Insurance team James Garner* Head of Asian Insurance Research The Hongkong and Shanghai Banking Corporation Limited +852 2822 4321 james.e.garner@hsbc.com.hk Michael P Chang* The Hongkong and Shanghai Banking Corporation Limited +852 2996 6555 michaelpchang@hsbc.com.hk Sinyoung Park* The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch +822 3706 8770 sinyoungpark@kr.hsbc.com Grace Q Zhou* The Hongkong and Shanghai Banking Corporation Limited +852 2822 3053 graceqzhou@hsbc.com.hk *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations 1
2 Sector structure Life Primary Non Life Composite Asia Insurance Reinsurance Korea Korean Re Conglomerate China Ping An Asia-Pacific Equity Research China China Life New China Life Korea Samsung Life Korea Life Tong Yang Life China Korea Dongbu Hyundai M&F LIG Meritz F&M Samsung F&M China China Pacific China Taiping How an Insurance company makes money Life-Spread investment Life-Unit linked investment Life-Protection Non-life + Investment return + Management fee (% AUM) + Protection premium + Premiums - Policyholder return* -Expenses - Claims costs - Claims expense = Investment spread +/- Hedging profit/(loss)** = Pre-tax profit (or Technical margin) - Operating expense -Expenses = Pre-tax profit = Underwriting profit/(loss) = Pre-tax profit + Investment income = Pre-tax profit *Can be fixed guarantee return or profit sharing (e.g. 90% of investment profits) ** Insurers sell income & capital protection guarantees and make a spread between premium and cost of external hedge Removed for Compliance reasons Source: HSBC
Chinese insurers versus 10-year Chinese government bond yield 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 160 140 120 100 80 60 40 20 0 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 China Life A China Pac A Ping An A NCL A China Life H China Pac H Ping An H NCL H China Taiping 10 year yield (RHS) Source: Thomson Reuters Datastream, CEIC, HSBC Korean insurers versus Korean 10-year government bond yield 8.0% 7.0% 6.0% 5.0% 24000 21000 18000 15000 4.0% 3.0% 2.0% 1.0% 0.0% 12000 9000 6000 3000 0 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Korea SE Insurance KTB 10Y(RHS) Source: Thomson Reuters Datastream, HSBC 3
4 Sector P/EV to ROEV scatter graph 30% Meritz 20% Dongbu Hyundai China Taiping Asia-Pacific Equity Research 10% LIG Tong Yang Samsung F&M Samsung Life Korea Life Korean Re Ping An 'A' China Pac 'H' AIA Ping An 'H' China Pac 'A' Bangkok Life China Life 'H' China Life 'A' 0% 0.0x 0.5x 1.0x 1.5x 2.0x 2.5x -10% -20% New China Life 'H' New China Life 'A' -30% Data as of 21 May 2012 Source: Company data, Thomson Reuters Datastream, HSBC
Sector description Broadly speaking, insurance companies provide protection to individuals and businesses against uncertain events by transferring risk to an underwriter, which promises to pay the insured an amount, usually unknown, if those events occur. The unknowns make estimating profits difficult and give rise to accounting that has been a topic of debate for investors and insurance companies for some time. Life insurance companies also sell wealth accumulation/savings products where there may or may not be an insurance element. The widely referenced industry S-curve, which highlights the level of maturity of the insurance market and per capita GDP, is often used as an indication of potentially high-growth markets as GDP per capita increases. The insurance sector is divided into primary insurance and reinsurance, depending on the nature of the customer. Primary insurance, which underwrites risk directly from households and businesses, is further split between life and property & casualty (commonly referred to as non-life). By contrast, reinsurers only provide insurance to insurance companies. Some insurers also have banking and asset management operations alongside the typical life and non-life underwriting segments. Life insurance comprises two main classes of products, namely savings type and protection type products. Savings products generate investment margins which can be investment spread (i.e. difference between actual investment return and policyholder return) and investment fee (i.e. levered as % AUM) which must cover administration and acquisition expenses. Protection products, also termed personal risk products, which provide cover against death and disability usually generate underwriting margin (the difference between premiums paid and claims). Key themes Insurance is the smallest of the sub-sectors within the Asian financials space. It has performed much in line with the rest of Asia in the last decade, but remember that some larger (Chinese) players have only listed in the last five years and there are many more listings to come. Key players in Asian insurance market are AIA, China Life and Ping An. James Garner* Head of Asian Insurance The Hong Kong and Shanghai Banking Corporation Limited +852 2822 4321 james.e.garner@hsbc.com.hk Michael P Chang* The Hong Kong and Shanghai Banking Corporation Limited +852 2996 6555 michaelpchang@hsbc.com.hk Sinyoung Park* The Hong Kong and Shanghai Banking Corporation Limited, Seoul Securities Branch +822 3706 8770 sinyoungpark@kr.hsbc.com Grace Q Zhou* The Hong Kong and Shanghai Banking Corporation Limited +852 2822 3053 graceqzhou@hsbc.com.hk *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Growth in the economy and per capita income boosts demand for insurance. As income rises, demand expands from compulsory products (motor insurance) to more sophisticated products such as saving products, asset protection such as household insurance and retirement products. The insurance sector, like banks, needs to maintain a minimum level of solvency to be able to underwrite new products and honour its future liabilities. Investors screen companies using regulatory solvency models to measure the group s solvency position and gauge its financial and operational flexibility. Underwriting profitability and investment returns are key elements of operating profits. Underwriting profitability depends on the pricing of products, fee structure, claims experience and expenses, and is relevant to both primary and reinsurance segments. Underlying profitability at life companies is dependent on the type of product and can be broadly broken into risk result and investment spread for the traditional products which are generally split between policyholder and shareholder in a defined proportion and fee income for the unit-linked product. Surrender and lapses of policies also affect profitability at life insurers and have to be considered for calculations along with expenses. Primary non-life and reinsurance companies measure technical profitability based on the combined ratio, the total of claims paid and losses incurred versus the premiums collected. 5
Sector drivers China Most H-share investors appraise Chinese life insurers using embedded value (EV) and new business value (NBV) information. Key NBV growth drivers include; life agent numbers, agent productivity levels, product mix (protection has higher margin), regulatory developments (e.g. banning life agents from bank branches) and competition. Recently life insurance sales through bank channels have been cannibalised by high-return wealth management products. H-share analysts usually ignore impossible to forecast life earnings. In contrast, the share prices of non-life insurers are impacted by earnings. Key non-life earnings drivers include combined ratio, premium growth and investment return. Chinese insurance share prices are geared to equity markets in four ways: (1) fundamental equity gearing as Chinese insurers are 10-14% equity invested; (2) solvency ratio is equity sensitive; (3) life insurance is an A-share market proxy for investors constrained by the qualified foreign institutional investor (QFII) scheme; (4) migration to more conservative valuation methodologies (e.g. from appraisal value to P/EV) during an equity market rout. In addition, regulatory reforms have had a significant impact on the sector s profitability and capital requirements and thus share prices. Korea Korean non-life insurance shares are appraised on a price to book basis and as such are driven by the earnings outlook despite the provision of EV information. One peculiarity in Korea is that the auto insurance loss ratio appears to have a disproportionately large impact on share prices even though auto business accounts for only 10-20% of total premiums received. Life insurers are largely appraised on an EV basis. As such the share price is sensitive to NBV growth outlook. In general, Korean insurers are highly sensitive to interest rate movements. The interest rate sensitivity is compounded by the insurers high exposure to high fixed return guarantees. Key segments China The Chinese insurance industry is in its infancy and offers significant long-term growth potential. It could be a potential beneficiary of the Chinese government s initiative to create more balanced growth by increasing consumer spending power. The expected rise in social welfare spending will ease the burden on households and help reduce their level of precautionary savings (mainly for education, healthcare and retirement). The positioning of China s insurance industry on the S-curve is on the cusp of where we would expect insurance growth to take off relative to GDP; within China, this relationship between GDP levels and penetration exists across the country s provinces. The unleashing of the Chinese consumer offers opportunities for the industry through insurance on durable goods (car insurance has already benefitted), increased spending on discretionary investment type products (this represents a large portion of the life insurance sector) and potential for a higher proportion of savings to be diverted into retirement products. Still, the profitable development of China s insurance markets will not be a smooth ride and there are several structural challenges, including the visible hand of the regulator, decentralised policy initiatives, a tight insurance labour market, competitive threat posed by the banks, burgeoning legacy issues (systems, products), and the likely revamp of the regulatory solvency system. 6
China s non-life market is primed for strong premium growth in light of a relatively low penetration rate, immature market structure evidenced by high dependence on the motor business versus more mature markets and the government s pressing need to get insurance risks off its own balance sheet. While the outlook for non-life premium growth is strong, the outlook for profitability is less so. China s non-life market faces deep structural challenges. Competition has been characterised as intense, irrational and on occasions legally dubious, and this is compounded by a lack of actuarial skills, relatively low barriers to entry and undue focus on market share. Recent reforms by the regulator have improved the operating environment, leading the current record high profitability ratios for the non-life sector. Looking further out, we expect the existing top five incumbents will lose market share over the next 15 years as direct distribution trends mirroring more developed markets take hold. Our analysts are more positive about the profitable development of China s life sector, given the centralisation of back offices, emphasis on higher margin products/lower cost distribution channels, professionalisation of agency sales forces, the emergence of scale benefits (material expense overruns should dissipate) and liberalisation of investment rules which could improve asset-liability mismatch and augment returns. Korea We do not see the Korean insurance market as ex-growth despite its superficially high premium penetration rates and pedestrian valuations. For example, Korean insurance penetration is high but premium density (e.g. premium per capita) of USD2,332 per capita is relatively low versus Japan (USD4,441) and Taiwan (USD3,296). Also, Koreans are poorly prepared for retirement, with retirement income equating to just 15% of final salary, in part due to serious flaws in the severance payment plan which is in the process of being replaced with the new corporate pension scheme whose assets under management (AUM) has grown rapidly to KRW52trn as of March 2012 from KRW16bn in May 2005. Note that Korean insurers adopted a uniquely Korean version of Risk Based Capital (RBC) in 2011 which will continue to flatter their solvency as Solvency 1 ratios do by ignoring longevity risk and levying very low equity investment and asset-liability mismatch risk charges. On 31 January 2012, the regulator highlighted a number of tightening measures for 2012 and the years to come. We believe that the regulatory body will take a step-by-step approach as a more demanding RBC model could force most insurers to raise money, even the recently listed insurers. In Korea, insurers have sold a raft of income and capital protection guarantees to take a bigger slice of the expanding variable annuity market. There is a risk that increasingly complicated income and capital protection guarantees sold with variable annuity products are not being priced, let alone hedged, correctly as competition intensifies. Insurers can limit guarantee risks through active portfolio management (e.g. automatic rebalance when the market falls, equity caps) but active hedging remains both problematic and limited in Korea. Valuation A one-size-fits-all approach is not applicable to the Asian insurance space. While Chinese insurance investors are comfortable using EV information, Korean insurance investors largely ignore it in favour of earnings. HSBC s Asian insurance analysts use four valuation methodologies (1) appraisal value / sumof-the-parts; (2) price to EV; (3) price to book; and (4) price to tangible asset value and weight them according to country business model specifics to gauge realistic 12-month price targets. 7
Sector snapshot Key sector stats Sector: Insurance 4% of MSCI Asia ex-jp Trading data ADTV (USDm) n/a Aggregated market cap (USDm) 102,860 Performance since 1 Jan 2000 Absolute 220% Relative to MSCI Asia 1.5x 3 largest stocks AIA, CHINA LIFE, PING AN Correlations (5-year) with MSCI Asia 0.92 Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC Premiums in Korea s insurance market in 2010 totalled KRW132,366bn Non Life 37% Life 63% Top 10 stocks Stock rank Stocks Index weight Source: FSS, HSBC 1 AIA GROUP 29.7% 2 CHINA LIFE IN. 19.4% 3 PING AN IN 14.0% 4 CATHAY FINL 7.3% 5 SAMSUNG F&M. 7.0% 6 CHINA PAC.IN 5.6% 7 SAMSUNG LIFE IN. 4.5% 8 * 3.1% 9 DONGBU INSURANCE 1.8% 10 SHIN KONG FINL.HLDG. 1.8% *Removed for compliance reasons Source: MSCI, Thomson Reuters Datastream, HSBC Country breakdown Country Weights (%) PE band chart Price level 400 350 300 250 200 150 100 50 0 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 25x 20x 15x 10x China 43.5 Hong Kong 29.7 Korea 16.0 Taiwan 10.7 Source: MSCI, Thomson Reuters Datastream, HSBC Key sector driver: Premiums in China s insurance market in 2011 totalled RMB1,434bn Non Life 33% Source: MSCI, Thomson Reuters Datastream, HSBC PB vs ROE 16 14 12 10 8 6 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 Life 67% Dec-04 Nov-05 Oct-06 Sep-07 Aug-08 Jul-09 Jun-10 May-11 Apr-12 Fwd ROE % (LHS) Fw d PB (x ) Source: MSCI, Thomson Reuters Datastream, HSBC Source: CIRC, HSBC 8