yield has little difference. We estimate the participation insurance yield at 3-3.5%. However, both the interest rates on 3-year and 5-year deposits stand above 5%. Thus, insurance policies are unappealing. Historically speaking, there is a certain lag between participation insurance yield and insurance premium income growth, compared to medium and long-term deposit rates. Change in the relative attractiveness of participation insurance products in one year will affect the premium income growth in the following year. Looking ahead, we see insurers facing difficulty in raising the participation product yield due to the exhaustion of the special dividend reserve, and the uncertainty of the investment environment, despite the possible interest rate cut in 2012. As such, the participation insurance products still lack appeal.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Figure 5. Settlement Rate Trend for Three Major Insurers’ Participation Insurance (Estimates) (% ) 10 8 6 4 2 0 (2) (4) 2006

2007

2008

China Life

2009

2010

Ping An Life

2011E CPIC Life

  Source: Company data, BOCI Research estimates * When calculating investment return, we need to deduct the asset impairment losses. Ping An made a tremendous loss from its investment in Fortis in 2008, leading to a negative settlement rate for participation insurance in 2008 under our calculation.

Figure 6. Rate Comparison for 3-year Deposits, 5-year Deposits, and Participation Insurance

Figure 7. Monthly Premium Growth of 3 Major Life Insurers (% )

(% ) 8.0

100

7.0

80

6.0

60

5.0

40

4.0

20

3.0

0

Source: Company data, BOCI Research * The participation insurance rate refers to the average of China Life and CPIC’s rates.

China Life

Ping An Life

07/11

01/11

07/10

01/10

07/09

5-yr deposit interest rate Participation insurance interest rate 3-yr deposit interest rate

(20) 01/09

2011E

07/08

2010

01/08

2009

07/07

2008

01/07

2007

07/06

2006

01/06

2.0

CPIC Life

Source: Company data, BOCI Research * Due to the problem of common calculation method, China Life, Ping An and CPIC’s comparable premium growth in 2011 started in March, July and January, respectively.

(ii) Relatively low actual yield of universal insurance Base on the latest data (up to November 2011), the universal insurance settlement rate of the three major insurers has stayed at around 4% since the beginning of 2011. Ping An Life and CPIC Life even slightly nudged the settlement rate down respectively in February and November. This illustrates the lack of improvements in the investment yield and thus the appeal of universal insurance policies.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

5

 

Figure 8. Universal Insurance Settlement Rates for 3 Major Insurers (% ) 6.5 6.0 5.5 5.0 4.5 4.0

Ping An Life

China Life

09/11

12/10 03/11 06/11

06/10 09/10

12/09 03/10

03/09 06/09 09/09

09/08 12/08

03/08 06/08

06/07 09/07 12/07

12/06 03/07

3.0

09/06

3.5

CPIC Life

  Source: Company data, BOCI Research

Nevertheless, we should take note of the lower real interest rates on universal insurance than the settlement rates announced by the insurers. For example, a lump-sum-payment, endowment universal insurance product charges a premium of RMB100,000. With the 4% deduction of initial fee payment, the value of the universal insurance stands at RMB96,000. Assuming an annual 4.5% settlement rate and certain amounts of protection cost and surrender charges, we estimate the policy’s annualised yield will only reach 4% after 20 years. As such, at the current settlement rate of around 4%, the real interest rate on universal insurance should be even lower. Going forward, the universal insurance sales would depend on the debt and stock markets, and small rebounds should have little impact on the insurance policy yield. We also expect the universal insurance settlement rate to drop in the near term.

Figure 9. Examples of Real Interest Rates on Universal Insurance Year 1 2 3 4 5 6 7 8 9 10 20 30 35

Cost of Policy account Surrender protection (RMB) value (RMB) charge (RMB) 245 100,069 6,004 255 104,312 5,216 266 108,733 4,349 277 113,342 3,400 289 118,147 2,363 301 123,156 0 314 128,376 0 327 133,818 0 341 139,491 0 355 145,404 0 538 220,232 0 815 333,568 0 1,004 410,522 0

Cash value (RMB) 94,065 99,096 104,384 109,942 115,784 123,156 128,376 133,818 139,491 145,404 220,232 333,568 410,522

Yield since initial premium payment (%) (5.94) (0.45) 1.44 2.40 2.97 3.53 3.63 3.71 3.77 3.81 4.03 4.10 4.12

Source: BOCI Research estimates

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

6

 

II. Bancassurance to Remain Depressed Bancassurance and retail sales agents will continue to be the main channels of premium income. Since the beginning of 2011, the proportion of sales through the bancassurance channel has continued to shrink. The proportion of the bancassurance premium income for the three companies of China Life, Ping An Life (based on written premiums) and CPIC Life respectively decreased from 50%, 16.5% and 54.8% in 2010 to 48.3%, 12% and 51.5% in 1H11. In 1H11, the three major life insurers posted almost no growth in the total premium income from the bancassurance channel. The new policy business receded 10.3% YoY, of which the first-year lump-sum and first-year installed payment policies decreased 10.1% YoY and 11.3% YoY, respectively. The bancassurance growth entirely came from policy renewal. Looking ahead, we believe that bancassurance premium income is unlikely to rebound, and will probably post flat growth. First, the banks still face heavy deposit pressure in 2012 and must first fulfill their deposit-taking duties. Second, even with an interest rate cut, policy yield should remain unattractive. Third, without stronger incentives for banks, selling insurance products is tantamount to selling wealth management funds. Hence, insurers need to offer higher fees to incentivise banks. Fourth, bank staff may not be able to provide consumers with professional advice due to the highly professional insurance products.

Figure 10. Three Major Life Insurers’ Premium Income Channel Proportion 100%

4.6

3.8 11.9

6.1

80% 48.3

51.3

60%

Figure 11. Three Major Insurers’ Bancassurance Channel Growth (% ) 200

155.9

150

139.7

112.7

100 84.2

40% 47.1

20%

50 42.5

0%

0

(9.9) (5.2)

10.5 (22.8) Ping An Life

(50) China Life

Retail channel

Ping An Life

Bancassurance channel

Source: Company data, BOCI Research

CPIC Life Group channel & others

China Life First-year installment

(17.4) (18.5)

First-year lump-sum

CPIC Life Renewal

Source: Company data, BOCI Research

III. Meagre Growth in Number of Sales Personnel; Agent Capacity Needs to Ramp up Currently, the growth in the number of life insurance sales personnel faces a bottleneck. The life insurance agent number posted a mere 11% increase in 2010. We believe the increase is likely to stand at around 5% in 2011. Among the three life insurance companies, Ping An Life still managed to register 4.7% growth in 1H11, but its full-year 2011 growth may be lower than in 1H11. CPIC Life’s sales personnel generally stayed flat, whereas the size of China Life’s sales team shrank to the 2006 level. In our view, there is relatively strong pressure on expanding the sales force mainly due to the following. First, China adopts the agency system rather than employee system for managing insurance sales personnel, and we fail to see any institutional changes in the short term. According to the various companies’ sales regulations, the sales agents’ income basically includes direct commission and additional commission (mainly basic salary and subsidy). The agents lack the basic social security and a sense of belonging to the companies. Second, the authorities’ regulations over commission rates continue to cap the growth of the sales agents’ income. In fact, the Notice on Matters related to Regulating Personal Insurance Operations announced in July 2011 merely restated the previous rate standards. Third, in 2011, inflation has caused an actual decrease in the agents’ income. Since February 2010, China’s actual interest rate has remained in the negative territory, and the higher living cost has also diminished the appeal of jobs as life insurance agents. 5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Under our estimation, China Life, Ping An Life and CPIC Life’s sales agents earned a monthly commission income of RMB1,900-2,200 per person in 1H11. Albeit approximately 30% higher than the full-year 2010 average, the income level was still relatively low. Looking ahead, we believe the life insurance premium income growth will come from the sales agent channel given the bancassurance depression. On the one hand, the number of agents is still important to life insurers at the current stage of development for life insurance. However, to reach double-digit growth should be difficult in 2012. We estimate the sales agent growth at around 6%. On the other hand, future growth of both the life insurers and agents depends on the capacity ramp-up for individual agents. For sales agents, commission income can hardly increase under the current framework for the standard commission rate. As such, agents must raise their own capacity and the volume of installed-payment insurance business in order to increase income. As for insurance companies, we believe there is room for individual capacity ramp-up, especially for life insurers with lower individual capacity. On one hand, market leaders can raise capacity through cross-selling to provide more comprehensive services to clients and also expand into tier-2 and 3 cities. On the other hand, to insurers with a larger proportion of the bancassurance channel sales, significantly ramping up individual capacity is inevitable with the bancassurance depression to continue into the future, given the large pressure on banks to compete for deposits and tight liquidity.

Figure 12. Three Major Life Insurers’ Agent Capacity Comparison (Monthly First-year Premium per Person) (RMB) 12,000 10,000 8,000 6,000 4,000 2,000 0 2006

2007

2008

CPIC Life

2009

Ping An Life

2010

1H11

Figure 13. Three Major Life Insurers’ Number of Retail Life Insurance Agents (10,000 persons) 90 80 70 60 50 40 30 20 10 0 2006 2007

China Life

2008

CPIC Life

2009

Ping An Life

2010

1H11 China Life

Source: Company data, BOCI Research

Source: China Insurance Annual Report, Company data, BOCI Research * China Life’s 2009 and 2010 data are estimates based on mid-year 2010 figures

Figure 14. Life Insurance Agent Commission Rate and Per-person Capacity

Figure 15. Commission Rates for Three Major Life Insurers’ Agents

(% )

(% ) 50 40 30 20 10 0 (10) (20)

16 15 14 13 12 11 10 2006

2007

2008

2009

2010

Commission rate (LHS) Premium growth per life insurance agent (RHS) Income growth per life insurance agent (RHS) Source: Company data, BOCI Research * Commission rate = life insurance agent commission income/agent premium income

5 January 2012

(RMB/month) 2,500 2,000 1,500 1,000 500 0 CPIC Life 2008

Ping An Life 2009

2010

China Life 1H11

Source: Company data, BOCI Research estimates

China Insurance Sector This document may not be distributed in or into the PRC.

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IV. New Policy Business Adjustment and Raising Value

Focuses

on

Structural

As seen from the structure of premium growth, the insurance policy renewal segment has provided the main momentum for life insurance premium growth in 2011, with first-year premium income posting sharp growth declines. Even though Ping An Life is less impacted by the bancassurance channel, new policies maintained mere single-digit growth. Under such circumstances, life insurers followed the strategy of structural adjustment, by raising the installed payment business proportion and new business profit margin (NBV/FYP). Due to the larger bancassurance percentages of China Life and CPIC, their installed payment businesses as a percentage of new policies account for a smaller proportion than that of Ping An Life, but they are still on an uptrend. In the future, the overall premium size would not grow significantly, and, as such, the life insurers share the common objective of adjusting structure, developing medium to long-term installed payment business, and raising the new business value. However, the development of medium to long-term installed payment business may be unfavourable to premium income growth and commission rate control.

Figure 16. Three Major Life Insurers’ Installed Payment Business as % of New Policy Business

Figure 17. Three Major Life Insurers’ New Policy Business Growth YoY

(% )

(% )

60

53.0

50

51.0

50 40 30

42.0

40 27.4

31.1

28.8

33.0

30 20

20

10

10

0

0

17.0

11.6 (0.4)

2.9

(10) China Life

Ping An Life

2010 Source: Company data, BOCI Research

CPIC Life 1H11

China Life

Ping An Life

2010

(5.4) CPIC Life 1H11

Source: Company data, BOCI Research estimates

V. Surrender Rate Difficult to Improve and Unfavourable to Policy Renewal Given the relatively low insurance policy yield, life insurers have recorded an increase in the surrender rate in 2011, particularly China Life and CPIC, which have a higher bancassurance proportion. Given that most bancassurance policies are of the lump-sum payment type and the return on such policies can be easily compared to that on medium to long-term deposits, installed payment policies face strong pressure of surrender when the insurance policy yield is unattractive. Looking ahead, we expect the upside on insurance policy yield to be limited and insurance products to come under relatively large surrender risks. The surrender rate is likely to increase, though the extent of such an increase should be narrower than in 2011. The higher surrender rate should directly impact the growth of renewal policy premium.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Figure 18. Three Major Life Insurers’ Surrender Rate Comparison

Figure 19. Comparison of Five-year Deposit Rate and Life Insurance Net Investment Yield

(% )

(% )

7 6 5 4 3 2 1 0

7.0 6.5 6.0 5.5

2004

2005

2006

2007

China Life surrender rate Ping An surrender rate Source: Company data, BOCI Research

2008

2009

2010

1H11

CPIC Life surrender rate

5.0 4.5 4.0 3.5 3.0 2004

2005

2006

2007

5-yr deposit interest rate

2008

2009

2010

1H11

Net investment yield

Source: China Insurance Annual Report, Company data, BOCI Research *The mid-year 2011 net investment yield is estimated on the basis of the three insurers’ average net investment yield from life insurance

Figure 20. Sensitivity Analysis on Life Insurance Premium Income Growth Bancassurance growth (%) In which: New policy growth (%) Renewal growth (%) Retail insurance growth (%) In which: Sales personnel growth (%) Agent capacity growth (%) Other channel growth (%) Life insurance premium income growth (%)

Bear case (4.6) (15.0) 65.0 11.0 3.0 8.0 (5.0) 1.6

Base case 0.4 (10.0) 70.0 16.0 6.0 10.0 0.0 6.6

Bull case 5.4 (5.0) 75.0 21.0 9.0 12.0 5.0 11.6

Source: China Insurance Annual Report, Company data, BOCI Research

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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P&C INSURANCE PEAKING OUT We expect P&C insurance’s profit margin to peak out in 2012 after enjoying three consecutive years of profit margin growth and combined cost ratio decline in 2009-11. Lower premium rates as well as higher combined cost ratio and compensation ratio have become irreversible trends. As auto insurance accounts for about 75% of business, and the proportion of non-auto insurance can hardly be lifted in the short term, the future profit growth of P&C insurance overall should continue to decline.

Figure 21. Monthly P&C Insurance Premium Income (RMB m) 60,000

(% ) 100 80

40,000

60

30,000

40

20,000

20

10,000

0

0

01/99 08/99 03/00 10/00 05/01 12/01 07/02 02/03 09/03 04/04 11/04 06/05 01/06 08/06 03/07 10/07 05/08 12/08 07/09 02/10 09/10 04/11

50,000

(20)

Monthly P&C insurance premium income (LHS) Monthly P&C insurance premium income YoY (RHS)

 

Source: CIRC, BOCI Research

Based on current research, the so-called underwriting cycle of P&C insurance can be found in many countries worldwide. Owing to limited data available, we use the total figures for the three companies PICC P&C, Ping An P&C and CPIC P&C to represent the sector’s combined cost ratio and compensation ratio before 2007. From the figures, we can see that during 2003-08, China’s P&C insurance sector witnessed the up-cycle of the combined cost ratio and compensation ratio. In 2003-04, the premium adequacy ratio experienced a one-off hike, but the lack of regulations on the sector, intensifying vicious cycle, and the medium to small-sized insurers’ poor risk awareness and reckless expansion led to a subsequent down-cycle as long as five years in China’s P&C insurance sector. After 2009, China’s P&C insurance sector has entered a period of recovery. The combined cost ratio has continued to decline, down to 92% currently, which is the lowest in ten years. However, we believe this up-cycle has neared its end. On the one hand, the process of liberalising the commercial auto insurance premium rate is underway; on the other, while the premium rate goes down, the insurers’ insurance coverage is enlarged. As such, we anticipate the current underwriting cycle will come to an abrupt halt and the combined cost ratio will trend up.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Figure 22. Study of Non-life Insurance Cycles in Various Nations

Source of study Venezian (1985) Renbao Chen, Kie Ann Wong, Hong Chew Lee (1999)

Cummins, etc (1987)

Basic variable Combined cost ratio Compensation ratio

Compensation ratio

Country USA

Figure period 1960-1980

Non-life insurance underwriting cycle (year) 6.06

Singapore

1970-1995

7.78

1957-1979

12.01 13.86 4.69

Malaysia Japan Australia

Canada France Germany Italy New Zealand Switzerland Lamm-Tennant and Weiss(1997) Combined cost Netherlands 1965-1987 ratio Spain

6.65 8.23 7.76 11.71 6.36 5.35 12.03 5.70

Source: Wang Lizhen, Li Xiufang and Guo Siwen’s Analysis of the Roots of the Underwriting Profit Cycle in China’s Life Insurance Sector, BOCI Research

Figure 23. Combined Cost Ratio and Compensation Ratio of China’s P&C Insurance Sector (1999-1H11) (% )

(% )

120

25

100

20

80

15

60

10

40 20

5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Sector combined cost ratio (LHS) Sector combined compensation ratio (LHS) Real GDP growth (RHS) Nominal GDP growth (RHS)

 

Source: China Insurance Annual Report, Company data, BOCI Research estimates

I. Auto Insurance Business Auto insurance premium income should depend more on the number of underwritten vehicles Since the beginning of 2011, the sector’s P&C insurance premium income has stood at around 17-18%. However, if we strip off the 20-25% growth in non-auto insurance, auto insurance may have grown merely 16-17%, which was 7-8ppts higher than the overall vehicle ownership growth in 2011. As seen from the above, after enjoying the high premium growth of nearly 40% in the whole auto insurance sector in 2010, the sector may not see such a high growth period again. If the commercial auto insurance premium liberalisation is implemented in 2012, the auto insurance premium rate may only be revised down, and the premium per vehicle can hardly increase. As such, the auto insurance premium income growth may be more correlated with vehicle ownership and the number of underwritten vehicles going forward. 5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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As of end-September 2011, China’s vehicle ownership nationwide amounted to 220m units, up 7% from the year beginning, and car ownership stood at 101m units, up 12.1% from the year beginning. As for production and sales, the 10M11 auto production and sales volumes came in at 15,030,000 and 15,160,000 units, respectively, up 2.8% YoY and 3.3% YoY. We forecast the full-year 2011 auto sales growth at around 3-4%. Considering the high base for comparison in 4Q10, the full-year vehicle ownership growth may reach 8.6%. Looking ahead, if there is no specific policy incentive, passenger vehicles as consumer durables are expected to maintain some growth (5-8%), while the passenger vehicle growth may come below 5% (though the 1H12 growth is probably negative). In consideration of the around 70% proportion of passenger vehicles in general as well as the impact of the macro-economic trends on passenger vehicles, we anticipate an around 5% growth for auto sales in 2012. As such, we estimate that in 2012, if the vehicle ownership growth stays at around 7.5-8% and vehicle insurance rate continues to increase somewhat without further increases in the premium per vehicle, then the whole sector’s auto insurance premium income may grow around 12-13%.

Figure 24. P&C Insurance Premium Income Growth Analysis

Figure 25. China’s Vehicle and Car Ownership Growth

(% )

(% ) 20

50

19.2

17.8

40 13.5

15

30

13.5

20 10

10 0

11.0

9.8

8.7

6.3

5

(10) 2008

2009

2010

1H11 0

P&C insurance premium income growth Non-auto insurance premium income growth Auto insurance premium income growth

2008

2009

Nationwide vehicle ownership

2010

2011E

Nationwide car ownership

Source: Company data, BOCI Research estimates *1H11 figures estimated on the basis of three major P&C insurers’ data

Source: WIND database, BOCI Research

Figure 26. China’s Vehicle Ownership and Underwritten Vehicle Growth Estimates

Figure 27. Vehicle Insurance Rate and Auto Insurance Premium Income Growth

(% )

(% )

25

60 50

20

40

15

30

10

20

5

10 2008

2009

2010

2011E

2012E

Underwritten vehicle growth Nationwide vehicle ownership growth Source: China Insurance Annual Report, WIND database, BOCI Research estimates

5 January 2012

2007

2008

2009

2010

2011E

2012E

Vehicle insured rate Vehicle insurance premium income growth Source: China Insurance Annual Report, BOCI Research estimates

China Insurance Sector This document may not be distributed in or into the PRC.

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Figure 28. Auto Insurance Premium Income Growth Sensitivity Analysis Bear case 131.8 9.1 239.6 6.5 55.0 (5.0) 3.6

Underwritten vehicles (m units) Underwritten vehicle growth (%) Nationwide vehicle ownership (m units) Nationwide vehicle ownership growth (%) Vehicle insurance rate (%) Per-vehicle insurance premium growth (%) Auto insurance premium income growth (%)

Base case 135.5 12.1 241.9 7.5 56.0 0.0 12.1

Bull case 139.2 15.2 244.1 8.5 57.0 5.0 20.9

Source: WIND database, China Insurance Annual Reports, BOCI Research estimates

Figure 29. Monthly Auto Production and Sales Volume Changes (% ) 160 120 80 40

Monthly auto production growth YoY

09/11

05/11

01/11

09/10

05/10

01/10

09/09

05/09

01/09

09/08

05/08

01/08

09/07

05/07

01/07

09/06

05/06

01/06

09/05

05/05

(40)

01/05

0

Monthly auto sales growth YoY

  Source: WIND database, BOCI Research

Premium Rate Liberalisation: Limited Short-term Impact, but Trims Sector Earnings Estimates in Long Term According to CIRC’s Notice on Strengthening Management of Commercial Vehicle Insurance Premium Rates (Consultation Paper) released in September 2011, the P&C insurers’ commercial auto insurance premium rate system is divided into three levels.

The first is that insurance companies can set their own commercial auto insurance terms according to the Association terms, and set their own commercial auto insurance premium rates in reference to the sector’s net loss ratio. The second is that insurers with combined cost ratio lower than the sector average and 100% for two consecutive accounting years can duly expand the coverage of commercial auto insurance terms on the basis of the Association terms while setting their own commercial auto insurance terms and premium rates in accordance with the sector’s net loss rate. The third is that qualified insurers can set their own commercial auto insurance terms and rates according to their own numbers. Among these, the four conditions regarding the required years of operating commercial auto insurance, combined cost ratio, solvency ratio and underwriting amount are hard constraints. As PICC P&C’s solvency ratio fell below 150% in 2010, CPIC P&C and Ping An P&C are the only listed companies allowed to independently set their auto insurance premium rates in 2012. Besides, a small number of medium and small-sized firms including Sunshine P&C Insurance, Alltrust P&C Insurance, Huatai P&C Insurance, and Anbang P&C Insurance may also be granted the independent pricing power. PICC P&C may also obtain such a right in 2013 after completing its share placement. A majority of the medium and small insurers may encounter difficulty in independent product development given their insufficient underwritten vehicle number.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Figure 30. Three Major P&C Insurers’ Combined Cost Ratio Comparison

Figure 31. Three Major P&C Insurers’ Solvency Ratio Comparison (% )

(% ) 100

97.8

98 96 94

200

195.5 167.0

175.0

179.6

159.0

150 93.7

93.2

115.0

92.9

92.5

91.1

92 90

100 50

88 0

86 CPIC P&C

Ping An P&C

2010

PICC 1H11

Source: Company data, BOCI Research

CPIC P&C

Ping An P&C

2010

PICC 1H11

Source: Company data, BOCI Research

We believe that if the new management method for auto insurance premium rates is implemented in 2012, the impact on P&C insurance companies’ earnings is limited in the short term, but this should add fuel to the competition in the auto insurance sector in the longer run. Reduction in the premium rate or rise in services expenses should squeeze the P&C insurers’ earnings and impact the long-term earnings estimates. First, we expect the liberalisation of the commercial auto insurance premium rate to have some adverse impact on P&C insurers’ overall profits, which, however, should be limited in the short run. 1.

From the regulator’s perspective, the CIRC has laid out certain terms and conditions in the new management method for premium rates in order to avert vicious competition among insurers. These include: the insurers’ planned commercial auto insurance rates should be submitted to and approved by the CIRC; insurers with large discrepancy between the combined claim ratio and the planned figure in the two recent years should explain to the CIRC.

2.

From the insurers’ perspective, among the total P&C insurance premium income, vehicle insurance accounts for around 75%, of which traffic insurance accounts for about 25-27%. If we expect commercial auto insurance to make up 74% of vehicle insurance, and assume the commercial auto insurance premium rate to decline by 5%, 10% and 15%, then the sector’s combined cost ratio will respectively increase 2.7ppts, 5.6ppts and 8.7ppts.

3.

Currently, Shenzhen and Beijing are running the pilot scheme for floating vehicle insurance rates. The regulator intends to abolish the old system of three sets of premium rates and to expand the floating range while lowering the standard rate. This is to link the premium rate more closely to the claim record and prevent significant drops in insurers’ earnings. At the present stage of execution, although the premium income somewhat declines, the combined cost ratio stabilises without marked rises. In our view, the current pilot programme has not yet been completed, and its execution in the coming two years needs more observation.

Second, in terms of the longer-term trend, the liberalisation of the commercial auto insurance premium rates will surely result in lower premium rates. In the long run, insurers must raise operating efficiency and lower cost. Price competition is the major form of competition in the auto insurance business. In reality, the various insurers provide almost homogeneous service capability and standard, and a majority of the auto insurance customers are price-sensitive. Their choice of insurance companies is still conservatively based on prices. Against such a backdrop, insurers’ competitiveness lies in lower cost and higher efficiency. Besides, auto sales have entered a relatively stable period, implying more intense overall competition in the auto insurance sector.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Finally, if the new method is enforced, we expect the following outcomes upon the abolition of the current standard rates. On one hand, the large insurers as represented by Ping An P&C and CPIC P&C should take the driver’s seat in market competition. They can capitalise on their advantages in the combined cost ratio resulting from economies of scale and reduce the commercial auto insurance premium rates. The medium and small insurers would struggle for survival and suffer market share erosion. On the other hand, the medium and small insurers can only compete in other means, such as raising the commission fees for sales agents. Thus, the P&C insurers’ overall profits may shrink further. All in all, if the CIRC launches the new regulation on liberalising the commercial auto insurance premium rates in 1H12, it is applicable to few insurers only. Also, the two listed insurers qualified for independent pricing would not seek to enlarge market shares by slashing auto insurance premium rates. Even if the rates may be cut in 2012, the degree would be limited. However, we believe that once the rate liberalisation trend is established, the market may lower the insurers’ earnings estimates and valuations, putting their stock prices under pressure.

Enlarged Insurance Coverage to Hurt Auto Insurance Business Certain new regulations in the September consultation paper will adversely impact the auto insurance business in the short term. One of them is the prohibition of the so-called “high premium, low compensation” phenomenon. The insurance companies and the insured will be required negotiate and agree on the actual value of the insured vehicle based on the fair market value. They should also mutually agree on the insured amount. In the past, the insurers set the insured amount for old vehicles according to purchase prices of new ones, and, in case of a complete loss, compensate the vehicle owners by deducting the depreciation amount from the new vehicle purchase prices. The eradication of the “high premium, low compensation” phenomenon would directly decrease the insurers’ auto insurance premium income. Another regulation is to require the insurers to pay third-party liability compensations. In other words, when third-party liability arises, the insurer will exercise the right to request compensation from the third party on the behalf of the insured starting from the day on which the insurer makes compensation to the insured. This means the insurers must shoulder the burden of recovering compensation and must implement system reforms in order to cope.

II. Non-auto Insurance Business The non-auto insurance business accounts for around 25% of P&C insurance. There is no pattern to follow based on its historical premium income growth. Moreover, the insurance categories under non-auto insurance are wide-ranging, and the various products are highly different. In particular, a number of insurance sub-categories require high levels of technical and specialist knowledge, and effective estimation for them is difficult. First of all, non-auto insurance includes property insurance, cargo insurance, liability insurance, credit insurance, agriculture insurance, etc. Based on the data from 1998 onwards, the various insurance categories have seen lower market concentration. The traditional enterprise property insurance and cargo insurance have shrunk in proportion, respectively down to 30% and 9% of the overall non-auto insurance business. Liability insurance has seen no major change in proportion, while agricultural insurance and credit insurance have steadily gained larger shares under the CIRC’s incentive in recent years. Looking ahead, we see the growth potential for non-auto insurance as limited in the short term but huge in the long term. As we maintain a bleak outlook on the macro-economy in 2012 given the declining economic activity, the non-auto insurance business growth may slow yet stay at 20%.

5 January 2012

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Figure 32. Non-auto P&C Insurance Premium Income Mix

Figure 33. Non-auto P&C Insurance Premium Income Growth (% )

(% ) 50 40 30

Source: Company data, BOCI Research

5 January 2012

2010

2009

2008

2007

2006

2005

2004

2003

2002

(10)

2001

0 2000

2010

2009

2008

2007

2006

2005

Cargo Liability Agriculture

10

1999

Enterprise Other property Credit and guarantee

2004

2003

2002

2001

2000

1999

20 1998

60 50 40 30 20 10 0

Source: Company data, BOCI Research

China Insurance Sector This document may not be distributed in or into the PRC.

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MAJOR INSURERS’ PREMIUM INCOME ESTIMATES Life Insurance Premium Income According to the 10M11 life insurance premium income announced by CIRC, under the new statistical methods, China Life, Ping An Life and CPIC Life took up respective market shares of 34%, 12.3% and 9.8%. Due to the change in statistical methods, Ping An Life’s market share was lowered. We anticipate that China Life’s market share in terms of premium will still shrink in 2012 and that of Ping An Life may somewhat increase given its faster-than-average premium income growth.

Figure 34. Three Major Life Insurers’ Market Shares (% ) 60 50 40 30 20

China Life

Ping An Life

09/11

05/11

01/11

09/10

05/10

01/10

09/09

05/09

01/09

09/08

05/08

01/08

09/07

05/07

01/07

09/06

05/06

01/06

09/05

05/05

0

01/05

10

CPIC Life

  Source: CIRC, BOCI Research

Under the new statistical methods, China Life’s 11M11 cumulative premium income stood at RMB301.2bn, up 0.6% YoY. The premium growth slowed by 0.8ppt from 10M11. We have a bleak outlook on the full-year 2012 premium income. Even with a certain amount of renewal premium, the bancassurance premium income would probably record negative growth, and the new policies will continue to come mainly from the retail insurance channel accompanied by a possible rebound in the agent number. The full-year 2012 premium income may decline 4% YoY. Within this, the first-year premium is expected to drop 11%.

Figure 35. China Life’s Premium Income (New Calculation) (RMB100m) 3,500

(% ) 14 12

2,500

10

2,000

8

1,500

6

1,000

4

500

2

0

0

3M10 4M10 5M10 6M10 7M10 8M10 9M10 10M10 11M10 2010 1M11 2M11 3M11 4M11 5M11 6M11 7M11 8M11 9M11 10M11 11M11

3,000

Insurance premium (LHS)

YoY (RHS)

  Source: Company data, BOCI Research

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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CPIC’s 11M11 life insurance premium income stood at RMB87.9bn, up 6.9% YoY, which was 0.5ppt lower than 10M11. Though the deceleration slowed somewhat, the trend remained. We expect CPIC’s life insurance premium income to grow more slowly YoY in 2012, at 5.8%. CPIC Life faces a similar problem to China Life, and its bancassurance channel income may drop 3-4%.

Figure 36. CPIC Life Insurance Premium Income (New Calculation) (RMB m) 100,000

(% ) 35 30

80,000

25

60,000

20

40,000

15 10

20,000 01/10 02/10 03/10 04/10 05/10 06/10 07/10 08/10 09/10 10/10 11/10 12/10 01/11 02/11 03/11 04/11 05/11 06/11 07/11 08/11 09/11 10/11 11/11

0

5 0

CPIC life insurance premium income (LHS) Life insurance premium income growth YoY (RHS)

 

Source: Company data, BOCI Research

Ping An’s life insurance business posted 11M11 cumulative premium income of RMB110bn, up 29.4% YoY under comparable statistical measures. Based on the currently available comparable data, the premium growth continued on a downtrend. Compared to other competitors, Ping An Life’s per-unit commission cost yielded the largest new policy premium. We expect Ping An Life’s premium income in 2012 to continue to benefit from its strong retail insurance channel (including its leading training mechanism and application of the MIT system) and highly-efficient individual output. The overall new policy business may only grow about 2%, and the full-year life insurance premium income growth should fall to 17%. However, Ping An Life is poised to widen the gap between itself and other competitors, leaving them farther behind.

Figure 37. Ping An’s Life Insurance Premium Income (New Calculation) (RMB m) 120,000

(% ) 40

Ping An life insurance premium income (LHS) Life insurance premium income YoY (RHS)

11M11

10M11

9M11

8M11

7M11

6M11

10

5M11

0

4M11

15 3M11

20,000 2M11

20

1M11

40,000

12M10

25

11M10

60,000

10M10

30

9M10

80,000

8M10

35

7M10

100,000

 

Source: Company data, BOCI Research

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Figure 38. First-year Premium/ Commission per Life Insurance Agent for Three Major Insurers 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 2008

2009

CPIC Life

2010

1H11

Ping An Life

China Life

  Source: Company data, BOCI Research

Property Insurance Premium Income In 11M11, the overall property insurance premium income amounted to RMB369.6bn, up 17.6% YoY. Whether overall property insurance or vehicle insurance alone, Ping An P&C’s growth rate surpassed those of the sector and major competitors. Generally speaking, Ping An P&C’s market share has been increasing (at around 17% currently), and PICC P&C’s share has been decreasing (at around 37% currently). CPIC P&C has maintained the 13% market share in general.

Figure 39. Three Major P&C Insurers’ Market Shares (% ) 60 50 40 30 20

PICC

Ping An P&C

09/11

05/11

01/11

09/10

05/10

01/10

09/09

05/09

01/09

09/08

05/08

01/08

09/07

05/07

01/07

09/06

05/06

01/06

09/05

05/05

0

01/05

10

CPIC P&C

  Source: CIRC, BOCI Research

PICC’s 11M11 premium income stood at RMB157.5bn, an increase of 12.3% YoY. We hold the view that despite the rises in its solvency and business development upon the share placement, the full-year 2012 premium income growth should decline to 11%, and the auto insurance premium income growth may even trail that of the sector by 1-2ppts. In addition, its high proportion of auto insurance should also drag the overall premium income growth.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Figure 40. PICC P&C Insurance Premium Income Growth (% ) 14 12 10 8 6 4 2 0 (2)

01/10 02/10 03/10 04/10 05/10 06/10 07/10 08/10 09/10 10/10 11/10 12/10 01/11 02/11 03/11 04/11 05/11 06/11 07/11 08/11 09/11 10/11 11/11

(RMB m) 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0

PICC P&C insurance premium income (LHS) PICC P&C insurance premium income YoY (RHS)

 

Source: Company data, BOCI Research

Ping An’s P&C segment recorded an 11M11 premium income of RMB74.68bn, up 29.4% YoY, which exhibited a slight slowdown. We believe Ping An P&C will continue to outperform the sector in terms of premium income growth in 2012, by way of its advantage in the established brand name and strong electronic sales network. The full-year growth may be as much as 19%. Ping An P&C enjoys the first-mover advantage in telephone and internet sales with large publicity efforts. In terms of cross-selling, it also leaves competitors far behind. As such, Ping An P&C’s market share should continue to expand.

Figure 41. Ping An P&C Insurance Premium Income (% ) 70 60

Ping An P&C insurance cumulative premium income (LHS) Ping An P&C insurance premium income YoY (RHS)

11M11

10M11

9M11

8M11

7M11

6M11

5M11

4M11

3M11

2M11

1M11

12M10

11M10

10M10

9M10

50 40 30 20

8M10

7M10

(RMB m) 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0

10 0

 

Source: Company data, BOCI Research

CPIC recorded 11M11 P&C insurance premium income of RMB55.9bn, up 19.8% YoY. The growth remained steady. Looking into 2012, we estimate that CPIC P&C’s premium income growth may decline to 14%, within which the auto insurance premium income growth may slightly beat the sector’s average and that of non-auto insurance may stay at around 18%.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

21

 

Figure 42. CPIC P&C Insurance Premium Income (% )

(RMB m) 60,000

25

50,000

20

40,000

15

30,000

10

20,000

5

0

0

01/10 02/10 03/10 04/10 05/10 06/10 07/10 08/10 09/10 10/10 11/10 12/10 01/11 02/11 03/11 04/11 05/11 06/11 07/11 08/11 09/11 10/11 11/11

10,000

CPIC P&C insurance premium income (LHS) P&C insurance premium income YoY (RHS)

 

Source: Company data, BOCI Research

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

22

 

DEBT MARKET TO IMPROVE, STOCK MARKET TO STAY DEPRESSED Insurers’ Investment Structure According to the CIRC’s latest data, as of end-October 2011, invested insurance fund totalled RMB5.37trn, up 16.6% from the beginning of 2011. It also eclipsed the end-September figure by RMB106bn. Within the total, bank deposits stood at RMB1.68trn, down RMB35.5bn from the previous month. The balance of other insurance fund investment amounted to RMB3.68trn, up RMB142bn from September. Based on these figures, the insurance companies may have enlarged bond and equity portfolios but reduced deposits, as both the stock market and debt market showed signs of bottoming out.

Fixed-income Investment Return In 2011, the insurers have made little change to the proportion of fixed-return asset investments, which is kept at around 76-77%, showing a less-than-1ppt change from the year beginning. The only changes have been made to the investment mix. Due to the bond market woes in the first three quarters, the various insurers lowered the proportion of bonds but heightened that of fixed-term deposits. However, with the bond market bouncing back, we estimate the insurers may have increased fund allocation to bonds in 4Q11. As for bond investment sub-categories, China Life has the largest proportion of investment available for sale, kept at around 60% since 2008. This has also led to the significant decrease in its solvency in 2011. Ping An and CPIC’s bonds are mostly held-to-maturity, with around 30% of bonds available for sale.

Figure 43. Three Major Insurers’ Bond Investment to Total Assets (1H11) 90 80 70 60 50 40 30 20 10 0

Figure 44. Three Major Insurers’ Bond Mix (1H11) (% )

(% ) 100 19.2

34.3

37.8

80 60

57.7

43.2

China Life

26.4

Ping An Life

Bond Source: Company data, BOCI Research

40 51.0

CPIC Deposit

72.3

28.1

26.5

2.0 Ping An Life

1.2 CPIC

60.5

20 0

69.9

1.8 China Life Trading

Available for sale

Held to maturity

Source: Company data, BOCI Research

From the perspective of investment return, fixed-return investment impacts the income/loss statement mainly through term deposits, bond interest income, price-spread income from assets available for sale, and changes in the fair value of trading assets.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

23

 

If we assume that in 2012 the overall fixed-return investment as a percentage of total investment remains unchanged, bond investment proportion should expand among the fixed-return investments compared to mid-year 2011. We have conducted a sensitivity analysis to calculate the impact on insurers’ earnings as a result of a 10-20bp drop in the bond market rate curve in 2012. Under our estimation, if the interest rate cut factor is excluded and the overall bond rate declines 10-20bps on average, the insurers’ earnings will rise 2-4% on average and, among them, China Life will benefit the most given its highest proportion of assets available for sale. As most of their investments are held-to-maturity, the other two major insurers’ earnings are relatively insensitive to the bond rate changes, even after we consider the proportion of floating-rate debts.

Figure 45. Analysis on Insurers’ Earnings Sensitivity to Bond Market Rate Trend Major assumptions 5-year deposit rate cut (bps) Bond rate decrease (bps) Bond duration (yr) Impact on 2012 earnings (%) China Life Ping An CPIC

1 interest rate cut (base rate trimmed by 25bps) 30 30 35 45 9 9

No interest rate cut 0 0 10 20 9 9 3.2 1.4 1.0

6.4 2.7 2.0

8.2 3.5 1.9

11.4 4.9 2.9

Source: Company data, BOCI Research estimates * Assuming a floating rate on 50% of deposits, and on 30% of held-to-maturity bonds

Figure 46. One-year Deposit Interest Rate and One-year Treasury Bond Yield (at end-Nov 2011) (% ) 4.5 4.0 3.5 3.0 2.5 2.0 1.5

1-yr treasury bond yield

08/11

02/11

08/10

02/10

08/09

02/09

08/08

02/08

08/07

02/07

08/06

02/06

08/05

02/05

08/04

02/04

08/03

02/03

08/02

0.5

02/02

1.0

1-yr deposit interest rate

  Source: WIND database, BOCI Research

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

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Figure 47. Yield Curves for Various Bonds (% ) 7.0 6.0 5.0 4.0 3.0 2.0

02/11

02/10

02/09

02/08

02/07

02/06

02/05

02/04

02/03

0.0

02/02

1.0

1-yr treasury bond

5-yr treasury bond

1-yr financial bond

5-yr financial bond

1-yr corporate bond

5-yr corporate bond

 

Source: WIND database, BOCI Research

Equity and Fund Investment Yield Under the tightened liquidity, high inflation, weakening economic growth expectations and the volatile European and US markets in 2011, the A-share market has been downcast. Despite the three temporary rebounds in the market (respectively from late January to mid-April, from late June to mid-July, and from late October to early November), the market has gone on a downtrend most of the time. Losses from equity investment are the major reason for the insurers’ relatively poor earnings in 2011. Currently, the three major insurers’ equity investment proportions (equities and funds) range between 11-13%. Even though the CIRC relaxed the restrictions on investments in equities and equity funds in August 2010, the woes of the stock market since April 2011 have deterred the insurance companies from enlarging equity investments.

Figure 48. Three Major Insurers’ Equity Investment Asset Proportion

Figure 49. Three Major Insurers’ Fund Investment Asset Proportion

(% )

(% )

10.0

8.0

8.0

7.0 6.0

6.0

5.0

4.0

4.0

2.0

3.0

0.0 2008

2009

China Life Source: Company data, BOCI Research

5 January 2012

2010 Ping An

1H11 CPIC

2.0 2008

2009

China Life

2010 Ping An

1H11 CPIC

Source: Company data, BOCI Research

China Insurance Sector This document may not be distributed in or into the PRC.

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Looking into the future, BOCI’s strategy team forecasts that in 1H12, the A-share market will continue to find the bottom. The market has still not reached a consensus on the trough. The Shanghai Composite Index (SHCOMP) may drop below 2,000, so the A-share market still has a 10-15% downside in early 2012. As for 2H12, the stock market trend should depend more on whether the monetary policy reversal is larger than the market expects. If without significant changes, the A-share market may exhibit an L-shaped trend in 2012, first posting drops without rallying later. Though without theme-based or long-term investment opportunities, we believe that after the market bottoms out, 2012 should offer better structural opportunities than 2011 with gradually relaxed liquidity. On such premises, we see it as unlikely for insurers to increase equity investment allocation. In general, we believe they will continue to post big losses from asset impairment given the 10-15% stock market drop expected in 1H12. In our base-case scenario, insurers can still obtain a 2.5% return from stock investment, which contributes 5-6% to insurers’ 2012 earnings on average. If the stock market is better than expected by, say, rallying from 2,000 to 2,500-2,600, stock investment return may contribute more than 15% of insurers’ earnings. In this case, China Life should benefit most given its relatively higher proportion of stock investment. However, if SHCOMP continues its way down after hitting 2,000, then stock investment would erode the insurers’ earnings.

Figure 50. Estimated Contribution of Stock Market Trend to Insurers’ Earnings for 2012 China Life Ping An CPIC

Bull case 21.2 14.8 15.2

Base case 7.1 4.7 4.9

Bear case (13.0) (8.0) (8.4)

Source: Company data, BOCI Research estimates

Huge Potential of Alternative Investment Currently, insurance companies make only a tiny proportion of investments in assets other than equities/funds and bonds even though the CIRC has expanded their permitted investment area in stages. As early as in March 2006, the CIRC announced the Pilot Scheme for Managing Indirect Investment of Insurance Funds in Infrastructure Projects, which regulates the indirect investment of insurance funds in infrastructure projects. In September 2010, the CIRC made public the Interim Measures on Insurance Fund Investment in Equities and Interim Measures on Insurance Fund Investment in Real Estate, which permit the insurance funds to invest in unlisted company equities and real estate (mainly referring to non-infrastructure real estate and related financial products).

While broadening the scope for insurance fund investment, the CIRC also emphasises the risk management for such funds. First, the CIRC has set concrete requirements on the proportions of insurance funds invested in infrastructure projects, unlisted company equities and real estate: the balance of an insurer’s investment in infrastructure debts should not exceed 10% of the total assets as at the previous quarter end; the book balance of an insurer’s investments in real estate and real estate-related financial products in total should not exceed 10% of its total assets as at the previous quarter end; the book balance of an insurer’s investments in unlisted companies’ equities and equity-related financial products of unlisted companies such as equity funds in total should not exceed 5% of its total assets as at the previous quarter end. Second, the CIRC has defined the investment targets. It specifies that insurance funds can be invested only in growing or mature companies’ equities but not venture capital funds or equities of companies which do not tie in with the state’s policy, such as those highly-polluting, energy-intensive, low-tech and low-cash-return companies. Also, the regulator stipulates that insurance funds can be invested only in real estate with clearly delineated property rights, relatively centralised management and satisfactory investment yield, but not in commodity housing, direct property development or set-up of real estate enterprises. Third, the CIRC has required relatively high standards for insurers’ investment teams, solvency, financial indicators, net asset size, etc. 5 January 2012

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As of end-October 2011, the insurers’ total asset size reached RMB5.82trn, implying that, in principle, as much as RMB1.4trn of insurance funds can be invested in the above-mentioned alternative investment areas. In fact, insurers exercise extreme caution in alternative investments and mainly undertake investments in infrastructure debt-financing projects, which are expected to amount to RMB80bn-90bn in scale, or 50% of total alternative investments. Under our estimation, insurance funds invested in infrastructure should continue to grow steadily given the expansionary fiscal policy. On the other hand, if the central government continues to control the property market and housing prices slump, then investment of insurance funds in real estate may ramp up and become the new driver for the diversifying insurance fund investment.

Figure 51. Three Major Insurers’ Investment Mix at Mid-year 2011 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Cash

3.6 13.4

2.5 11.5

77.5

76.9

5.5

9.3

China Life

Ping An Life

Fixed-income

6.5 12.6

77.4

Equity/fund

3.5 China Pacific Others

  Source: Company data, BOCI Research

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

27

 

BLEAK OUTLOOK ON SOLVENCY At present, the insurance companies’ solvency remains precarious. If investment income remains unexciting in 2012, some insurers’ solvency will drop to the minimum requirement of 150%. CPIC’s solvency is relatively better. After capital injection into CPIC P&C and issuing subordinated bonds for CPIC Life, the two subsidiaries’ solvency pressure has been alleviated. Nevertheless, owing to the dismal prospect in 2012, we expect the two subsidiaries to experience the pressure to raise funds amounting to RMB10bn-15bn in 2012. As for China Life, in spite of its issuance of RMB30bn subordinated debts in 2011, its solvency may still drop to around 170% at year end, implying a possible need to raise RMB20bn-30bn in 2012. In our view, Ping An may need capital replenishment most urgently. According to its latest announcement, Ping An will publicly issue A-share convertible bonds (CB) of no more than RMB26bn with six-year maturity and a maximum coupon rate of 3%, while it has authorised the board of directors to issue new shares at no more than 20% of the nominal value of its A shares and H shares, respectively. The converted shares involved in the A-share bond issue are already included in the 20% new A-share issue. As such, potential further share issuance lies with H shares, and Ping An still has a financing quota of RMB25bn-30bn in principle. Our primary concern is the capital market slide in 2012. We also assume that the capital market will improve in 2013. According to the CIRC’s stipulations, convertible bonds, as capital liability, can be included in paid-in capital calculation in principle. As such, when making our estimation for 2012 and 2013 solvency, we assume the convertible bonds are included in the paid-in capital immediately after issuance. Thus, Ping An’s solvency may reach 165% and 187% for 2012 and 2013, respectively. Insurance companies can replenish solvency in several ways, including subordinated bonds, convertible bonds, shareholders’ capital injection, share placement, open-market re-financing, etc. We see higher likelihood for CPIC and China Life to replenish capital through subordinated debts. The two subsidiaries under CPIC may still have a combined quota of RMB15bn to issue debts, while China Life can still issue up to RMB70bn in debts, representing a large quota. However, given the CIRC’s prohibition of insurance groups’ issuance of subordinated debts, Ping An Life and Ping An P&C may still have respective quotas of RMB6bn and RMB4bn to issue subordinated debts, which would give little boost to the overall solvency. In our opinion, after Ping An completes the A-share CB issuance in 2012, it would seek to undertake a capital replenishment project combining subordinated debts and H-share refinancing.

Figure 52. Comparison of Major Insurers’ Solvency

Figure 53. Estimates of Current Size of Major Insurers’ Subordinated Bonds as % of Net Assets

(% )

(% )

250

80

72.2

70

200

60

150

50

100

40

26.2

30

50

20

0 China Life Ping An Life

Ping An CPIC Life P&C

2010 Source: Company data, BOCI Research

5 January 2012

CPIC P&C 1H11

PICC

14.3

17.5

21.8

10

0.0

0 China Life Ping An Life

Ping An P&C

CPIC Life

CPIC P&C

PICC

Source: Company data, BOCI Research

China Insurance Sector This document may not be distributed in or into the PRC.

28

 

VALUATION AND STOCK PICKS Sector Valuation and Investment Phase As CPIC was listed only in late 2007, we use the data from 2008 onwards to compare the insurance sector and the stock market. Based on the weekly data, from January 2008 to the present, there are a total of 204 weekly data points. In terms of the differences between the weekly changes in SHCOMP and those in the insurance sector, there are about 40 data points with a ±5% difference and all the data points show no continuity and consistency in direction. Next, we expand the wavelength to study the monthly changes in data since 2008. From January 2008 to the present, there are a total of 48 monthly data points, with 22 of them showing a ±5% difference between SHCOMP and the insurance sector. 16 of them are found in 2008 and 2H09 with high volatility in the stock markets. Moreover, the most important feature is even those continuous data points with large discrepancies exhibit no consistency in direction and trend. As such, our conclusions on the stock price trend for the insurance sector are: 1.

All the three insurer stocks’ betas fall within 1.1-1.2, and the average beta for the insurance sector stands at 1.14. It is considered a high-beta sector, with higher volatility than the market index.

2.

The insurance stock price trends are highly correlated with the market index. Especially after 2010, the monthly change difference has seldom exceeded ±5%.

3.

Over a longer wavelength, the insurance stocks generally underperform the market during an overall market downtrend; however, they generally outperform the market during an overall market uptrend.

4.

We have also studied shorter wavelengths of about three months. During these periods, insurance stocks often underperform the market, possibly because the overall market lacks direction and investors start to be concerned about insurers’ fundamentals. Also, against a weak market backdrop, the insurers’ fundamentals may deteriorate.

Figure 54. Insurance Sector Investment Phase Analysis

Phase in cycle Jan 2008 to Oct 2008

SHCOMP change (69.3)

Nov 2008 to Jul 2009

90.8

Aug 2009 to Jun 2010

(34.2)

Jul 2010 to Oct 2010

27.0

Nov 2010 to Jan 2011 Feb 2011 to Apr 2011 May 2011 to Dec 2011

(5.3) 4.5 (25.7)

Insurance Type of sector change wavelength Performance (72.1) Long Market slumped; insurer stocks underperformed 125.4 Long Market soared; insurers outperformed market (37.2) Long Market plummeted; insurers underperformed 10.6 Short Given short cycle and weak market, insurers underperformed market; investors focused on fundamentals (17.7) Short Continued market slide, insurer stocks lacklustre 0.6 Short (23.3) Long

Source: WIND database, BOCI Research

In terms of either the P/E, P/B or implied new business multiplier, the current valuation of the insurance sector is lying at relatively low levels historically. Its present valuation stands at 12x implied new business multiplier.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

29

 

Figure 55. Listed Insurers’ Rolling P/E and Rolling P/B (x)

(x) 14

250

12

200

10

150

8

100

6 4

50

0

01/07 04/07 07/07 10/07 01/08 04/08 07/08 10/08 01/09 04/09 07/09 10/09 01/10 04/10 07/10 10/10 01/11 04/11 07/11 10/11

01/07 04/07 07/07 10/07 01/08 04/08 07/08 10/08 01/09 04/09 07/09 10/09 01/10 04/10 07/10 10/10 01/11 04/11 07/11 10/11

0

2

Source: WIND database, BOCI Research

Figure 56. Listed Insurers’ Implied New Business Multiplier

Figure 57. Monthly Change Difference between Insurance Sector and Overall Market

(x)

(% )

0

01/07 04/07 07/07 10/07 01/08 04/08 07/08 10/08 01/09 04/09 07/09 10/09 01/10 04/10 07/10 10/10 01/11 04/11 07/11 10/11

Source: WIND database, Company data, BOCI Research

09/11

05/11

01/11

09/10

05/10

20

01/10

01/08

40

09/09

60

05/09

80

01/09

100

09/08

120

05/08

40 30 20 10 0 (10) (20) (30)

140

Closing price based on arithmetic average Closing price based on weighted average share capital Closing price based on weighted average free float Source: WIND database, BOCI Research

Stock Picks Life insurance companies should continue to face huge challenges in 2012 if without strong policy incentives. Under the conditions of relatively tight liquidity and the considerable pressure on banks to attract deposits, life insurance premium income through the bancassurance channel should record almost flat growth. Retail insurance sales channel should still provide the main driver for life insurance premium growth. However, given the difficulty in sales personnel reinforcement, the individual agent capacity ramp-up is particularly important. Nevertheless, even if the individual capacity can be ramped up, the sector should still see difficulty in achieving double-digit premium income growth. The P&C insurance business should peak out in 2012. Although auto insurance may maintain double-digit growth in premium income, the higher auto insurance premium rates and larger insurance coverage would eat away insurers’ profitability and push up the combined cost ratio, which in turn shorten the underwriting cycle. As for investment, the bond market may provide better investment opportunities than 2011. The insurers’ floating loss from bonds should narrow, but the stock market should cause larger erosion to their earnings and solvency. Overall speaking, we estimate 2011-13 earnings growth respectively at -35.6%, -4% and 8% for China Life, -9.6%, 0.6% and 10.2% for Ping An, and 10.7%, 4.2% and 13.5% for CPIC.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

30

 

As for stock picks, we consider three factors: (i) non-life insurance business should continue to drive earnings even without strong growth in life insurance; (ii) we select those with lower solvency pressure and business growth potential; (iii) we prefer stocks with undemanding valuations under a weak market environment. Therefore, our top pick is CPIC.

Figure 58. China Listed Insurers’ Valuations Code

Company

Rating

601628 CH China Life 601318 CH Ping An 601601 CH CPIC 601336 CH New China A-share insurer avg.

BUY BUY BUY NR

2628.HK China Life 2318.HK Ping An 2601.HK CPIC 1336.HK New China 2328.HK PICC 0966.HK Taiping H-share insurer avg.

HOLD HOLD HOLD NR HOLD NR

Closing price (RMB) 16.57 33.99 18.70 26.80 24.02

TP (RMB) 18.50 40.00 22.50 27.00

Upside (%) 11.65 17.68 20.32 12.43

18.62 50.55 22.00 24.15 10.52 14.82 23.44

20.50 56.79 25.08 10.88 28.31

10.10 12.34 14.00 3.42 9.97

2010 13.93 15.01 18.79 14.33 15.52

P/E (x) 2011E 2012E 21.64 22.55 16.94 16.85 16.98 16.11 29.76 21.80 21.33 19.33

2010 2.24 2.32 2.00 4.90 2.87

12.83 18.30 18.13 10.59 18.44 9.21 14.58

19.94 20.66 16.38 17.84 12.69 16.69 17.37

2.07 2.83 1.93 3.62 3.61 1.64 2.62

20.78 20.54 15.55 13.95 10.32 11.78 15.49

P/B (x) 2011E 2012E 2.46 2.15 2.21 2.08 1.74 1.64 2.51 2.16 2.23 2.01 2.27 2.70 1.67 1.93 2.86 1.45 2.15

1.98 2.54 1.58 1.55 2.39 1.29 1.89

Price/embedded value per share (x) 2010 2011E 2012E 1.57 1.58 1.56 1.29 1.27 1.19 1.46 1.45 1.35 1.15 1.41 1.32 1.37 1.43 1.35

Price/appraisal value per share (x) 2010 2011E 2012E 0.72 0.70 0.67 0.47 0.47 0.47 0.65 0.62 0.57 0.38 0.72 0.69 0.56 0.63 0.60

1.45 1.58 1.41 0.85 1.61 1.38

0.66 0.58 0.63 0.28 0.54

1.45 1.55 1.40 1.04 1.38 1.36

1.43 1.45 1.30 0.98 1.13 1.26

0.64 0.58 0.59 0.53 0.59

0.61 0.58 0.55 0.51 0.56

Source: Company data, Bloomberg, WIND database, BOCI Research

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

31

 

APPENDICES. KEY MONTHLY INSURANCE DATA I. China Listed Insurers’ Market Performance Figure 59. A-share Insurers’ Market Performance since 2007 (RMB) 160 140 120 100 80 60 40 20 0

Figure 60. H-share Insurers’ Market Performance since 2006 (HK$) 120 100 80 60 40

01/07 04/07 07/07 10/07 01/08 04/08 07/08 10/08 01/09 04/09 07/09 10/09 01/10 04/10 07/10 10/10 01/11 04/11 07/11

0

Ping An

CPIC

01/06 04/06 07/06 10/06 01/07 04/07 07/07 10/07 01/08 04/08 07/08 10/08 01/09 04/09 07/09 10/09 01/10 04/10 07/10 10/10 01/11 04/11 07/11

20

China Life

Source: WIND database, BOCI Research

Ping An

CPIC

China Life

PICC P&C

Source: Bloomberg, BOCI Research

Figure 61. Major Insurers’ Stock Price Performance Latest price (RMB/HK$) 33.990 18.700 16.570 2,186.30 50.550 22.000 18.620 10.520 18,378.23

Ping An CPIC China Life SHCOMP Ping An CPIC China Life PICC P&C HSI

1 wk (3.49) 1.80 (0.24) 0.25 (5.07) 7.06 (2.21) 1.94 1.95

Stock (%) 1 month (6.47) (2.25) (5.91) (9.38) (5.51) (6.38) (7.82) 1.15 0.69

YTD (38.73) (16.96) (20.49) (22.14) (41.31) (31.05) (40.35) 0.07 (20.22)

Source: WIND database, BOCI Research

II. China Insurance Sector Fundamental Data Figure 62. Premium Income Growth

Figure 63. Life Insurance Market Share

(% )

(% ) 60 50 40 30 20

Source: CIRC, BOCI Research

5 January 2012

01/11

0

01/05 05/05 09/05 01/06 05/06 09/06 01/07 05/07 09/07 01/08 05/08 09/08 01/09 05/09 09/09 01/10 05/10 09/10 01/11 05/11 09/11

Cumulative premium income YoY Monthly premium income YoY

01/10

01/09

01/08

01/07

01/06

01/05

01/04

01/03

01/02

01/01

01/00

10 01/99

120 100 80 60 40 20 0 (20)

China Life

Ping An Life

CPIC Life

Source: CIRC, BOCI Research

China Insurance Sector This document may not be distributed in or into the PRC.

32

 

Figure 64. P&C Insurance Market Share

Figure 65. Compensation Ratio

(% )

(% )

60

40

50

35

40

30

30

01/11

01/10

01/09

01/08

01/07

01/06

01/05

CPIC P&C

01/04

Ping An P&C

01/03

PICC

10

01/02

15 01/01

0

01/00

20 01/05 05/05 09/05 01/06 05/06 09/06 01/07 05/07 09/07 01/08 05/08 09/08 01/09 05/09 09/09 01/10 05/10 09/10 01/11 05/11 09/11

10

01/99

25

20

Source: CIRC, BOCI Research

Source: CIRC, BOCI Research

Figure 66. Investment Asset Growth

Figure 67. Interbank Market Treasury Bond Yield Curve 5.0

70

4.0

60

3.0

50

2.0

40

1.0

30

0.0

20

3-month treasury bond yield 1-yr treasury bond yield 3-yr treasury bond yield 5-yr treasury bond yield

01/11

Source: CIRC, BOCI Research

Source: CIRC, BOCI Research

Figure 68. Stock Market Performance since 2006

Figure 69. Bank Deposit Proportion

SHCOMP (LHS) CSI300 (RHS) Source: CIRC, BOCI Research

5 January 2012

SSE180 (LHS)

01/11

01/10

01/09

20

01/07

0

30 01/06

01/06 06/06 11/06 03/07 08/07 01/08 05/08 10/08 03/09 08/09 12/09 05/10 10/10 02/11 07/11

1,000

01/05

2,000

4,000

40

01/04

3,000

01/03

8,000

50

01/02

4,000

01/01

5,000

60

01/00

6,000 12,000

0

(% )

7,000

01/99

16,000

01/08

01/10

01/09

01/08

01/07

01/06

01/05

01/04

01/03

01/02

01/01

0

01/00

10

(% )

02/02 08/02 02/03 08/03 02/04 08/04 02/05 08/05 02/06 08/06 02/07 08/07 02/08 08/08 02/09 08/09 02/10 08/10 02/11 08/11

(% ) 80

Bank deposits as % of total investment assets Bank deposits as % of total assets Source: CIRC, BOCI Research

China Insurance Sector This document may not be distributed in or into the PRC.

33

 

LISTED COMPANIES IN THIS REPORT China Life (2628 HK/HK$18.62, HOLD; 601628 CH/RMB16.57, BUY) Ping An Insurance (2318 HK/HK$50.55, HOLD; 601318 CH/RMB33.99, BUY) China Pacific Insurance (2601 HK/HK$22.00, HOLD; 601601 CH/RMB18.70, BUY) PICC P&C (2328 HK/HK$10.52, HOLD) China Taiping Insurance (966 HK/HK$14.82, NR) New China Life Insurance (1336 HK/HK$24.15; 601336 CH/RMB26.80, NR)

Prices as of 22 December 2011 All figures subject to rounding

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

34

 

DISCLOSURE The views expressed in this report accurately reflect the personal views of the analysts. Each analyst declares that neither he/she nor his/her associate serves as an officer of nor has any financial interests in relation to the listed corporation reviewed by the analyst. None of the listed corporations reviewed or any third party has provided or agreed to provide any compensation or other benefits in connection with this report to any of the analysts, BOCI Research Limited and BOCI Group. Member companies of BOCI Group confirm that they, whether individually or as a group (i) do not own 1% or more financial interests in any of the listed corporations reviewed; (ii) do not have any individual employed by or associated with any member companies of BOCI Group serving as an officer of any of the listed corporations reviewed; and (iii) have not had any investment banking relationships with any of the listed corporations reviewed within the preceding 12 months. Certain member companies of BOCI Group are involved in market-making activities for China Life. This disclosure statement is made pursuant to paragraph 16 of the “Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission” and is updated as of 3 January 2012. Waiver has been obtained by BOC International Holdings Limited from the Securities and Futures Commission of Hong Kong to disclose any interest the Bank of China Group may have in this research report.

5 January 2012

China Insurance Sector This document may not be distributed in or into the PRC.

35

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