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Insurance
Outlook for Chinese insurance shares remains uncertain as
positive impact from rate hikes is offset by regulatory headwinds –
we still see strong upside in Chinese insurance ‘A’ shares
Reiterate our preference for Composite over Life insurance names
in Korea – most preferred stock is OW-rated Samsung F&M
In our view, OW(V)-rated China Taiping and LIG are the best
stocks to play the ‘Chinese growth’ and ‘Korean valuation’
anomaly themes, respectively
2011 outlook
China
The MSCI China Insurance Index has risen 2% year
to date, in line with MSCI China. PICC P&C was
the strongest performer y-t-d, rising a staggering
66% in light of better than expected operational
performance (6.8%pt unexpected swing in interim
combined ratio) and a continuation of strong top-line
growth. The worst performer was China Life ‘A’
shares, down 30% y-t-d, driven by an unexpected
slowdown in new business value (NBV) growth and
its unwelcome tag as an A-share proxy (Shanghai
composite down 14%).
We are cautious on the Non-life space; PICC
P&C is both expensive and poorly capitalised. We
accept there is a risk that the starting point of a
grossly overvalued stock may be overlooked and
the shares trade on momentum (e.g. car sales,
interest rate hikes) as they have done this year.
Although operational results were much better
than expected given the clampdown by the CIRC,
the regulatory outlook may not be as positive
going forward. The CIRC is considering allowing
up to 17 foreign insurers to sell compulsory auto
products which can be used to cross-sell more
profitable non-compulsory lines.
We continue to see share price upside in the ‘H’
and ‘A’ shares of China Life, China Taiping and
Ping An, which supports our current Overweight
ratings. That said we see downside risks from the
intensification of uneconomic competition
(evident in 1H), technical pressure from potential
new listings (eg, Taiking Life, PICC Group, New
China Life, according to local media such as 21st
Century Business Herald and Hexun) and fallout
from regulatory changes. This past three months
we have already seen potentially damaging
guidance from the CBRC on bancassurance and
also the CIRC proposing to liberalise Traditional
Life guarantee rates.
Korea
The Korea SE Insurance index has fallen 11%
year to date, underperforming the KOSPI, which
rose 13% during the period. The Life names have
dragged the index down, with Tong Yang Life
being the worst performer (-17%) and both Korea
Life and Samsung Life trading below their listing
prices. It seems investors share our cautious view
on the Korean Life insurance industry that is
‘generally’ characterised by weak capital bases
(on a more realistic RBC basis), relatively high
exposure to negative spread products and growing
concern about the provision of unhedged income
& capital protection guarantees.
The best-performing Korean insurance share was
OW(V)-rated Hyundai F&M, which rose 22%
YTD, closely followed by Korea Re (+21%) and
Dongbu (+20%).
Looking into 2011 we continue to have a strong
preference for Non-life names where we see lower
risks, more valuation upside (even in the unlikely
event that the industry embraces the unloved
Embedded Value methodology) and stronger
balance sheets. We could also see share price
catalysts in the form of a long overdue second
round of auto insurance price hikes early next year.
India
There are no quoted pure play insurers in the
Indian market although that could be about to
change with the expected listing of Reliance Life
(spun out of Reliance Capital) and Standard Life
HDFC. The successful listing of an Indian insurer
coupled with a long-awaited increase in FDI
limits could open the floodgates for more listings
in this important market, where the Life insurance
penetration rate (4.6%) is 2x that of China (2.3%).
We hope that 2011 will herald a more stable
regulatory environment for the Indian Life
insurance industry, which has been hit with fee
caps, surrender penalty caps and the proposed
withdrawal of much-needed tax breaks on key
products by 2012.
2011 high conviction idea
Overweight Samsung F&M
Samsung F&M is a well managed and well
capitalised group that offers value at current share
price levels. Key attractions of stock include:
Capital redeployment. Samsung F&M is
holding KRW3,604bn (=38% current market
cap) above the 200% solvency ratio and is
considering deploying some of their ‘to be
defined’ excess capital and have kept all options
on the table including M&A, organic growth, a
special dividend and a share buyback.
Quality play. Samsung F&M benefits from
having a strong brand, excellent group
connections (management talent, intra-group
sales) and significant economy of scale
benefits (26% market share). The group has a
track record for product innovation, EV
disclosure and responsible management –
investors can sleep relatively easy at night.
Auto loss ratio improvement. One key
catalyst could come from an improvement in
the share price sensitive auto loss ratio which
is at cyclical high. Loss ratios tend to improve
from January and Samsung F&M could
improve further owing to a second round of
auto price increases and positive regulatory
intervention (replace lump sum deductible for
proportional claims insurance).
Valuation
Samsung F&M shares offer a 41% potential return
against our KRW270,000 target price, which is
predicated on 30% weight to EV and a 70%
weight to PB methodologies.
Risks
Key risks to our OW rating comes from weaker
than expected capital markets and a value
destructive acquisition.
Winners from Chinese growth
Chinese insurers should benefit
Despite posting impressive premium growth over
the past decade, we still believe China’s insurance
industry offers significant premium growth
potential, driven by a plethora of powerful forces:
Increased recognition by the government that
net exports and investments can no longer be
the drivers of long-term GDP growth and that
consumption will have a bigger role to play,
which should be positive for life insurance.
The life insurance market remains relatively
underpenetrated. China is on the cusp of an
average GDP per capita level where
consumers withdraw deposits and replace
them with higher return long-term structured
products.
Potential introduction of tax-advantaged
insurance products which remains the biggest
delta in the insurance industry
We estimate annual insurance premium growth
for the Chinese insurance market over the next 15
years after making assumptions about nominal
GDP growth and what the insurance penetration
rate will rise to within the next 15 years.
Our current valuations are predicated on our basecase Life and Non-life 15-year premium CAGR
assumptions of 12% and 16%. In our more bullish
scenario we assume Life and Non-life 15-year
premium CAGRs of 21% and 24%, respectively.
Stock beneficiary
Migration from our base case to bull case
premium growth assumptions would have an
impact on our valuations, as detailed in Exhibit 2.
In the sensitivity analysis, we assume that the
additional valuation benefit of higher Life
premium growth from the introduction of
generous, easy-to-understand and tax-advantaged
retirement savings products is offset by the likely
lower margins on these products (we have
assumed a margin haircut of 50%).
We believe the best way to play the Chinese
growth story is through Overweight (V)-rated
China Taiping. The least exposed to the growth
story is Underweight (V)-rated PICC P&C.
Risks
The biggest risks to our valuation comes from lower
than expected growth. We consider our base case
premium growth forecasts to be extremely
conservative as they are predicated on world average
penetration rates in 2015 that are significantly below
the levels seen in other Asian countries.
Pricing anomalies
Korea embracing Embedded Value
The Korean insurance industry is a genuine
anomaly where stocks are valued on a punitive PB
methodology instead of a more conventional
Embedded Value (EV) approach.
Korean insurers offer deep value on more
appropriate embedded value metrics. The Korean
sector is trading on just 0.7x our 2011e group
embedded value, which implies a meagre 8%
ROEV versus our average expectation of 16%. A
multiple of 1.6x is more appropriate for a sector
given our ROEV expectation, 1% sustainable
growth and a 10.5% required return.
It is interesting to note that the Korean insurers
trade at a significant discount to their Chinese
counterparts on price to embedded value multiples
and yet there is only a 5ppt difference in our
average ROEV (akin to ROE in EV calculation)
between the two sectors over the next three years.
While the listing of three pure play life insurers
will help the embedded value cause, it will be
some time before Korean insurance investors fully
embrace the embedded value methodology which
gives rise to materially higher valuations. The
biggest challenges to overcome the valuation
methodology are:
Disclosure shift. It is no wonder that many
analysts and investors focus on PB given that
Korean insurers provide monthly earnings
data (versus annual EV data) and earnings
targets (versus no EV targets). Management
must improve the quantity of EV data (e.g.
quarterly NBV) and target focus if they want
investors to buy into EV.
Investor education. Many of the Korean
non-life insurers shot themselves in the foot
when they delayed the publication of EV data.
While Samsung F&M has disclosed EV data
for 5 years, its slower-moving peers only have
2 years of data.
Embedded value disclosure improvements.
Korean insurers need to materially improve
their embedded value disclosure in a number
of key respects, including; a reconciliation
from ‘shareholders funds’ to ‘adjusted net
worth’, standalone EV calculations and roll
forwards for Life and Group basis and
adoption of EEV methodology to allow
investors to draw a line in the sand with
respect to embedded high fixed return
guarantees.
Stock beneficiaries
All Korean insurers screen inexpensive in both
absolute and relative terms on embedded value
metrics. In Exhibit 3 we highlight that the total
potential return estimates increase from 23% to
132% if we were to base our price targets solely
on the embedded value methodology.
We believe the best way to play the Korean
valuation anomaly story is through Overweight
(V)-rated LIG, whose shares should benefit the
most from the migration to 100% weight to
embedded value. Interestingly, Underweight (V)-
rated Korea Life shares will be least exposed.
Risks
The biggest risk is if the market does not embrace
embedded value methodology. There is little
impact on our current price targets as we only
assign a 10-50% weight to EV in our price target
derivation calculation.
Valuation and risks
Samsung F&M (000810 KS, OW(V),
KRW191,000, TP KRW270,0000)
We derive our KRW270,000 target by weightings
of 30% and 70% to our ‘price to group embedded
value’ (KRW462,184) and ‘price to adjusted book
value’ methodologies (KRW204,199). We also
incorporate a 10% discount to allow for weak
disclosure. With 41% potential return indicated,
we maintain our OW(V) rating.
Downside risks are: (1) Group uses ‘excess’
capital to make a value-destructive deal. Samsung
F&M showed an intention to expand in the
overseas market in its FY08 results release: above
400% solvency ratio is the highest among life and
non-life peers in Korea. (2) The market continues
to obsess about competition with Life insurers,
especially Samsung Life. Samsung Life is the
largest life insurer in Korea and aims to grow in
the lining benefit market and retirement pension
market where Samsung F&M is focusing with
long-term products.
LIG (002550 KS, OW(V),
KRW20,200, TP KRW29,000)
We derive our KRW29,000 target by weightings
of 10% and 90% to our ‘price to group embedded
value’ (KRW60,404) and ‘price to adjusted book
value’ methodologies (KRW33,859). We also
incorporate a 20% discount to allow for weak
disclosure. With 44% potential return indicated,
we maintain our OW(V) rating.
Key downside risks to our rating include a faster
than expected deterioration in the group’s large
loan book, weaker than expected capital markets
and a further deterioration in 13th persistency
ratio, which is relatively lower than peers.
China Taiping (966 HK, OW(V),
HKD25.9, TP HKD37)
We derive our HKD37 price target by weightings
of 70% and 30% to our ‘price to group embedded
value’ (HKD38) and ‘price to embedded value’
methodologies (HKD35).
Key downside risks are: (1) capital raising, (2)
further deterioration in ICBC relationship, and (3)
weaker than expected NBV growth.
Korea Life (088350 KS, UW(V),
KRW7,360, TP KRW7,500)
We derive our KRW7,500 target price by
applying 50% weights to the valuation implied by
‘price to book value’ (KRW9,260) and ‘price to
group embedded value’ (KRW12,073). We apply
a 30% discount in light of disclosure (limited EV
reporting track record), high burden of
problematic fixed interest rate guarantee policies
and relative capital weakness under a more
realistic application of a RBC model.
Key upside risks are: (1) investors put greater
weight on embedded value methodology. (2) Fall
in exposure to high interest rate guarantee through
financial engineering, policy lapse or rapid growth
in new sales.
PICC P&C (2328 HK, UW(V),
HKD11.64, TP HKD7.8)
We value PICC using our PB methodology, with a
sustainable ROE assumption of 20%, based on
our average ROE forecast over the FY10-12
period. We assume a long-term growth rate of 4%
and a cost of equity of 10.4%, which generates a
target price-to-book ratio of 2.5x. We apply this to
our FY10 forecast of book value per share of
HKD3.2, and roll forward the valuation date to 12
months from today, to arrive at a valuation and
12-month target price of HKD7.8.
Key upside risks are: a stronger-than-expected
A-share market and an earlier-than-expected
listing of PICC’s parent on the A-share market
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