With the exception of PICC P&C (2328 HK) which was one of our preferred picks and has delivered double digit positive returns this year, Hong Kong & Chinese insurers have generally under-performed on the back of the steep selloff in Chinese equities. Amongst the listed insurers under our coverage, share price correction has been sharper in Ping An Insurance (2318 HK) on the back of the company’s soured investments in China Fortune (undergoing debt restructuring process, two thirds of its CNY54bn exposure is already provisioned for) within its investment portfolio of ~CNY3.8tn earlier in the year, and recent concerns over the impact of China’s economic moderation and higher policy risks on its wider range of businesses (banks, fintech, insurance, asset management, securities), which have been positive drivers during periods of stronger economic growth.
As highlighted in our earlier updates, key reasons for the insurance sector’s weakness this year include policy/regulatory worries, slower than expected economic growth, sluggish life business amid agency force attrition and recent concerns over potential contagion impact from Evergrande and the real estate sector – despite (belated) clarifications from various listed insurers including Ping An that they do not have meaningful/any exposure to the developer. As a house, while we are watchful for near-term risks to growth and expect further consensus corporate earnings forecast cuts in Chinese equities with the upcoming 3Q21 reporting season, we expect risks from the Evergrande saga should be eventually contained in an orderly manner with possibility for policy fine-tuning, and maintain our constructive medium-term view on China’s growth.
Within this report, we provide our thoughts on the common client questions that we have received on the Hong Kong/China insurers and reiterate our constructive stance on the sector’s longer term growth outlook, in line with our house’s view of China’s growth prospects. Given the insurers’ excess capital buffers accumulated and scenario analysis conducted, our base case is that the real estate exposures for the large listed Chinese insurers should be manageable. While we expect some reduction in the sector’s core solvency ratios from upcoming regulatory update expected on China’s solvency rules, comfortable buffers above regulatory thresholds should remain for the large-listed insurers under coverage.
Despite limited near term catalysts, undemanding valuations suggest a positive risk reward proposition for longer term investors with tolerance for volatility as China transits on a multi-year path towards its common prosperity goals. The insurers’ sector valuations last trades at trough levels of 0.4x-1.1x price/book for the H-shares listings of Chinese insurers, reflecting offshore investors’ relatively higher uncertainties over potential systemic risks (A-share listed insurers continue to trade above book values, implying relatively stronger confidence of domestic investors, possibly due to expectations formed from past cases of government intervention via asset disposals and business restructuring, although different free float levels for A shares have also contributed to this effect). As highlighted in our earlier Chinese financials sector analysis, we advocate a very gradual accumulation phase for long term investors as the near term outlook continues to be soft and investor sentiment will need time to stabilize and is still likely to fluctuate with headline news-flow on Evergrande and the real estate sector.
Within the sector, we continue to favour Hong Kong insurer AIA (1299 HK, fair value HKD120) for its relatively lower beta, strong track record and more diversified geographic exposure although its China expansion should see further positive momentum supported by new provincial licenses yearly and synergies from its distribution cooperation with Postal Savings Banking Corporation (1658 HK, fair value HKD6.50). Tactical oriented investors may wish to take some profits on PICC P&C (2328 HK, fair value HKD8.50) which has gained double digit and outperformed this year helped by its relative shelter from life insurance growth headwinds. While we see valuation support and positive long term risk reward proposition for Chinese insurers such as China Pacific (2601 HK, fair value HKD31), China Life (2628 HK, fair value HKD16.80) and Ping An Insurance (2318 HK, fair value HKD81), patience will be needed, in particular for Ping An due to its broader scope of businesses, which has seen relatively higher share price volatility whenever macro or real estate related sector worries spike.
Scenario analysis of potential negative impact on large insurers from further deterioration in the real estate sector suggest tolerable impact is likely. An extreme scenario (not our base case) that includes ~80% discount to the insurers’ equity stakes in property developers and ~50% discount on non-standard real estate assets and equity type wealth management products suggests up to mid-teens impact on estimated net book values of large-listed insurers, which looks manageable in view of continued underlying profit generation expected. Should such a high-stress scenario materialize (not our base case), we see likelihood of supportive regulatory measures to provide some flexibility for the computation and implementation timeline of the next set of solvency rules update.
Overhang from heightened investor worries over regulatory risks, Evergrande and real estate concerns, and subdued industry growth outlook amid a slower macro environment
Key reasons for the insurance sector’s underperformance this year include:
• Strong market risk-off mode on multiple concerns including regulatory risks, Covid resurgence/weaker consumer demand and softer macro growth outlook. Insurance sector’s recovery as a result has also been postponed to FY22e.
• Higher risk premiums sought for Chinese equities, reflected in the strong de-rating of MSCI China equities which has tumbled ~34% from its March 2021 peak levels (as of 15/10/21).
• Rising fears over contagion effect from Evergrande, which faces various interest payment deadlines and worries this may lead to some systematic risk on China property industry and thus impact on insurers’ investment portfolios.
• The limited disclosure standards of the Chinese insurers on their individual insurance fund portfolio holdings have weighed on share prices. Conversations with various insurance firms’ management teams post recent 1H21 results suggest that listed large insurers do not appear to have meaningful positions related to Evergrande, which is likely to range around mid-single digit percentage of total investment assets. It is possible however that smaller non-listed insurers may have higher exposure to the real estate sector and hence could see higher capital risks. As shown in previous cases, regulators should be able to assume control to stabilise operations if they see the need, which should help to limit the overall impact to the broad sector.