China / Hong Kong Industry Focus China Insurance Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 1 Nov 2017 Multi-year value growth ahead HSI: 28,336 • Strong growth potential back by C-ROSS, favourable policy direction, and structural drivers ANALYST • Favourable asset/liability mismatch position Ken SHIH +852 2820 4920 [email protected] bodes well under a rising rate environment; China lifers’ book value is set to rise Keith TSANG CFA, +852 2971 1935 nd [email protected] • Impact from 2 phase of auto insurance pricing reform expected to be more severe; online insurers considered to be a disruptive force Recommendation & valuation • Initiating coverage on China Insurance sector. Top picks: China Taiping (966 HK), CPIC (2601 HK), and C losing Targe t FY17F Ping An (2318 HK). Top SELLs: PICC P&C (2328 HK), Stock Ticker Rating Price Price PB Yield ROE and China Re (1508 HK) (HKD) (HK D) (X) (%) (% ) Spotlight on value enhancement: We believe China’s low Ping A n - H 2318 H K BUY 68. 1 86. 0 2.4 1.5 17.8 insurance coverage, launch of China Risk-Oriented Solvency C hina Life - H 2628 H K BUY 25. 8 32. 0 1.9 1.8 9.6 System (C-ROSS), and policy guidance will continue to direct China Taiping 966 HK BUY 25.1 38.0 1.4 1.1 8.9 China life insurers to refocus on traditional life products and C hina Pacific - H 2601 HK BUY 37. 7 54. 0 2.0 2.8 11.1 value enhancement. Despite the surge in 2016, we expect A IA 1299 H K BUY 59. 4 75. 0 2.4 1.9 14.7 leading lifer’s such as China Taiping, CPIC and Ping An, to Manulife 945 HK BUY 157.2 196.9 1.0 4.8 9.9 record strong VNB growth of 30-32% CAGR in FY17-19F. The PICC Group 1339 H K H OLD 3. 7 3. 9 0.7 1.2 12.2 ability to enhance value serves as a key spotlight. China Re 1508 HK F.V. 1.7 1.5 0.8 3.5 7.9 Negative duration gap bodes well: Lacking domestic long- PICC P& C 2328 H K SELL 15. 2 11. 7 1.4 2.6 15.6 duration investable assets, China insurers are holding a mismatched portfolio, as average asset/liability duration stands C losing Targe t FY17F at 6/13 years with China Taiping’s and CPIC’s having the Stock Ticker Rating price Price PB Yield ROE widest duration mismatch. With China bond yields edging (RMB) (RMB) (X) (%) (%) Ping An - A 601318 CH BUY 64.1 75.4 2.6 1.3 17.8 upwards, China lifers’ book value is set to rise given the China Pacific - A 601601 CH BUY 42.1 47.4 2.7 2.1 11.1 negative duration gap. The expected rise in China bond yields China Life - A 601628 CH HOLD 31.0 28.1 2.7 1.2 9.6 will also alleviate life insurer’s pressure on reserves. P&C insurers suffering; online insurers a disruptive force: As A s of Oct-30, 2017 opposed to the consensus view where it expects the second Source: Thomson Reuters, DBS Vickers, Bloomberg Finance L.P. auto insurance pricing reform to have a neutral impact on P&Cs, we, however, expect the impact to be negative. The further pricing cut along with slower China auto sales will lead to fewer economy of scale which ultimately may result in a higher cost. Online insurers are also a potential disruptive force on the segment, given the homogenous product features. Players such as Zhong An (6060 HK, NR) and Ping An are likely to be the long term winners. Upgrading cycle intact. China insurers’ share price on average have risen 32% YTD, backed by a rise in interest rates and VNB growth. We expect the upgrading cycle to continue in FY18F, led by continuous value enhancement initiatives, and stronger earnings. We suggest that investors focus on insurers with better product mix, strong VBN growth outlook and stable investment position. Suggest to avoid P&Cs and Reinsurers due to deteriorating outlook, and competition. Top BUYs: China Taiping, CPIC, Ping An. Top SELLs: PICC P&C and China Re. ed-TH / sa- CW Industry Focus China Insurance Sector Table of Contents Investment summary 3 Multiple premium growth structure drivers ahead 4 Concentrated industry dynamics 9 Transforming into value growth 12 C-ROSS changing the industry landscape 12 Policy guidance favours protection type policy growth 14 Pressure of maintaining cost of liability “low” 16 Favourable portfolio adjustments continue 17 Value enhancement the next spotlight 19 Channel strength another key success factor: 23 P&C insurers remain under transition 25 Pure online insurers a potential disruptive force 28 An ecosystem-based growth model 31 Expanding into traditional life and P&C business 34 Ping An - Surfing on the “Fintech” wave 35 Favourable asset liability duration mismatch position 37 China Taiping, CPIC and Ping An are the main beneficiaries 38 Life insurance reserving pressure alleviating 41 750-day 10-year bond yield to trend upwards in 4Q17 43 China life insurers’ Embedded value on the rise 45 China policy update – No more universal Life riders 46 Premium sales to normalise in Hong Kong 49 Upgrading cycle to continue 52 Stock Profiles 61 Ping An Insurance (Group) Company (2318 HK / 601318 CH) 61 China Life Insurance Company Limited (2628 HK / 601628 CH) 67 China Taiping Insurance Holdings Company Limited (966 HK) 73 China Pacific Insurance (Group) Company Limited (2601 HK / 601601 CH) 79 AIA Group Limited (1299 HK) 85 Manulife Financial Corporation (945 HK) 108 The People's Insurance Company (Group) (1339 HK) 120 China Reinsurance (Group) Corporation (1508 HK) 126 PICC Property & Casualty Company Limited (2328 HK) 132 Page 2 Industry Focus China Insurance Sector Investment summary Favourable duration mismatch with less reserving pressure We initiate coverage on China insurance sector with a positive Lacking of domestic long-duration investable assets, China view. We see three major structural drivers ahead which will insurers are carrying a natural duration mismatch portfolio, as further drive both China life insurers’ premium and value average asset and liability duration standing at 6 and 13 years, growth in the long term. This will ultimately lead to further respectively, with China Taiping and CPIC running at the sector re-rating cycle, although China insurers' share prices on widest duration mismatch. Amid a rising interest environment, average have risen by 32% YTD. Structural drivers include a) this augurs well for China insurers to further grow their book China’s low insurance penetration with higher demand for values. In addition, as the 750-day 10-year government bond better healthcare plan and ageing population implies great yield is expected to start trending upwards from October 2017, premium growth upside, b) Launch of China Risk-Oriented this will also help to alleviate insurers’ reserving pressure, which Solvency System (C-ROSS) with policy directing towards on average had ate up 26-52% of China life insurers’ pre-tax protection-type products, providing significant VNB and EV profit during 2015 to 1H17. Earnings growth momentum is enhancement opportunity, and c) Rise in domestic interest rate expected to turn positive onward. China insurers are also accompanied by the 750-day 10-year China government bond considered more rate sensitive compared to China banks. yield, which is expected to trend upwards from October 2017, augur well for insurers’ natural duration mismatch portfolio P&C insurers still suffer. On-line insurers a disruptive force with less reserving pressure. On the other hand, given the launch of the auto insurance second pricing reform in July As oppose to the consensus view where market expects a 2017, we expect P&C insurers to continue to consolidate. neutral impact from the 2nd phase of auto insurance pricing reform, we however believe the influence should be more Trading at 1.1x P/EV versus past 5-year mean P/EV of 1.3x, we substantial. The further pricing cut coupled with the slowdown expect sector re-rating to continue. Our top BUYs are China in China new auto sales will lead to fewer premium growth Taiping, CPIC and Ping An, given their better underwriting and scale, which ultimately may result in higher combined ratio. portfolio mix, stronger value growth potential and lengthier In addition, with the strong growth potential from on-line negative duration gap. We also consider Ping An as China’s insurers, where on-line insurance segment is expected to leading Fintech innovator. Our top SELLs are PICC P&C and account for 24% of total insurance market by 2021F, up from China Re given deteriorating outlook and rising competition. 8% in 2016, we believe on-line insurers may also regard as a potential disruptive force to the P&C segment, given the Value enhancement the key spotlight homogenous product feature. Players including Zhong An (6060 HK, NR) and Ping An is likely the long-term winner. China’s insurance penetration stood at only 2.3%/1.8% for life /non-life segments respectively in 2016. Compared to Upgrading cycle to continue – BUY China Taiping, CPIC and developed countries whose penetration are at 5.1%/3.1% Ping An respectively, the level remains low. Coupled with rising demand for better healthcare and critical illness insurance China insurers’ share prices on average have risen 32% YTD coverage, and demographic shifting to an ageing population versus MSCI China of 46%, driven mainly by the rise in China whose ageing wallet remains low, China’s premium growth bond yield and strong VNB growth.