China's Life Insurance Sector Faces Significant Credit Quality Differentiation

China’s Life Insurance Sector Faces Significant Credit Quality Differentiation

A Credit Study on the Life Insurance Industry in China

November 18, 2020

ANALYSTS

Key Takeaways Ying Li, CFA, FRM Beijing − Our study of 35 of China's major life insurers reveals a wide divergence in credit quality +86-10-6516-6061 between the leading players and small and mid-sized ones. [email protected]

− A regulatory clampdown on short-term savings products since 2016 has pushed Xiaochen Luan, CFA, FRM Chinese life insurers to refocus on protection-type products and improve their product Beijing mix. This initiative has moderated premium growth in recent years but is positive for +86-10-6516-6069 [email protected] the long-term sustainability of the sector.

− We expect the life insurance sector to maintain a relatively stable credit outlook in the Zheng Li Beijing face of economic uncertainty caused by COVID-19. The effects of the pandemic have +86-10-6516-6067 mainly included a slowdown in top-line premium growth and heightened investment [email protected] return volatility. Nevertheless, we believe the strong capital and earning buffers of leading life insurers will protect their credit quality. Cong Cui Beijing +86-10-6516-6068 [email protected] Contents Xuefei Zou, CPA Overview ...... 2 Beijing +86-10-6516-6070 Industry Risk ...... 5 [email protected] Business Risk Profile ...... 10 Longtai Chen Capital & Earnings ...... 11 Beijing Risk Position ...... 16 +86-10-6516-6065 Financial Flexibility ...... 20 [email protected] Financial Risk Profile ...... 22 Yifu Wang, CFA, CPA Anchor ...... 23 Beijing +86-10-6516-6064 Stand-alone Credit Profile ...... 23 [email protected] External Support ...... 26 About This Article ...... 28 Appendix: Related Methodologies ...... 28

S&P Global (China) Ratings www.spgchinaratings.cn November 18, 2020 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Overview

This desktop analysis is based on S&P Global (China) Ratings Insurance Methodology. According to our insurance methodology, we typically determine the stand-alone credit quality based on our assessment of an institution’s anchor which is further adjusted with assessment of management and governance, liquidity and peer comparison. We typically arrive at the anchor by assessing the institution’s business risk profile (“BRP”) and financial risk profile (“FRP”). We then determine the issuer credit rating (“ICR”) based on the stand-alone credit profile (“SACP”) and our assessment of potential group or government influence. We have conducted a desktop analysis of 35 life insurance companies (including specialized health insurance companies), which together accounted for about 90% of premiums in the sector in 2019.

Chart 1 Insurance Methodology Framework of S&P Global (China) Ratings We determine the issuer credit rating of an insurer based on its stand-alone credit profile and our assessment of potential group or government influence.

Our study of 35 of China's major life insurers reveals a wide divergence in credit quality between the leading players and small and mid-sized ones. Leading insurance companies tend to enjoy stable market share and good profitability. Healthy sector-wide statistics may have obscured difficulties faced by smaller insurers. We consider that a tightening of regulations since 2017 has hit smaller insurers more than others, by largely removing their ability to grow their business through investment-type products. Larger companies generally enjoy advantageous economies of scale, while smaller insurers have struggled to achieve sufficient scale in recent years. A few small and mid-sized players have also faced difficulties in terms of regulatory compliance and corporate governance, leading to regulatory intervention.

S&P Global (China) Ratings www.spgchinaratings.cn 2 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 2

Distribution of Indicative Stand-alone Credit Quality of 35 Major Life Insurers in China 8 There is a wide divergence in stand- alone credit quality between leading

4 insurers and small and mid-sized ones. Number of Insurers of Number

Note 1: Our assessment of indicative stand-alone credit quality doesn’t consider the possibility of group or government support in times of stress. Note 2*: The indicative credit quality distributions expressed in this report are only our indicative views of credit quality derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for a few cases where we have already assigned public ratings on a company). The opinions expressed herein are not and should not be represented as a credit rating and should not be taken as an indication of a final credit rating of any particular institution. Source: S&P Global (China) Ratings. Copyright © by 2020 S&P Ratings (China) Co., Ltd. All rights reserved.

Government and group support are integral parts of our credit analysis of life insurers. About half of the life insurers we tested have higher indicative issuer credit quality than indicative stand-alone credit quality, due to their external support.

Chart 3 Distribution of Indicative Issuer Credit Quality of 35 Major Life Insurers in China

12 Government and group support are integral parts of our

6 credit analysis of life insurers. Number of Insurers of Number

Note 1: Our assessment of indicative issuer credit quality considers the possibility of group or government support in times of stress. Note 2*: The indicative credit quality distributions expressed in this report are only our indicative views of credit quality derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for a few cases where we have already assigned public ratings on a company). The opinions expressed herein are not and should not be represented as a credit rating and should not be taken as an indication of a final credit rating of any particular institution. Source: S&P Global (China) Ratings. Copyright © by 2020 S&P Ratings (China) Co., Ltd. All rights reserved.

Although the [Bspc] category in our desktop analysis covers about 1.7 trillion RMB in life insurance company assets, the financial obligations of these [Bspc] category companies were only about 59 billion RMB (around 28 billion RMB of which was in bonds) as of the end of 2019. We believe the low financial leverage level of life insurers significantly mitigates any potential credit risk shock on the capital market from low-quality small life insurers.

S&P Global (China) Ratings www.spgchinaratings.cn 3 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 4 Distribution of Indicative Issuer Credit Quality of 35 Major Life Insurers by Assets 8,000 The good credit quality of large life insurers underpins the overall stability of

4,000 the industry. il. Yuan) il. b (

0 [AAA]* Category [AA]* Category [A]* Category [BBB]* Category [BB]* Category [B]* Category Indicative Issuer Credit Quality

Note 1: Our assessment of indicative issuer credit quality considers the possibility of group or government support in times of stress. Note 2*: The indicative credit quality distributions expressed in this report are only our indicative views of credit quality derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for a few cases where we have already assigned public ratings on a company). The opinions expressed herein are not and should not be represented as a credit rating and should not be taken as an indication of a final credit rating of any particular institution. Note 3: Categories can be adjusted by “+” and “-” except for AAA. Source: S&P Global (China) Ratings. Copyright © by 2020 S&P Ratings (China) Co., Ltd. All rights reserved.

We expect the life insurance sector to maintain a relatively stable credit outlook in the face of economic uncertainty caused by COVID-19. The effects of COVID-19 mainly include a slowdown in top-line premium growth and investment portfolio return volatility. Nevertheless, we believe the strong capital and earning buffers of leading life insurers will protect their credit quality.

Table 1 Credit Outlook of Major Life Insurers in China for the Next 12 Months

Factors Outlook Key Views

We expect stable premium growth as life insurers have shifted to the traditional business of providing protection products under regulatory requirements, after a boom over the past decade driven by investment-type products. Business Stable Risk Profile COVID-19 has caused a slowdown in top-line premium growth. Less face-to- face contact for agent and bancassurance channels in the first half of the year was negative for new business origination. The effective control of the pandemic within China so far is positive for the business development of life insurers. The challenging macroeconomic environment from low interest rates and a Financial volatile capital market will weigh on profitability and asset quality, but most Stable Risk Profile life insurers have enough capital buffer and financial flexibility to maintain a healthy financial risk profile.

The leverage of Chinese life insurers remains low, leading to lower interest Liquidity Stable payment pressure.

Stand-alone We believe tight regulatory oversight over the insurance industry has helped Credit Stable stabilize the credit quality of Chinese insurers. Quality

We believe government support will remain available for leading life insurers. External Stable Support Government intervention for small and mid-sized life insurers with serious compliance breaches is credit-positive for the sector.

S&P Global (China) Ratings www.spgchinaratings.cn 4 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

We expect most banking and insurance groups to maintain stable credit profiles despite the pandemic, so their ability to provide support to their life insurance subsidiaries will probably remain stable.

We believe that large life insurers will remain stable due to their strong Issuer business franchise, healthy capital and stable government support. Credit Stable Quality Small and mid-sized players face more difficulties in the face of slowing premium growth and investment performance volatility.

Industry Risk

China is the world’s second largest insurance market in terms of gross premiums written, second only to the U.S. Within the wider insurance industry, life insurance dominates, with premiums of 3 trillion RMB in 2019, accounting for 69% of gross premiums written in the entire insurance sector. China had 89 registered life insurance companies with aggregated assets of 18.7 trillion RMB as of the end of 2019. We expect the number of life insurers in the market to remain relatively stable for the foreseeable future.

The Chinese government has taken steps to level the playing field for foreign insurers, loosening restrictions on foreign investors establishing life insurers in China. We believe this regulatory change will not have a significant impact on the short-term competitive landscape, as new players in the market would need time to develop distribution channels.

Chart 5 Number of Life Insurers in China China had 89 life 100 insurance companies as of the end of 2019, and we expect the number of players to 50 remain relatively stable in the Number of Insurers of Number foreseeable future.

We believe life insurance demand will remain strong, given China's growing affluence, greater public awareness of risk and continued urbanization. The positive trend for life insurance in China is reflected by insurance penetration and density. Insurance penetration considers the position of the sector relative to the overall national economy and is measured by percentage of premiums/GDP. Insurance density considers the sector’s importance relative to the population base of a country, measured by premiums/population. Generally speaking, the higher the penetration and density levels, the more developed the insurance sector is. Compared with developed countries, China still has a lot of room for growth in terms of insurance penetration and density.

S&P Global (China) Ratings www.spgchinaratings.cn 5 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 6 Estimated Insurance Penetration and Density of Major Countries/Regions in 2019

Life Insurance Density (USD per capita) Compared with 0 5,000 10,000 developed countries, Argentina China still has room Mexico for growth in terms of Brazil Saudi Arabia insurance Russia penetration and Turkey density. South Africa Indonesia India Mainland China Thailand Canada USA Greece Spain Germany France Netherlands UK Denmark Australia Singapore Japan South Korea Hong Kong SAR

0 10 20 Life Insurance Penetration (% of GDP)

Life Insurance Penetration Life Insurance Density

Source: Swiss Re Institute (https://www.swissre.com/institute/research/sigma-research/sigma-2020-04.html), collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

Chart 7 China’s Life Insurance Penetration and Density

2,000 4 We believe life insurance demand will remain strong, considering China's 1,000 2 (%) growing affluence, (Yuan) greater public awareness of risk and continued 0 0 urbanization. 2010 2011 2012 2013 2014 2015 2016 2017 2018 Insurance Density Insurance Penetration (Right Axis)

S&P Global (China) Ratings www.spgchinaratings.cn 6 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Since 2016, the regulator has been issuing a series of regulations to ensure that life insurers refocus on protection-type policies and stay away from excessive risk accumulation derived from investment-type policies. In our view, this regulatory initiative has moderated short-term premium growth, but is positive for the long-term sustainability of this sector.

Chart 8 Life Insurance Premium Growth YoY

80 Due to the decrease of investment-type 60 products in recent years, life insurers’ 40 premium growth (%) 20 moderated.

(20) 2015 2016 2017 2018 2019 2020Q3

Life insurance Health Insurance Accident Insurance

We believe the regulatory push for protection-type products can help consolidate the market position of top insurers which have strong distribution channels and competitive protection-type products. There has been an obvious slowdown in growth among small and mid-sized insurers which used to focus on selling short-term investment-type policies before the regulatory clampdown. This trend has been an important driver for credit quality differentiation in recent years.

In terms of distribution channels, many life insurers struggle to develop direct customer loyalty, as about 90% of premiums are sold through middlemen in the form of individual agents or bancassurance channels. According to the People’s Bank of China (PBOC), direct sales by life insurers accounted for only 8% of total premiums in 2018. Small and mid-sized life insurers typically rely heavily on bancassurance channels which are more effective in selling investment- type products, but less effective at selling protection-type products. Bancassurance channels contributed to 31% of total premiums written in 2018, down by 10 percent points YoY because of the regulatory clampdown on investment-type products.

China’s life insurance industry has a significant asset-liability duration gap, as its liabilities tend to be long-term and its investments are generally short-term. One reason for such a mismatch is the lack of long-term investment assets in the domestic capital market. We believe this mismatch will gradually narrow in the long term as China’s capital market becomes more sophisticated, generating more long-term investment opportunities.

In 2019, the life insurance sector achieved aggregate net income of 230 billion RMB. The sector’s return on equity (“ROE”) was about 16% in 2019. But the good profitability number on a sector-wide level disguises the wide divergency of earnings among life insurers. We believe this gap in earnings is mainly due to differences in operational scale.

S&P Global (China) Ratings www.spgchinaratings.cn 7 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

COVID-19 has caused a short-term slowdown for premium growth. The life insurance companies reported gross premiums of 2.6 trillion RMB in total for the first three quarters of this year, up by 7% YoY. The growth rate was down 6 percentage points YoY. As of the end of September 2020, the sector’s total assets increased to 19.1 trillion RMB, up by 12.6% compared to the end of 2019. But as China’s economy steadily recovers and measures to control the outbreak have been effective so far, we believe the negative pressure is controllable for the life insurance industry.

We believe the industry risk of China’s life insurance industry is intermediate. According to our methodology, industry risk is typically considered against a six-point scale, with “1” indicating the lowest risk and “6” indicating the highest risk. Currently, we believe China’s life insurance industry’s score is at “3”, reflecting the sector’s good growth potential, the focus on protection- type policies and tighter regulation, as well as the difficulties in developing proprietary distribution channels, the performance uncertainty of insurers’ investment portfolios and the asset-liability mismatch.

Competitive Position

We believe that a life insurer’s market share is one of the most important indicators of its competitive position. In addition to the absolute size of premiums, we also consider branding, stability of premium revenue, control of distribution channels, product risk and product diversification, among other factors.

Life insurance is a highly polarized market in China. The top 5 life insurers had 53% of the market in 2019 in terms of gross premiums written. The regulator’s move to refocus on protection products has increased the divergence of premium growth among insurers. Small and mid-sized players have struggled to develop attractive protection policies, leading to falling premiums as they attempt to wean off their over-reliance on investment-type products.

Chart 9 Distribution of Life Insurers’ Premium Market Share in 2019 China’s life insurance sector is 70 divided between a few large players,

urers around a dozen

35 mid-sized ones and dozens of

Number of Ins of Number small insurers.

0 <1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Market Share (%)

S&P Global (China) Ratings www.spgchinaratings.cn 8 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 10

Premium Market Share Breakdown of Life Insurance Industry in China 100 China’s small and mid-sized life insurers have lost market share after the regulatory

50 clampdown on investment-type products. Market Share of Life Insurers(%)

0 2014 2015 2016 2017 2018 2019 2020.06

China Life Insurance Ping An Life Insurance China Pacific Life Insurance China Taiping Life Insurance New China Life Insurance Others

Chart 11

YoY Growth Rate of Premiums in 2019 of Major Life Insurers in China

15 There has been great divergence in terms of growth 10 momentum among life insurers. 5 Number of Insurers of Number

In addition to market share, control over distribution channels is another important factor in our analysis of an insurer’s competitive position, because it has a direct bearing on the stability of premiums and overall profitability.

Another important aspect of our analysis of competitive position is product risk. in general, we view traditional protection products as less risky than investment products. As investment products may be embedded with an investment return guarantee feature, such products may create significant market risk exposure for the insurers. Thanks to the regulator’s clampdown on investment products, we believe the product risk has significantly reduced in recent years. Most of the insurance companies we tested now concentrate on protection products.

S&P Global (China) Ratings www.spgchinaratings.cn 9 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Our assessment of life insurers’ competitive position has a six-point scale, with “1” representing the strongest position and “6” the weakest.

Table 2 Competitive Position Assessment

Assessment What it typically means

An insurer's competitive strengths make it highly resilient to adverse operating 1 conditions. It has no material competitive weaknesses and has substantial business diversity.

An insurer's competitive strengths make it resilient to adverse operating conditions. It has 2 very few material competitive weaknesses and broad business diversity.

An insurer's competitive strengths outweigh its weaknesses and make it somewhat 3 resilient to adverse operating conditions.

An insurer's competitive strengths and weaknesses are balanced and make it somewhat 4 vulnerable to adverse operating conditions.

An insurer's competitive weaknesses somewhat outweigh its strengths and make it 5 vulnerable to adverse operating conditions.

An insurer's competitive weaknesses outweigh its strengths and make it highly vulnerable 6 to adverse operating conditions.

Business Risk Profile

We typically combine the industry risk and competitive position to arrive at an insurer’s BRP. Our assessment of BRP comprises of a six-point scale, with “1” indicating the lowest business risk and “6” indicating the highest. The following matrix demonstrates our general approach to combining industry risk and competitive position to arrive at BRP. According to table 3, when the industry risk is “3”, where the life insurance sector currently sits, life insurers’ BRPs are typically decided by their competitive position.

Table 3

Industry risk Competitive position 1 2 3 4 5 6 1 1 1 1 2 3 5 2 1 2 2 3 4 5 3 2 3 3 3 4 6 4 3 4 4 4 5 6 5 4 5 5 5 5 6 6 5 6 6 6 6 6

S&P Global (China) Ratings www.spgchinaratings.cn 10 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 12

Distribution of Indicative BRP Scores of 35 Major Life Insurers

20 Market share is one of the most important factors 10 in assessing life insurers’ BRP. Number of Insurers of Number

Note 1: For our testing purpose, we score the BRP of insurers in a scale of 1 to 6. 1 means the strongest BRP and 6 the weakest. Note 2: The indicative scores expressed in this report are our indicative views of risk factors derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for some institutions for which we have assigned ratings on). The opinions expressed herein are not and should not be represented as part of a credit rating. Source: S&P Global (China) Ratings. Copyright © by 2020 S&P Ratings (China) Co., Ltd. All rights reserved.

Table 4 Medians of Key Business Metrics in 2019 of 35 Life Insurers Tested

Total Assets as of Life Insurance Indicative Total Premium Return on Assets End of 2019 Premium Market BRP score (Billion RMB) (%) (Billion RMB) Share (%)

1 3,152 531 18 2 2 543 98 4.0 1 3 55 14 0.5 0.5 4 194 54 2 0.1 5 80 3 0.1 (0.03) Note: The indicative scores expressed in this report are our indicative views of risk factors derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for some institutions for which we have assigned ratings on). The opinions expressed herein are not and should not be represented as part of a credit rating. Source: Public information of companies, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

Capital & Earnings

Our assessment of life insurance companies’ FRPs is a combination of our considerations of capital and earnings, risk position and financial flexibility.

In our analysis of capital and earnings, we typically focus on an insurer's ability to absorb losses by considering its future capital adequacy. Our analysis of capital is primarily based on our expectations for an insurer’s regulatory solvency ratio over the next two years, which is typically our most important metric. During our assessment, we may look at both core solvency ratio and comprehensive solvency ratio. We typically use the former to be the primary driver considering that it contains high-quality core capital.

China’s life insurance industry has healthy regulatory solvency ratios. As of the end of the second quarter of 2020, the comprehensive solvency ratio and core solvency ratio of the life insurance industry were 236.4% and 226.6% respectively. The comprehensive solvency ratio is comfortably

S&P Global (China) Ratings www.spgchinaratings.cn 11 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020 above the minimum regulatory requirement of 100%. The strong capitalization provides a significant buffer against potential increases in asset risk and earnings volatility from current economic uncertainties.

Chart 13 Distribution of Reported Regulatory Comprehensive Solvency Ratio of Life Insurers as of End of 2019

25 Life insurance sector’s reported 20 comprehensive

15 solvency ratio is comfortably above 10 the regulatory Number of Insurers of Number 5 minimum of 100%.

Compared with the hybrid bonds issued by Chinese banks, the hybrid bonds issued by Chinese life insurers in the domestic market have more bond components than equity components. For example, the perpetual bonds issued by Chinese banks typically have three major clauses for absorbing losses when necessary, namely (1) subordination clause, (2) principal write- down/common equity conversion clause and (3) coupon cancellation clause. The tier-2 capital bonds issued by Chinese banks generally have two major clauses: (1) subordination clause and (2) principal write-down/common equity conversion clause. In contrast, the hybrid bonds issued by life insurers in the domestic market typically only have subordination clauses.

Chart 14 Domestic Hybrid Bonds Issued by Life Insurers in China

80 The life insurance sector’s issuance of hybrid bonds has 40 been restrained in recent years. Hybrid Bond Issurance (bil. Yuan) (bil. IssuranceHybrid Bond 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

S&P Global (China) Ratings www.spgchinaratings.cn 12 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

As a supplemental analysis of capital strength, we also assess an insurer’s profitability to evaluate its internal capacity for generating capital. We typically assess insurers’ return on assets and return on equity, and also consider stability of earnings.

In our opinion, the shift from investment products to protection ones will also improve the stability and quality of earnings. Investment products typically generate profits from spread difference, which involves relatively high market risk. In contrast, protection products enable insurers to earn an insurance margin. In addition, long-term protection products can generate recurring cash flow for insurers.

Investment returns are a very important source of profitability for life insurers. Low interest rates under the COVID-19 environment have forced life insurers to reinvest maturing assets at lower yields and may increase their appetite for higher risk assets to seek higher yields.

Chart 15 Insurance Sector’s Investment Return 8 5,000 The insurance sector’s investment return volatility has 4,000 been high, which is highly correlated with 5 the stock market 3,000 performance. CSI 300 Closing Index Investment Return (%) Return Investment

2 2,000

Insurance Sector's Annual Investment Return CSI 300 (Right Axis) Sources: CBIRC, STCN, Wind, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

Chart 16 Distribution of Net and Gross Investment Returns of Major Life Insurers in 2019

20 Overly high investment return may be viewed negatively because it 10 may indicate high risk in the investment Number of Insurers of Number portfolio.

0 1 2 3 4 5 6 7 8 Net Investment return (%) Gross Investment return (%)

Note: Net investment return doesn’t include any gain from fair value changes, which gross return includes. Source: Public information of companies, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

S&P Global (China) Ratings www.spgchinaratings.cn 13 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

In addition to investment returns, life insurers’ profitability is also sensitive to the discount rate they use for actuarial calculation. In 2018 and 2019, due to the increase of the 750-day moving average of 10-year treasury bonds, which is used as the discount rate for policy reserve purposes, reserve costs fell and profits were reported for this reason. In the first half of 2020, life insurers reported an increase in insurance contract reserves because of lower rates which dampened their profitability.

Chart 17 750-day Moving Average of 10-year Treasury Bond Yield Life insurers’ 5 profitability is sensitive to the discount rate they 4 use for actuarial

(%) calculation.

2 Jan-10 Dec-10 Nov-11 Oct-12 Sep-13 Aug-14 Jul-15 Jun-16 May-17 Apr-18 Mar-19 Feb-20

10-Year Treasury Bond 750-Day Moving Average of 10-Year Treasury Bond

Source: Wind, S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved. There is a wide divergence in profitability of life insurance companies. Large players enjoy good earnings, while smaller ones have much lower profitability and some of them are making a loss. According to PBOC, about 32% life insurers made a loss in 2019. In 2019, the top 10 life insurers accounted for about 95% of the total net income of the sector.

Chart 18 Distribution of Return on Equity of Major Life Insurers in 2019

30 There is wide earning divergency among life 20 insurers due to different operational scale and investment

umber of Insurers 10 performance. N

0 (20) (15) (10) (5) 0 5 10 15 20 >20 ROE (%)

S&P Global (China) Ratings www.spgchinaratings.cn 14 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

The earning pressure from COVID-19 has been mild so far for major listed life insurers. We believe their profitability will continue to come under pressure going forward due to low interest rates and higher volatility in the capital market.

Chart 19 Annualized ROE of Major Insurers

30 2019 2020Q1 2020Q2 2020Q3 The earning pressure from COVID-19 has been controllable for 15 major listed life insurers. Annualized ROE (%) ROE Annualized

0 PAG NCI CPIC China Life

Note: PAG – Ping An Insurance (Group) Company of China, Ltd., NCI – New China Life Insurance Company Ltd., CPIC – China Pacific Insurance (Group) Co., Ltd., China Life – China Life Insurance Company Limited Source: Public information of companies, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

Our capital & earnings scores range from “1” to “6”, with “1” indicating the strongest ability and “6” the weakest.

Table 5 Capital & Earnings Assessment

Score Description

1 Projected capital and earnings are much better than the industry average level.

2 Projected capital and earnings are above the industry average level.

3 Projected capital and earnings are consistent with the industry average level.

4 Projected capital and earnings are somehow below the industry average level.

Projected capital and earnings are below the industry average level, but we 5 determine there is no significant risk of breaching the minimum regulatory capital requirements.

6 Significant risk of breaching the minimum regulatory capital requirements.

S&P Global (China) Ratings www.spgchinaratings.cn 15 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 20 Distribution of Indicative Capital and Earnings Score of 35 Major Life Insurers Our capital analysis is 15 primarily based on our expectations for an insurer’s 10 regulatory solvency ratios over next two years. 5 Number of Insurers of Number

Note 1: For our testing purpose, we score the capital and earnings profile of insurers on a scale of 1 to 6. 1 means the strongest capital and earnings and 6 the weakest. Note 2: The indicative scores expressed in this report are our indicative views of risk factors derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for some institutions for which we have assigned ratings on). The opinions expressed herein are not and should not be represented as part of a credit rating. Source: S&P Global (China) Ratings. Copyright © by 2020 S&P Ratings (China) Co., Ltd. All rights reserved.

Risk Position

Our risk position analysis typically considers the material risks not incorporated into our analysis of capital and earnings, as well as specific risks captured by our capital and earnings analysis that may make an insurer’s capital more or less volatile. This may include factors such as risk management, investment portfolio quality/leverage and risk concentration, amongst other factors.

When we assess an insurers’ risk position, we consider the regulatory risk ratings conducted by CBIRC as an important factor. According to CBIRC’s risk assessment, the majority of life insurers have satisfactory risk management, but there are still a few high-risk institutions. As of the end of March 2020, among the 178 insurance companies under CBIRC’s regular review, 102 and 72 were classified as Type A and Type B respectively. 3 of them were classified as Type C insurers and 1 was classified as Type D (A is the best and D is the worst).

Investment risk is another key consideration when assessing risk position, because it decides the overall asset quality of an insurer. In today’s low interest rate environment, we believe insurers may increase their exposure to higher risk assets (such as alternative investment products) in order to achieve a good return. Life insurers have demonstrated different approaches to investment, leading to diverging market risk and credit risk exposures.

S&P Global (China) Ratings www.spgchinaratings.cn 16 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 21 Breakdown of the Average Investment Portfolio of China’s Insurance Industry

100% Insurers increased their alternative investment exposure in 2017.

50% Structure of Insurers' Investment Portfolio Investment Insurers' of Structure 0% 2013 2014 2015 2016 2017 2018 2019 2020.6

Bank Deposits Bond Investments Equity Investments Other Investments

Chart 22 Distribution of Ratio of Cash & Deposits/Total Investment Portfolio as of End of 2019 of Major Life Insurers The ratio of cash & 15 deposits/total investment portfolio of life insurers ranges

10 from 2% to 40%.

5 Number of Insurers of Number

0 <5 10 15 20 25 30 >30 Cash & Bank Deposits /Total Investment (%)

We expect more volatility in the investment returns of insurance companies as uncertainty over economic growth and the pandemic increases turbulence in the capital market. The investment return of life insurers is highly sensitive to stock and bond market performance.

S&P Global (China) Ratings www.spgchinaratings.cn 17 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 23 Distribution of Ratio of Bond/Total Investment Portfolio as of End of 2019 of Major Life Insurers

9 The ratio of

ers bond/total 6 investment portfolio of life insurers has 3 wide divergence. Number of Insur of Number

0 <5 10 15 20 25 30 35 40 45 50 55 >55 Bond/Total Investment (%)

Chart 24 Distribution of Ratios of Equity/Total Investment Portfolio as of End of 2019 of Major Life Insurers 9 Life insurers also diverge widely in ers 6 terms of equity investment exposure.

3 Number of Insur of Number

0 <5 10 15 20 25 30 35 40 >45 Equity/Total Investment (%)

Note: The equity investment includes both long-term equity investment and other equity holdings. Source: Public Information of companies, S&P Global (China) Ratings Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

Chart 25

Stock Market Movement 5000 4000 COVID-19 has increased the volatility of the stock market.

4000 3000 CSI 300 Closing Index S&P 500 Closing Index

3000 2000 2019-01 2019-04 2019-07 2019-10 2020-01 2020-04 2020-07 2020-10 CSI300 S&P 500 (Right Axis)

S&P Global (China) Ratings www.spgchinaratings.cn 18 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

In addition to market risk, COVID-19 has also increased pressure on credit risk in life insurers’ fixed- income portfolios. Bond defaults were already increasing in recent years before COVID-19. We also expect higher credit risk for non-standard fixed-income product investments. Nevertheless, supportive fiscal and monetary policies and the steady economic recovery in the second and third quarters of 2020 in China have softened the bond default pressure to some degree.

Chart 26 Defaults in China's Domestic Bond Market 120 90 The default risk has risen significantly in China’s bond market since 2018. 60

60 Number of Issues of Number

Amount (bil. Yuan) (bil. Amount 30

0 0

Outstanding Amount at Default Outstanding Issues at Default (Right Axis)

China’s government has been channeling insurers’ investment into sectors and projects that are of strategic importance to the state. For example, insurance companies are encouraged to buy asset management products issued by bank-affiliated asset investment companies which specialize in debt-to-equity swaps. The regulator has also loosened investment restrictions on bank hybrid bonds. We believe uncertainty over such investments is more or less compensated by government support for these sectors and projects.

In recent years, the regulator also moved to prevent life insurers from overly aggressive investment in domestic stock markets and overseas markets. Before 2017, there were several high-profile cases of life insurers making high-risk investments in the stock market with the intention of acquiring and controlling public companies or conducting large-scale overseas acquisitions. Such investment strategies have been stopped by the regulator and we believe this regulatory intervention has improved the overall robustness of insurance companies.

Risk position scores range from “1” to “5”, with “1” indicating the lowest risk and “5” indicating the highest risk. A score of “3”, “4”, or “5” may lead to a negative adjustment to the FRP score.

S&P Global (China) Ratings www.spgchinaratings.cn 19 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 27 Distribution of Indicative Risk Position Score of 35 Major Life Insurers

30 One main differentiating factor in risk position is the insurer’s risk appetite 15 in its investment strategy. Number of Insurers of Number

Note 1: For our testing purpose, we score the risk position of insurers in a scale of 1 to 5. 1 means the strongest risk position and 5 means the weakest. Note 2: The indicative scores expressed in this report are our indicative views of risk factors derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for some institutions for which we have assigned ratings on). The opinions expressed herein are not and should not be represented as part of a credit rating. Source: S&P Global (China) Ratings. Copyright © by 2020 S&P Ratings (China) Co., Ltd. All rights reserved. Financial Flexibility

We also consider the risks posed by an insurer’s use of financial leverage and having a significant number of intangibles on its balance sheet. A company with high leverage and a low fixed-charge coverage ratio is likely to have less capacity and flexibility to withstand a stress scenario. We assess an insurer's financial flexibility as “neutral”, “moderately negative”, or “negative”. We assess an insurer's financial flexibility as “moderately negative” when we determine that the use of leverage materially increases the insurer's risk. If we believe this risk is significantly higher, we assess an insurer's financial flexibility as “negative”. Otherwise, the assessment is “neutral”.

Typically, we use an insurer’s financial leverage ratio, fixed-charge coverage ratio and financial obligations to EBITDA ratio to evaluate its debt burden and interest payment capability. We also take into consideration its funding plan, financial management strategy and funding ability, etc.

Chart 28 Distribution of Financial Leverage Ratio as of End of 2019 of Major Life Insurers 15 We typically view having a financial

10 leverage ratio higher than 40% negatively.

5 Number of Insurers of Number

0 0 10 20 30 40 50 >50 Financial Leverage (%) Note 1: Financial leverage Ratio = (Short-term debt + Long-term debt + Bonds payable (incl. Hybrid bonds) + Preferred shares) / (Short-term debt + Long-term debt +Bonds payable (incl. Hybrid bonds) + Total equity) *100% Note 2: When the financial leverage ratio is zero, it means the life insurer has no debts, which is viewed positively. Source: Public information of companies, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

S&P Global (China) Ratings www.spgchinaratings.cn 20 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 29 Distribution of Ratio of Fixed-charge Coverage in 2019 of Major Life Insurers

10 We typically view a fixed-charge coverage of less than 5 4X negatively.

Number of Insurers of Number

0 <0 4 10 50 100 200 >200 N.M. Fixed-charge Coverage (X)

Note 1: Fixed-charge coverage = EBITDA / Interested expense related to bonds payable Note 2: N.M.-not meaningful. When this ratio is not meaningful, it means there is no financial obligations requiring interest payment, which is viewed positively. When the coverage is negative, it means the company has negative EBITDA, which is viewed negatively. Source: Public information of companies, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

Chart 30 Distribution of Ratio of Financial obligations to EBITDA in 2019 of Major Life Insurers

15 We typically view a financial 10 obligations/EBITDA ratio larger than 4X negatively. 5 Number of Insurers of Number

0 <0 0 1 2 3 4 >4

Financial Obligations/EBITDA (X)

Note: When this ratio is zero, it means it has no financial obligations, which is viewed positively; when this ratio is negative, it means EBITDA is negative, which is viewed negatively. Source: Public information of companies, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

Bonds issued by Chinese life insurers in the domestic market are typically hybrid bonds. The very limited use of bond markets for funding helps maintain good financial flexibility in this sector. According to our desktop analysis of 35 life insurers, about 75% of them are viewed as having “neutral” financial flexibility, 17% as “moderately negative”, and the remaining 8% as “negative”. When the assessment is “moderately negative” or “negative”, it has a negative impact on the final FRP score.

S&P Global (China) Ratings www.spgchinaratings.cn 21 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Financial Risk Profile

After we complete our assessment of risk position and financial flexibility, we adjust an insurer’s capital and earnings score based on these two factors before arriving at its FRP. We assess FRP on a six-point scale, with “1” indicating the lowest financial risk and “6” the highest financial risk. When the risk position assessment has a score higher than “2”, this typically leads to a negative adjustment to the capital and earnings score. When the assessment of financial flexibility is “moderately negative” or “negative”, it typically leads to a negative adjustment to the capital and earnings score.

Chart 31

Distribution of Indicative FRP Scores of 35 Major Life Insurers

15 Life insurers have divergent financial 10 risk profiles.

5 Number of Insurers of Number

Note 1: For our testing purpose, we score the FRP of insurers on a scale of 1 to 6. 1 means the strongest FRP and 6 the weakest. Note 2: The indicative scores expressed in this report are our indicative views of risk factors derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for some institutions for which we have assigned ratings on). The opinions expressed herein are not and should not be represented as part of a credit rating. Source: S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

Table 6 Medians of Key Financial Ratios as of End of 2019 of 35 Major Life Insurers Tested

% of bonds in Indicative Core solvency ratio Net investment ROE in 2019 (%) investment FRP score (%) return in 2019 (%) portfolio

1 249 19.4 4.8 41

2 198 8.4 5.0 36

3 144 0.6 4.9 31

4 132 5.2 5.2 26

5 129 6.2 6.7 16

6 103 4.8 4.8 16

Note : The indicative scores expressed in this report are our indicative views of risk factors derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for some institutions for which we have assigned ratings on). The opinions expressed herein are not and should not be represented as part of a credit rating. Source: Public information of companies, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

S&P Global (China) Ratings www.spgchinaratings.cn 22 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Anchor

Typically, an insurance company's BRP and FRP assessments are combined to determine its anchor. For example, for an insurer with its BRP and FRP both assessed as “1”, its SACP tends to indicate very strong credit quality, such as “aaa”/“aa+” quality. For an insurer with BRP and FRP both assessed as “6”, its SACP tends to indicate very low credit quality, such as “b-” quality.

Table 7 Determining the Anchor

Anchor Financial Risk Profile (FRP)

1 2 3 4 5 6

1 aaa/aa+ aa+/aa aa-/a+ a/a- bbb bb+

Business 2 aa+/aa aa-/a+ a/a- bbb+ bbb- bb Risk 3 a+/a a/a- bbb+ bbb bb+ bb- Profile (BRP) 4 bbb+ bbb bbb- bb+ bb- b+

5 bb+ bb+ bb bb- b+ b

6 bb- bb- bb- b+ b b-

Stand-alone Credit Profile

The SACP is typically derived from considering both the anchor and other assessments such as management considerations, liquidity analysis and holistic assessment. We may arrive at an SACP that is higher, lower or the same as the anchor after considering these factors. For example, an insurer’s SACP may be higher than the anchor if there are significant positive factors that have not been captured in our BRP and FRP analysis. An insurer’s SACP may be lower than its anchor if its liquidity position is weak and/or it has weak management and governance.

Our analysis of management and governance typically considers strategic competence, operational effectiveness, financial management and governance practices, and how they shape the insurer's competitiveness in the marketplace.

We typically assess an insurer's governance as “neutral”, “moderately negative” or “negative”. When the assessment is “moderately negative” or “negative”, we generally make a downward adjustment to the anchor. We believe that most of the major life insurers we tested have a “neutral” management and governance profile. Only five of them are assessed as “moderately negative”.

Table 8 Management and Governance Assessment

Descriptor What it typically means

Neutral The assessment result is not negative or moderately negative.

We assess management and governance as moderately negative when we Moderately negative identify some material shortcomings in an organization's management and governance structures.

S&P Global (China) Ratings www.spgchinaratings.cn 23 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

We assess management and governance as negative when we consider governance structures as posing a severe risk to an insurer. A governance Negative deficiency is severe when it has the potential to impair an enterprise's ability to execute strategy or manage its risks.

We believe the overall corporate governance of life insurers is improving thanks to regulatory intervention. CBIRC has strengthened its efforts to improve insurance companies’ corporate governance in recent years. In early 2018, the regulator put into effect Measures for the Management of Insurance Company Equity, which intend to prevent shareholders from imposing inappropriate influence on the operations of insurers. Under the Measures, related-party transactions with shareholders have also been put under more stringent scrutiny. In August 2020, the CBIRC issued a three-year plan (2020-2022) for improving corporate governance of the insurance industry.

Our liquidity analysis typically centers on an insurer's ability to cover its liquidity needs, both on an ongoing basis and in stressful market and economic conditions. The analysis is absolute, rather than relative to peers.

We assess an insurer's liquidity on a scale of “1” to “4”, where “1” is the strongest, “4” is the weakest. The two strongest assessments (“1” and “2”) do not affect an insurer's SACP, while the two weaker assessments (“3” and “4”) typically lead to a downward adjustment to the anchor.

Table 9 Liquidity Assessment

Descriptor What it typically means

There are no material liquidity risks and the liquidity ratio under stress is very 1/Exceptional favorable.

2/Adequate There are no material liquidity risks.

3/Less than adequate There are factors that raise concerns over liquidity.

There is a severe risk to the insurer's liquidity. The insurer may be unable to 4/Weak entirely service all its financial and policyholder obligations in a timely manner over the next 12 months.

We believe the liquidity profiles of life insurers in China diverge thanks to differences in how their investment portfolios are set up. We use liquidity ratio under a stressed scenario to assess the extent to which an insurer can cover its short-term debt and stressed insurance liability outflows over a one-year period with backup facilities and by converting assets to cash on a stressed basis. According to our preliminary desktop analysis of 35 major life insurers in China, the majority have healthy liquidity even under a stressed scenario, and only a few small and mid-sized ones may have liquidity challenges in times of stress due to them having a higher proportion of illiquid investments.

S&P Global (China) Ratings www.spgchinaratings.cn 24 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 32 Distribution of Liquidity Ratio in Stress Scenario of Major Life Insurers

12 We typically view a liquidity ratio under a stressed scenario lower than 1X as less 6 than adequate. Number of Insurers of Number

0 <0.50 1.00 1.25 1.50 1.75 2.00 2.50 >2.50 Liquidity Ratio in Stress Scenario (X)

BRP Score 1 BRP Score 2 BRP Score 3 BRP Score 4 BRP Score 5

Note 1: Liquidity Ratio in Stress Scenario= (Stressed liquid assets + backup facilities)/(Stressed insurance liability outflows + short term debt). The stressed liquid assets are subject to haircuts based on our assessment of the credit and liquidity risk of different assets. Typically, deposit has the smallest haircut while equity investment has a large haircut. Note 2: In this testing, because we do not have detailed information on back-up facilities, we typically assume back-up facilities as zero. Therefore, we believe the actual liquidity ratios of some insurers may be better than our conservative estimations here. Source: Public information of companies, collected and adjusted by S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

In order to achieve decent investment returns in a low interest rate environment, some life insurers may increase their investment in illiquid assets to boost investment returns. This may increase their liquidity pressure.

The surrender rate is an important factor affecting the liquidity of life insurers. According to PBOC, the life insurers’ average surrender rate was 4.97% in 2019, down by 1.86 percentage points YoY. Nevertheless, combined with moderated premium growth, surrender rate pressure may weigh on liquidity management for some small and mid-sized insurance companies.

Chart 33 Surrender Rate of the Life Insurance Sector in China

8 An increasing surrender rate may weigh on the liquidity management of some small life insurers. 4 (%)

0 2012 2013 2014 2015 2016 2017 2018 2019

Surrender Rate of Life Insurers in China

S&P Global (China) Ratings www.spgchinaratings.cn 25 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Chart 34 Distribution of Indicative Liquidity Assessment Scores of 35 Major Life Insurers 30 The majority of life insurers we tested have good liquidity 20 even in a stressed scenario.

10 Number of Insurers of Number

0 1/Exceptional 2/Adequate 3/Less than adequate 4/Weak

Note: The indicative scores expressed in this report are our indicative views of risk factors derived from a desktop analysis based on public information without interactive review with any particular institution or the full credit rating process such as a rating committee (except for some institutions for which we have assigned ratings on). The opinions expressed herein are not and should not be represented as part of a credit rating. Source: S&P Global (China) Ratings. Copyright ©2020 by S&P Ratings (China) Co., Ltd. All rights reserved

In addition to management and liquidity considerations, we may also make adjustments to capture a more holistic view of creditworthiness. Our holistic adjustment incorporates additional credit factors, as well as existing credit factors not fully captured that may be informed by peer analysis. Typically, we use the following table to make adjustments to the anchor to arrive at the final SACP based on our governance assessment, liquidity assessment and holistic adjustment.

Table 10 How we decide SACP

Anchor (aaa to b-) Typical Notching

Governance

- Neutral 0 notch

- Moderately negative -1 notch

- Negative -2 or more notches

Liquidity

-1/Exceptional 0 notch

-2/Adequate 0 notch

- 3/Less than adequate -1

- 4/Weak -2 or more notches

Holistic Adjustment Positive, negative or no adjustment

External Support

We believe insurance companies pose much less systemic risk compared to banks, thus government intervention and support may be less intense for life insurers. In international markets, most insurers weathered the 2008 financial crisis well, causing the Financial Stability

S&P Global (China) Ratings www.spgchinaratings.cn 26 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

Board to conclude that the traditional insurance model is not systemically risky. China’s life insurance regulator has a track record of taking over life insurers with serious compliance infractions, which helps maintain the overall stability and health of the life insurance sector and serves as a deterrence for other insurance companies in terms of compliance. In 2018, the regulator took over Anbang Life Insurance, and in 2020, it took over Tianan Life Insurance and Huaxia Life Insurance.

Compared with the banking sector where government support may be likely for small institutions, we typically expect much less government support for small privately-owned life insurers. Banks have significant exposure to each other, and contagion risk is high when a small or mid-sized bank fails. In contrast, small life insurers have much less contagion risk because their leverage is typically low, and the capital market typically has very limited exposure to them. In addition, the failure of a small insurer typically would not affect other insurers because of the lack of counterparty exposure between insurance companies. While the Baoshang Bank takeover caused a noticeable market shock and increased funding costs for small and mid-sized banks in general, the takeover of Anbang Life Insurance, Huaxia Life Insurance and Tianan Life Insurance in recent years didn’t cause any significant negative impact on the capital market or the operations of other insurance companies.

Chart 35 Asset Sizes of Different Financial Sectors as of End of 2019

Insurance Companies, 6%

Securities Firms, 3% The insurance sector is much smaller than the banking sector in China.

Banking and Related Financial Institutions, 91%

Although life insurance policies may have a significant impact on the wellbeing of the general public, there is a well-established mechanism in place in China to ensure that those policies remain effective for policyholders when a small life insurer goes bankrupt. Therefore, in our opinion, the government may not have a strong incentive to bail out small private life insurers. According to China’s Insurance Law, when a life insurance company goes bankrupt, it must assign its life insurance contracts and liability reserve funds to another insurance company. If it cannot reach an agreement with another insurance company, the insurance regulator shall designate an insurance company to take over those insurance policies.

The China Insurance Security Fund (CISF) is another mechanism available to protect policyholders’ interests. This fund was created in 2008 and raises money through mandatory contributions from insurance companies based on their premium income. The fund reported 146 billion RMB in its coffers as of the end of 2019, 54 billion RMB of which was in the life insurance security fund. The CISF will provide full coverage for policyholder’s losses within 50,000 RMB. For individual

S&P Global (China) Ratings www.spgchinaratings.cn 27 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020 policyholders, any additional loss exceeding 50,000 RMB will be covered by 90% by the CISF; for institutional policyholders, the CISF will cover 80% of additional losses.

We believe China’s state-owned leading life insurers are likely to receive support from the central government given their important role in providing insurance protection to the public and close ties with the government. As the Chinese population ages, the insurance industry is playing an important role in terms of social welfare and healthcare. In addition, insurers are also important institutional investors in the capital market. Because insurers typically have a long-term investment horizon and hold investments to maturity, they can act as a shock absorber in financial markets and provide important funding to the real economy.

In addition to government support, we also consider possible group support in times of stress. Among the 35 life insurers we tested, we believe that most are likely to receive support from their groups, particularly insurance groups or banking groups.

Typically, we use a five-point scale to assess the importance level of a life insurer to its parent group / government. Generally speaking, our approach to assess the support of life insurers is consistent with our approaches for banks and other financial institutions. In rare cases, group influence may be negative instead of positive, if the group has high default risk and we believe that the group’s low credit quality may have a material impact on the credit quality of its life insurance subsidiary.

Chart 36 Demonstration of Support Assessment Framework

Typically, we use a five-point scale to assess the importance level of a life insurer to its parent group.

Appendix: Related Methodologies

− S&P Global (China) Ratings--Insurance Methodology − Commentary: Understanding S&P Global (China) Ratings Insurance Methodology.

S&P Global (China) Ratings www.spgchinaratings.cn 28 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

About This Article

S&P Ratings (China) Co., Ltd. (S&P China) has conducted a desktop analysis of a selection of 35 major life insurance companies in China. We have chosen these institutions based on their asset size, representativeness of the life insurance industry and availability of public information. The analysis contained herein has been performed using S&P China methodologies for insurance companies. S&P China methodologies and analytical approaches are intended specifically for use in China only and are distinct from that used by S&P Global Ratings. An S&P China opinion must not be equated with or represented as an opinion by S&P Global Ratings or relied upon as an S&P Global Ratings opinion.

This desktop analysis has been conducted using publicly available information only, and is based on S&P China’s methodology for insurance companies and our understanding of the life insurance industry in China as well as our understanding of the institutions themselves. The analysis involves applying our methodology to public information to arrive at a potential view of credit quality across the life insurance sector. It is important to note that the opinions expressed in this report are based on public information and are not based on any interactive rating exercise with any particular institution. The opinions expressed herein are not and should not be represented as a credit rating and should not be taken as an indication of a final credit rating of any particular institution, but are initial insights of potential credit quality based on the analysis conducted. This desktop analysis does not involve any surveillance. The opinions expressed herein are not and should not be viewed as recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security.

We have conducted this desktop analysis on individual institutions and present the results contained herein at an aggregate group level. The different sections of this research show the statistics and performance of different groups of institutions and the market more broadly against the metrics we generally consider most relevant under our methodology.

Given the desktop nature of this analysis, and that we have not conducted an interactive review with those institutions, we may have made certain assumptions in lieu of confirmed information and where relevant we may also have attempted to consider any possibility of parent, group, government or other forms of potential support, to inform our view of potential credit quality. S&P China is not responsible for any losses caused by reliance on the content of this desktop analysis.

This report does not constitute a rating action.

S&P Global (China) Ratings www.spgchinaratings.cn 29 China’s Life Insurance Sector Faces Significant Credit Quality Differentiation November 18, 2020

This document is prepared in both English and Chinese. The English translation is for reference only, and the Chinese version will prevail in the event of any inconsistency between the English version and the Chinese version.

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