Insights

The revaluation possibility of China insurance industry

Over the past three years, the share prices of the listed Chinese insurance companies in Hong Kong have dropped by an average of around 18%. Is there any revaluation possibility? – Insurance stocks

Over the past three years, the share prices of the listed Chinese insurance companies in Hong Kong have dropped by an average of around 18%.

With an aging population and the increase in people’s awareness of using insurance as protection in China, an 18% price drop seems out of place, especially given all the favorable demographic factors underpinning a strong sector growth.

In this article, we will delve into the factors driving the share price drop of the Chinese insurance companies and see if they are still valid.

Multiple contraction

Over the past three years, the book values of the six Chinese insurance companies listed in Hong Kong have increased by an average of 13% per annum (p.a.). These six companies are: China Life Insurance Co Ltd (SEHK: 2628), Ping An Insurance Group Co of China Ltd (SEHK: 2318), People’s Insurance Co Group of China Ltd (SEHK: 1339), China Pacific Insurance Group Co Ltd (SEHK: 2601), New China Life Insurance Co Ltd (SEHK: 1336), and China Taiping Insurance Holdings Co Ltd (SEHK: 966).

The share prices of these insurance companies, however, have on average dropped by 6% p.a.. The increase in book values, coupled with the decrease in share prices, led to contraction of their P/B multiples.

In fact, the price-to-book value (PB) multiples of these insurance companies have dropped from 2.0x to 1.1x, which is equivalent to an average of 18% drop p.a.

What it also implies is that the market had failed to recognize or reward the robust book value growth of these insurance companies. The multiple contraction has wiped out all the impact of the book value growth and resulted in a share price drop.

Given the advantage of the demographic landscape in China, it’s quite strange that the market didn’t reward the book value growth, the listed insurance companies have demonstrated at all.

To find out the reason, one has to look deeper into the balance sheets of these companies.

Non-standard asset investments

Insurance companies with their massive balance sheets are among the major institutional investors in the financial markets.

They usually invest in “safe” asset classes such as government bonds and sometimes have a small allocation to equities. In the past five to ten years, Chinese insurers also started investing in an asset class called non-standard assets (NSA).

Non-standard asset investments are basically investments in asset classes other than the traditional assets, such as bonds, equity, funds, etc.

These non-standard assets are often marketed as trust products, banks’ wealth management products, and so on. In fact, they are part of the so-called “shadow banking” industry in China, where financial intermediaries facilitate the creation of credit in an unregulated manner.

As a result,  the disclosure of these products tends to be limited and not transparent. Different insurance companies have different classification rules, and so it’s extremely challenging for investors to gauge the exposure insurance companies have.

Take New China Life, for example, whose disclosure has been relatively better than the peers. Its NSA investments currently represent around 30% of its total investment assets.

Back to 2017

In 2017, one of the most widely debated concerns in the market is the possibility of a hard landing scenario of the Chinese economy.

With such concern in place and given insurers’ NSA exposure, it was unlikely investors would be bullish on insurers, which exhibited significant asset risks that are closely tied to the macroeconomic conditions in China.

In addition, the narrative in the market in 2017 was that China would step into a low interest rate environment. As such, the general view was that the insurers would have to resort to these non-standard assets to boost their yields.

However, the hard landing scenario for the Chinese economy did not eventually materialize, as regulators tightened their grip on NSAs and used de-leveraging to contain credit risks, the insurance industry in China began its transformation.

Foolish conclusion

With macroeconomic conditions in China continuing to improve after COVID-19, and the fact that China has not stepped into a low-rate environment, the credit risks in the market have been under control.

Meanwhile, the insurance sector is ripe for a re-rating given the intact fundamentals, strong growth potential, and decreasing asset risk.

There is a significant upside in the share price once the re-rating materializes with the normalized multiples back to the 2017 level, together with the sector’s strong book value growth.

More reading

This contributor does not hold any shares of the companies mentioned above.

The Motley Fool Hong Kong Limited(www.fool.hk) 2020

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