1 Credit Opinion: China Life Insurance Co Ltd Global Credit Research - 19 Apr 2013 Beijing, China Ratings Category Rating Outlook Insurance Financial Strength Moody's Rating STA A1 Contacts Analyst Phone Sally Yim/Hong Kong Stella Ng/Hong Kong Stephen Long/Hong Kong Alvis Chan/Hong Kong Key Indicators China Life Insurance Co Ltd Total Assets (RMB Mil.) $1,898,916 $1,583,907 $1,410,579 $1,226,257 $ 987,493 Shareholders' Equity (RMB Mil.) $ 223,101 $ 193,388 $ 210,475 $ 212,776 $ 174,871 Net Income (RMB Mil.) $ 11,272 $ 18,491 $ 33,811 $ 33,036 $ 19,274 Total Revenues (RMB Mil.) $ 371,485 $ 370,899 $ 385,838 $ 339,290 $ 300,385 High Risk Assets % Shareholders' Equity 86.8% 106.7% 103.0% 88.3% 47.4% Goodwill & Intangibles % Shareholders' Equity  2.9% 3.4% 1.8% 1.6% 1.6% Shareholders' Equity % Total Assets 10.8% 11.1% 13.6% 16.1% 17.0% Return on Capital (1 yr.) 4.4% 8.5% 16.0% 17.0% 10.1% Sharpe Ratio of ROC (5 yr.) 212.0% 262.6% Adjusted Financial Leverage  24.4% 14.9% 1.7% 1.6% 1.6% Total Leverage  24.4% 14.9% 1.7% 1.6% 1.6% Earnings Coverage (1 yr.)  5.2x 40.6x 204.0x 212.2x 125.2x Cashflow Coverage (1 yr.)  4.7x 61.0x N/A N/A N/A  Information based on IFRS financial statements  At China Life Co level only, not at China Life Insurance (Group) Company level Opinion SUMMARY RATING RATIONALE China Life Insurance Co Ltd is the largest life insurance company in China by premium income. It is 68.37%- owned by The China Life Insurance (Group) Company (China Life Insurance Group, or the Group), which is ultimately wholly-owned by the Ministry of Finance (MoF) of the People's Republic of China. The remaining shares are owned by public investors. We deem China Life a government-related issuer given its government ownership. China Life's A1 insurance financial strength rating reflects its strong brand, exceptional market position in the fast growing Chinese insurance market, whose long-term growth prospect is favorable against the backdrop of good economic growth and low insurance penetration. Its capitalization is solid. The company also has a liquid investment portfolio, mainly consisting of government and government agency bonds and listed equities. Unlike its regional peers, China Life does not have any negative spread burden as its legacy old policies were taken up by its
2 regional peers, China Life does not have any negative spread burden as its legacy old policies were taken up by its holding company. These strengths are offset by the company's 1) volatile profitability as a result of lower investment yield and impairment losses resulting from continued weakness in the capital markets, and 2) increasing financial leverage to replenish its solvency margin. Its short-term premium growth has slowed due to disruptions in the bancassurance channel. In addition, the company's capitalization is exposed to equity investments in the banking sector. China Life's rating incorporated its baseline credit assessment (BCA) of a2; a "strong" level of support, reflecting the strategic importance of China Life as the flagship company in the life insurance industry and its majority ownership by the Chinese government (Aa3 stable); a "high" level of dependence, reflecting China Life's exposure to China's economic environment and in light of its large holdings of debt securities issued by the government and government agencies. Credit Strengths - Strong brand, excellent market position and vast distribution network in the Chinese life insurance market - Favorable long-term growth prospects - Lack of a legacy negative spread burden - Ample liquidity in its investment portfolio - Effective majority ownership and support by the Chinese government Credit Challenges - Weakened and volatile profitability (including investment results) and negative pressure on capitalization due to volatile market conditions from equity investment exposure - Increased financial leverage - Large exposures to the banking sector - Short-term pressure on premium growth from lower bancassurance sales; and execution risk with regard to shifting its product structure to more regular premium and protection-type products Rating Outlook The rating outlook is stable. What to watch for: - Capital market developments and their impact on China Life's earnings and capitalization - Progress and execution risk with regard to the shift in product focus and strengthening its agency force - Plans of further issuance of debt to support regulatory capital and the resultant level of financial leverage What Could Change the Rating - Up Given China Life's large exposure to the banking sector, the likelihood of an upgrade in the near term is remote. Over the longer term, the rating could be upgraded if: - Equity investment exposure to the banking sector decreases to less than 15% of its capitalization - China Life maintains capital adequacy with an adjusted capital to assets ratio consistently above 12% or a local solvency ratio above 250% - Its profitability improves consistently with a return-on-capital of 10% or above - It successfully diversifies its distribution channels and product offerings
3 - It continues to improve its risk management What Could Change the Rating - Down China Life's rating could be downgraded if there is: - A significant and consistent weakness in capitalization, with adjusted capital to assets ratio falling consistently below 10% - A continued deterioration in profitability due to volatile investment income, missteps in underwriting or regulatory risk (for example, return on capital consistently staying below 4%) - An increase of high-risk assets to more than 150% of its shareholders' equity - A material increase in the company's adjusted financial leverage to more than 30%, or a significant rise in the holding company's financial leverage DETAILED RATING CONSIDERATIONS We rate China Life A1 for insurance financial strength, which is one rating notch above the a2 baseline credit assessment indicated by Moody's IFS rating scorecard, reflecting the assumption of government support in times of stress. Insurance Financial Strength Rating Moody's has identified the key factors currently influencing the rating: MARKET POSITION: Aaa - LEADING POSITION IN THE FAST GROWING CHINESE LIFE INSURANCE INDUSTRY China Life maintained its dominant and top position in the Chinese life insurance market with an absolute market share of 32.4% in 2012, and has led a competitive gap over the second player which has a 12.9% market share. As a result, it has a very strong relative market share ratio of 5.0x an average-sized company in the industry. China Life is particularly strong in the second and third-tier cities as well as the rural areas, as it built its network early when compared to other players. Nonetheless, its market position deteriorated over the past few years as other large and medium-sized companies build their brands throughout the mainland. But overall, it should be able to maintain its dominant position in the medium term. DISTRIBUTION: Baa - RELIANCE ON BANCASSURANCE CONTINUES TO HURT SHORT-TERM PREMIUM GROWTH The company's two main distribution channels are exclusive individual insurance agents and bancassurance, which contributed 55.6% and 39.9%, respectively, of its gross written premiums in The contribution from bancassurance has decreased from around mid-40% range in previous years because of weakened sales in this channel. Insurance products remain less attractive than wealth management products sold through bank counters that offer a higher yield. The China Banking Regulatory Commission has introduced restrictions on wealth management products with risky underlying assets offered by banks in March This will generally lower yields banks can offer on these products, thus making insurers' savings-type life insurance products more competitive. This would be credit positive for China Life. Overall, we believe that the company will have to strengthen its agency channel through more training, and improve its productivity in order to reduce its reliance on bancassurance. PRODUCT FOCUS AND DIVERSIFICATION: A - NO NEGATIVE SPREAD; EXECUTION RISK WITH REGARDS TO CHANGE IN PRODUCT FOCUS China Life's product risk is considered good because it does not have any negative spread burden from highguarantee policies, unlike some of its local and regional peers in Taiwan and Korea. These legacy policies remained with its parent company when China Life was listed in 2003.
4 It also carries a large block of participating policies which has low guarantee rates. Therefore, it does not carry significant interest-rate risk. However, the company's product diversification is limited, mostly because of its marketing strategy to focus on only two segments -- traditional life and participating products. But many of its participating products were shortterm in nature, with maturity at 5 years or below. In response to weak bancassurance sales, China Life started strengthening its agency force by providing more training, as well as focusing on selling more protection type products by its agency force. However, we believe that it will take time for its agency force to adapt to this new product strategy. ASSET QUALITY: Baa - EXPOSURE TO THE BANKING SECTOR REMAINS HIGH China Life's high-risk assets mainly includes equities and other loans. The percentage decreased to 86.8% of shareholders' equity at end-2012 from 106.7% at end-2011 due to increased holdings of bonds and cash deposits, now making up 84.9% of its overall investment portfolio, compared to 82.2% in The company has a large exposure to the banking sector through its investments in equities, financial bonds, and corporate bonds guaranteed by the banks. The top twenty equity investment list has quite a few names in the banking sector. Chinese banking stocks are highly volatile, and we expect some weakening in the banks' asset quality in As a result, we regard China Life's asset quality as being at the "Baa" level rather than the "A" level as indicated by the IFS rating scorecard. We will also monitor the composition of China Life's investment portfolio over time, as the regulator opens more investment channels as part of de-regulation. We believe that given China Life's large balance sheet, it will likely diversify its investment portfolios into these alternative channels such as project finance, real estate, private equity, which tend to carry higher risk than traditional investments given that these are rather new, emerging type of investments in China. CAPITAL ADEQUACY: A - CAPITALIZATION WILL REMAIN UNDER PRESSURE BECAUSE OF VOLATILITY OF STOCK MARKET At end-2012, China Life's adjusted capital-to-asset ratio was 10.8%, which slightly decreased from 11.1% at end Its solvency ratio was at 235.6% at end-2012, and was up from 170.1% at end-2011 due mainly to 1) the issuance of RMB38 billion subordinated debt in 2012 that qualifies as solvency capital, and 2) the increase in the fair value of available-for-sale securities. The company may possibly issue another RMB8 billion or its equivalent in other foreign currency of debt offshore, pending regulatory approval. We believe that the planned issuance is mildly credit positive, as it would help China Life to increase its local solvency margin ratio. We expect that the capitalization of China Life will remain under pressure because of stock market volatility that affects the valuation of its equity securities. Hence, we adjusted the capital adequacy score to "A" from "Aa" on our IFS rating scorecard. PROFITABILITY: A - NEGATIVE PRESSURE OF PROFITABILITY HAS NOT EASED China Life's net income for 2012 declined due to a decrease in investment yield and the increase in impairment losses resulting from the continued weakness in the capital markets. Return on average capital decreased significantly to 4.4% in 2012 when compared to the 5-year average of 14.8% between Its return-onaverage assets has also decreased to 0.6% for 2012, which is not favorable. Volatility in profitability (as measured by its Sharpe ratio of returns on capital) has increased. We believe that the negative pressure of profitability has not eased, given that the A-share stock market is still volatile. As a result, profitability could remain weak for quite some time for China Life, as its earnings would continue to be sensitive to the movement of the capital markets. LIQUIDITY AND ASSET-LIABILITY MANAGEMENT: A - GOOD LIQUIDITY WITH ASSET-LIABILITY MISMATCH China Life's investment portfolio is highly liquid, with only a very small portion in real estate and loans. As a result, it fares very well under Moody's liquidity stress test, with its liquid assets to liquid liabilities ratio above 4x.
5 As regulation eases and allows more alternative type of investments such as real estate and infrastructure project debt finance plan, etc., the overall liquidity of China Life's investment portfolio will slightly decrease as these asset types are less liquid than traditional investments of fixed income and equity securities. Overall, we consider China Life's liquidity and asset liability management to be more consistent with the "A" rating level, in light of asset/liability duration mismatches and the lack of a sophisticated asset/liability management model. Moreover, some of its debt securities investments are somewhat vulnerable to market liquidity risk, given its large portfolio relative to the overall market. FINANCIAL FLEXIBILITY: A - INCREASED FINANCIAL LEVERAGE BECAUSE OF SUB DEBT ISSUANCE At end-2012, China Life's adjusted financial leverage increased to 24.4%, up from 14.9% at end The increase was due mainly to the issuance of RMB38 billion of subordinated debt during the year to replenish its solvency capital. China Life has announced its plan to issue a further RMB8 billion of subordinated debt offshore, pending regulatory approval. Considering all these issuances, China Life's pro forma financial leverage would rise to around 25%-30%. This level hits the upper limit of the financial leverage the current rating can tolerate, although all proceeds from the issuance would be used to replenish capital, rather than used for higher risk activities, such as mergers and acquisitions. On the other hand, earnings coverage was 5.2x for 2012, and we expect it to stay around 5x-7x going forward, mapping to our "A" category. As a result, we regard China Life's financial flexibility as being more in line with that of its A-rated peers, than with the "Aa" rating indicated by the IFS scorecard. We also consider China Life's financial flexibility at the China Life Insurance Group level. Although the Group still bears a negative spread burden from old policies, these policies have been separated into a different fund and its liabilities are supported by the MoF. OPERATING ENVIRONMENT: CHINA: Baa Our overall Baa for the insurance operating environment is based on our assessment of China's generally high economic strength, moderate institutional strength, and low susceptibility to event risk (in accordance with our published sovereign rating indicators). These factors are counterbalanced by the limited penetration of the insurance market in the national economy and the per capita utilization of insurance in comparison to other countries worldwide. Overall, the Baa insurance operating environment for China exerts a mildly negative influence on China Life. Other Considerations We apply our Rating Methodology for Government-Related Issuers to China Life because of the 68.37% effective ownership by the MoF. We believe that the likelihood of government support is "strong", given the MoF's majority ownership and China Life's flagship status in the country's life insurance industry. The dependence level is "high", reflecting the company's exposure in the domestic economy and its large holdings of debt securities issued by the government and government agencies. Therefore, our A1 rating on China Life incorporated an uplift of one rating notch from its BCA of a2. Rating Factors China Life Insurance Co Ltd Financial Strength Rating Scorecard  Aaa Aa A Baa Ba B Caa Score Adjusted Score Business Profile A Aa Market Position and Brand (14%) Aaa Aaa
6 Relative Market Share Ratio X Distribution (9%) Baa Baa Distribution Control X Diversity of Distribution X Product Focus and Diversification (9%) A A Product Risk X Life Insurance Product Diversification X Financial Profile Aa A Asset Quality (9%) A Baa High Risk Assets % Shareholders' Equity 86.8% Goodwill & Intangibles % Shareholders' 2.9% Equity  Capital Adequacy (14%) Aa A Shareholders' Equity % Total Assets 10.8% Profitability (14%) A A Return on Capital (5 yr. avg) 11.2% Sharpe Ratio of ROC (5 yr. avg) 212.0% Liquidity and Asset/Liability Management (9%) Liquid Assets % Liquid Liabilities X Financial Flexibility (14%) Aa A Adjusted Financial Leverage  24.4% Total Leverage  24.4% Earnings Coverage (5 yr. avg)  117.4x Cashflow Coverage (5 yr. avg)  32.9x Operating Environment (10%) Baa Baa Aggregate Profile Aa3 A2 Aaa A  Information based on IFRS financial statements  The scorecard rating is an important component of the company's published rating, reflecting the stand-alone financial strength before other considerations (discussed above) are incorporated into the analysis  At China Life Co level only, not at China Life Insurance (Group) Company level 2013 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATIONS") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODY'S
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