Contrary to popular belief, we believe Chinese life insurers should benefit from monetary easing at this point in the cycle. We note that our China economist now expects two interest rate cuts in 2015. We believe a lower rate environment could ease competitive pressure and allow room to lower liability costs, which should more than offset reinvestment pressure. We expect the sector to deliver robust EV and VNB growth in 2014-16, and see the current sector valuation as attractive, especially the major insurers’ A-shares, trading at 0.9-1.1x 2014E P/EV. We initiate coverage of the Chinese insurance A-shares, with Buy ratings on China Life, Ping An and CPIC, and a Hold on NCI.
?Why are interest rate cuts positive?
There are three reasons why we believe potential interest rate cuts are positive for Chinese life insurers. Firstly, we believe insurers’ investment yields could be resilient, despite lower interest rates, thanks to the availability of higher yielding assets. We note that the listed insurers’ net investment yields of 4.8-5.1% in 1H14 are relatively low compared with the 6+% yields offered by new investments, such as preferred shares and other non-standard investments. Secondly, while asset duration is shorter than liability duration, we believe the sector’s liabilities could be re-priced faster than assets, due to the dominance of participating and universal life policies (~77-92% of reserves), which allow insurers flexibility in adjusting liability costs. Furthermore, we believe a lower interest rate environment could ease competitive pressure for the sector, and is positive for growth. Last but not least, an easing monetary situation should ease asset quality deterioration, which has been a key concern for investors.
Expect robust EV and VNB growth in 2014-16
We forecast robust EV and VNB growth for Chinese life insurers, with average EV growth of 23.7% and VNB growth of 18.3% in 2014, helped by strong investment markets. We forecast EV growth to be sustained at around 14.3%/13.9% in 2015/16, and VNB growth at 15.6%/14.6%, supported by stable market conditions and an increased focus on protection policies. As such, we see current sector valuations – at 0.9-1.1x 2014E P/EV for insurance A-shares, 0.9-1.3x for H-shares – as unjustified and yet to price in any recovery.
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China remains a nation of savers. A major contributor to this state of affairs is the underdeveloped insurance sector. If you need to hold large cash balances to provide for accidents, home repairs, healthcare, retirement and death you will need to adopt an inherently cautious attitude to personal finances. Sharing the burden for these eventualities with an insurance company reduces risk and allows for a more productive use of capital. Insurance remains a growth industry in China for these reasons but this is not a new story. The healthcare sector is where the majority of investors currently have their attention trained while the more established insurance companies remain largely rangebound.
PICC Property & Casualty (Est P/E 11.92, DY 2%) encountered resistance in the region of the 2007 peak from September. While some consolidation of recent powerful gains is underway, a sustained move below the 200-day MA, currently near HK$12.50, would be required to question medium-term scope for additional upside.
China Taiping Insurance (Est P/E 13.34, DY N/A) completed a two-year base in August and is not forming a first step above it. It will need to continue to find support in the region of the 200-day, currently near HK$15, if medium-term recovery potential is to be given the benefit of the doubt.
Ping An Insurance (Est P/E 10.53, DY 1.42%) has been largely rangebound for the last four years. Trading was suspended today pending the issuance of approximately HK$5 billion in additional shares. This event may cause some indigestion and delay potential for additional upside, but a sustained move below HK$55 would be required to question a gradual return to demand dominance.
While not specifically catering to China, Hong Kong listed AIA Group (Est P/E 21.06, DY 1.04%) remains in a reasonably consistent uptrend and a sustained move below HK$40 would be required to question that view.
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