Global Research 20 June 2016
China Reinsurance (Group) Corporation Equities
Further growth potential to be unleashed China Insurance, Full-Line
12-month rating Buy Well-positioned to capture structural growth potential China Reinsurance (China Re) is trading at 0.8x 2016E P/BV, compared to a 0.9x 12m price target HK$2.60 average for global reinsurance peers and 1.3x for primary property & casualty (P&C) Prior: HK$3.37 companies. Considering the large contributions from auto insurance and life Price HK$1.74 reinsurance, we believe China Re has a lower risk profile and thus deserves to trade at a premium over its global reinsurance peers. We think current valuation does not factor RIC: 1508.HK BBG: 1508 HK in the company’s premium growth potential under China's low cession rate and Trading data and key metrics support from the country’s new solvency system. With its strong pricing model and 52-wk range HK$2.75-0.00 extensive industry/client data, we believe China Re has a competitive advantage in risk Market cap. HK$11.6bn/US$1.50bn pricing and profitability. We reiterate our Buy rating. Shares o/s 6,679m (ORD) New solvency regime to further open up the reinsurance market Free float 43% Under China’s new solvency regime, China Risk Oriented Solvency System (C-ROSS), we Avg. daily volume ('000) 14,289 believe the primary insurance industry’s product mix will change and premiums will be Avg. daily value (m) HK$26.8 ceded to reinsurers. In the long term, we expect China Re to benefit from increasing Common s/h equity (12/16E) Rmb75.2bn demand for risk transfer and diversification from non-motor P&C products and P/BV (12/16E) 0.8x protection-type life products. C-ROSS encourages the use of onshore reinsurance, EPS (UBS, diluted) (Rmb) which we think also favours China Re. As China’s insurance market moves into a new From To % ch Cons. era of risk-based pricing, we expect China Re to have a competitive advantage over 12/16E 0.22 0.15 -34 0.16 primary insurers and to improve capital returns and efficiency. 12/17E 0.24 0.17 -29 0.19 12/18E 0.27 0.21 -23 0.20 We cut 2016/2017/2018E NPAT by 33.9%/29.4%/22.8% We lower our 2016/2017/2018 NPAT estimates, as we cut: 1) our investment yield Bob Leung assumptions to 4.3%/4.3%/4.3% to reflect our conservative market outlook; and 2) Analyst [email protected] our gross written premium (GWP) growth forecasts for China Property and Casualty +852-2971 5502 Reinsurance (China Re P&C) from 13.5%/11.2%/10.3% to 6.1%/13.2%/13.1%, due to weak auto reinsurance premium growth. However, we expect China Re P&C to Judy Chen Associate Analyst deliver a better combined ratio of 98.0%/98.0%/97.5% in 2016/2017/2018. Our NPAT [email protected] changes also reflect the increase in our primary P&C GWP growth assumptions from +852-2971 8904 13.3%/11.8%/11.0% to 19.1%/17.5%/17.1%, as China Continent is active in gaining market share. We cut our 2016/2017/2018 EPS estimates from Rmb0.22/Rmb0.24/Rmb0.27 to Rmb0.15/Rmb0.17/Rmb0.21. Valuation: cut price target from HK$3.37 to HK$2.60 We lower our SOTP-based price target by 23%, from HK$3.37 to HK$2.60, as we forecast lower investment income. Our PT implies 1.32x 2016E P/BV (previously 1.44x).
Highlights (Rmb) 12/13 12/14 12/15 12/16E 12/17E 12/18E 12/19E 12/20E EPS (local GAAP, diluted) 0.09 0.15 0.20 0.15 0.17 0.21 0.24 0.29 EPS (UBS, diluted) 0.09 0.15 0.20 0.15 0.17 0.21 0.24 0.29 Emb value EPS (UBS) - 0.07 0.07 0.05 0.06 0.06 0.07 0.09 Emb value per share (UBS) - 1.56 1.74 1.80 1.92 2.06 2.21 2.38 DPS (Rmb) 0.00 0.01 0.00 0.03 0.03 0.04 0.05 0.06 TNAV per share (UBS) 1.24 1.48 1.65 1.77 1.91 2.07 2.27 2.50
Profitability/valuation 12/13 12/14 12/15 12/16E 12/17E 12/18E 12/19E 12/20E P/E (local GAAP, diluted) x - - - 10.1 8.6 7.1 6.1 5.1 P/Emb value EPS (UBS) x - - - 30.1 26.2 22.7 19.8 17.2 P/EV per share (UBS) x - - - 0.8 0.8 0.7 0.7 0.6 RoEV (UBS) % - 4.3 3.3 2.7 2.9 3.1 3.4 3.6 Return on TNAV (UBS) % 7.6 10.9 12.2 8.6 9.4 10.4 11.1 12.1 Net dividend yield % - - - 2.0 2.3 2.8 3.3 3.9 Source: Company accounts, Thomson Reuters, UBS estimates. Metrics marked as (UBS) have had analyst adjustments applied. Valuations: based on an average share price that year, (E): based on a share price of HK$1.74 on 17 Jun 2016 22:38 HKT
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This report has been prepared by UBS Securities Asia Limited. ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 21. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
China Re Buy (HK$2.60 price target)
OUR THESIS IN PICTURES UBS Research THESIS MAP a guide to our thinking and what's where in this report
PIVOTAL QUESTIONS Q: Will China Re's premium growth be sustained above 15% in the next three years? Likely. Continued product reforms, price deregulation and new risk insurance launches (such as public liability and health insurance products) in China will significantly boost risk transfer and diversification of primary insurers, in our view. We forecast a 16.4% GWP CAGR for China Re over 2016-18. more Q: Will China Re see combined ratio improvement in 2016-17? Likely. Excluding the impact of Tianjin explosions, we forecast China Re P&C's 2016 combined ratio (COR) to improve by 90bps YoY to 98.0% and China Continent's COR to improve by 2.3ppts YoY to 99.0%. more Q: Will China Re remain profitable under intensified competition? Likely. We believe China Re's extensive industry/client data is difficult to replicate, as it has been in the market longer than any competitors. We also think the database supports a more accurate pricing model, allowing the company to stay ahead of its peers in risk pricing and product development. more
UBS VIEW Considering the large contributions from auto insurance and life reinsurance, we believe China Re has a lower risk profile and thus deserves to trade at a premium over its global reinsurance peers. As China’s insurance market moves into a new era of risk-based pricing, we expect China Re to have a competitive advantage over primary insurers and to improve capital returns and efficiency. We forecast a 16.4% GWP CAGR for 2016-18 and have a Buy rating.
EVIDENCE China Re P&C's COR was 98.9% in 2015 (+0.9% YoY) and China Continent's COR was 101.3% in 2015 (+1.5% YoY). While we await more disclosure on actual Tianjin losses, we estimate that excluding the impact of Tianjin explosions, CORs of China Re P&C and China Continent should reach 98.0-98.5% and 99.1-99.3%, respectively, in 2015.
WHAT'S PRICED IN? As China Re is the only listed reinsurance group in China, we believe listed financial groups and global large-cap P&C and reinsurance companies are its comparable peers. The stock is trading at 0.8x 2016E P/BV (global reinsurance peers are at 0.9x and primary P&C companies are at 1.3x). We believe China Re has a lower risk profile and thus deserves a valuation premium... more
UPSIDE / DOWNSIDE 1508.HK Price HK$1.74 BVPS (Rmb) P/BV Upside to Downside SPECTRUM 2016e Implied 6 to 1 3.50 3.00 +73% 2.50 3.01 = 1.93 x 1.3x Upside: 2.60 = 1.77 x 1.2x Price Target: +49% 2.00 1.50 1.52 = 1.66 x 0.8x Downside: -13% 1.00
0.50 17 Jun +12 mo. 0.00
2014 2015 2016 2017
Value drivers P&C Re GWP P&C Re average Primary P&C Primary P&C (2016-18E) CAGR combined ratio GWP CAGR average COR HK$3.01 upside 13% 96.5% 24% 98.0% HK$2.60 base 11% 97.8% 18% 98.5% HK$1.52 downside 4% 99.2% 11% 100.0% Source: UBS estimates more
COMPANY DESCRIPTION China Re is a domestic reinsurance group in China. Through its subsidiaries, it provides domestic property and casualty (P&C) reinsurance, life and health reinsurance, primary P&C,... more
Bob Leung, Analyst, [email protected], +852-2971 5502
China Reinsurance (Group) Corporation 20 June 2016 2
China Re UBS Research
OUR THESIS IN PICTURES return
Reinsurance's role under C-ROSS
The new solvency system should strengthen the role of reinsurers in China’s financial system
Reinsurance premium growth 400,000 350,000 300,000 250,000 200,000 China's reinsurance market could reach Rmb336.5bn in 150,000 2020 100,000 50,000 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2020F Reinsurance premium (Rmb mn) China Re's net profit breakdown 100% 19% 19% 24% 28% 80% 6% 15% 26% 13% 60% 25% 11% 26% 26% 40% China Re has diversified its earnings portfolio
20% 45% 45% 40% 32%
0% 2012 2013 2014 2015 P&C Re Life Re Primary P&C Asset Management Other
China Re's one-year forward P/BV 1.4
1.3
1.2
1.1 Given our strong outlook for China’s reinsurance market 1.0 and China Re’s industry leadership, we believe the 0.9 stock’s current valuation is attractive relative to its peers
0.8
0.7 Jan 16 Jun16 Feb 16 Feb Apr16 Dec15 Nov15 Mar 16 Mar May 16 PB +1 sd Mean -1 sd Sources for exhibits above: Company data, UBS Research , State Council
China Reinsurance (Group) Corporation 20 June 2016 3
China Re UBS Research
PIVOTAL QUESTIONS return
Q: Will China Re's premium growth be sustained above 15% in the next three years?
UBS VIEW
Continued product reforms, price deregulation and new risk insurance launches (such as public liability and health insurance products) in China will significantly boost risk transfer and diversification of primary insurers, in our view. We expect the role of reinsurers in China’s financial system to strengthen under C-ROSS and forecast a 16.4% GWP CAGR for China Re over 2016-18.
EVIDENCE Under C-ROSS, cost of capital will be based on the risks of each insurance business line, compared to premium volume under the previous solvency regime. We believe the primary insurance industry’s product mix will change and premiums will be ceded to reinsurers under the new regime. C-ROSS also encourages the use of onshore reinsurance, which we think favours China Re as well.
WHAT'S PRICED IN? China Re is trading at 0.8x 2016E P/BV, compared to a 0.9x average for global reinsurance peers and 1.3x for primary P&C companies. China Re's share price has declined by 31% since its listing. In our view, the current share price does not factor in the reinsurance industry's low cession rate and strong reinsurance premium growth potential driven by the new solvency system.
China: a new era of risk pricing
According to the 10 new guidelines issued by the State Council, China's reinsurance market could reach Rmb336.5bn in 2020, assuming the current ceding ratio remains unchanged. We believe the strong growth potential is a key reason for the new market entrants.
Figure 1: Ceded premium as a percentage of total Figure 2: Reinsurance premium growth insurance premium
16.0% 400,000 14.5% 14.0% 350,000
12.0% 300,000
10.0% 250,000 7.8% 200,000 8.0% 7.1% 6.9% 6.9% 6.3% 6.2% 5.9% 5.7% 150,000 6.0% 4.5% 4.4% 100,000 4.0% 50,000 2.0% 0 0.0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2020F Ceded premium/Total premium Reinsurance premium ceded (Rmb mn) Source: CEIC, CIRC Source: State Council, CEIC, CIRC
China Reinsurance (Group) Corporation 20 June 2016 4
Continued product reforms, price deregulation and new risk insurance launches (such as public liability and health insurance products) in China will significantly boost risk transfer and diversification of primary insurers, in our view. We also expect the implementation of C-ROSS to strengthen the role of reinsurers in China’s financial system.
New solvency regime to further open up the reinsurance market
We expect C-ROSS to lead to changes in the primary insurance industry’s product mix and premiums to be ceded to reinsurers. In respect of the product mix, as C- ROSS requires more capital reserves for investment products, the proportion of products with more reinsurance demand, such as protection-type life and health insurance, should increase gradually.
In terms of premiums ceded to reinsurers under C-ROSS, we expect cession rates for motor insurance to decrease due to the lower capital risk cost, while reinsurance demand for more volatile non-motor insurance with higher risk capital costs, such as commercial property, credit and agricultural insurance, may rise.
Furthermore, to help primary insurance companies deal with the new capital requirements under C-ROSS, we think reinsurance companies will need to design new financial reinsurance products.
Figure 3: Reinsurance's role under C-ROSS
Source: UBS
C-ROSS encourages the use of onshore reinsurance
C-ROSS puts reinsurers into two baskets, onshore and offshore, and allocates different risk factors to them based on solvency adequacy and asset collateralisation capacity. The lowest factor for offshore reinsurers is 8.7%, much higher than the 0.5% for onshore.
C-ROSS also encourages the onshore reinsurance business. Under the new regime, insurance companies are subject to higher risk capital cost when they cede premiums to offshore reinsurers rather than reinsurers in China. Therefore we expect primary insurers to prefer onshore reinsurers in China, leading to a reverse flow of reinsurance business previously carried out by offshore reinsurers.
China Reinsurance (Group) Corporation 20 June 2016 5
Another potential change is that although foreign reinsurers' China branches will be recognised as onshore entities, they will be subject to the same solvency requirements as China Re and other domestic reinsurers. As such, we believe foreign reinsurers will invest more capital in their China branches to increase solvency levels and reduce the corresponding risk factor (otherwise their business scale in China may be limited). We expect more foreign reinsurers to launch branches in China and raise the registered capital of their China branches to support business growth.
Reinsurers' credit rating and underwriting capacity to impact primary insurers' capital requirements Under the new solvency regime, credit risk, which consists of counterparty default risk, will impact insurers' minimum capital requirements. Reinsurers' solvency position will reflect primary insurers' risk factors directly. Under C-ROSS, we expect primary insurance companies and reinsurance companies to have more in-depth cooperation. Besides taking into account the credit rating and the underwriting capacity of reinsurers, primary insurance companies are likely to also pay more attention to reinsurance companies’ willingness to cooperate in the long term, their technical competence and risk management capability.
Figure 4: Risk factors on reinsurance assets ceded by primary insurers
Solvency of reinsurers Risk Factor
On-shore reinsurers >200% 0.5% (150%, 200%) 1.3%
(100%, 150%) 4.7%
(50%, 100%) 26.1%
<50% 74.5%
Off-shore reinsurers Reinsurance assets collateralised 8.7% All solvency adequacy ratios meet regulatory requirement Reinsurance assets not collateralised 58.8%
Partial or all solvency adequacy ratios fail regulatory requirement 86.7%
Source: CIRC
Figure 5: Risk factors on reinsurance assets ceded by reinsurers
On-shore reinsurers Solvency of reinsurers RF0 >200% 0.5%
(150%, 200%) 1.3% (100%, 150%) 4.7% (50%, 100%) 26.1% <50% 74.5% Off-shore reinsurers International rating RF0 AAA 0.5%
AA+ 1.2%
AA 3.1%
AA- 4.5%
A/A-/A+ 6.6%
BBB+/BBB/BBB- 11.5%
Lower ratings 65.8%
Source: CIRC
China Reinsurance (Group) Corporation 20 June 2016 6
China Re UBS Research
PIVOTAL QUESTIONS return
Q: Will China Re see combined ratio improvement in 2016-17?
UBS VIEW
Likely. Excluding the impact of Tianjin explosions, we forecast China Re P&C's reinsurance business' 2016 combined ratio (COR) to improve by 90bps YoY to 98.0% and China Continent's COR to improve by 2.3ppts YoY to 99.0%. We believe 2016 will be the first time in three years that the primary P&C industry’s COR falls. We expect major P&C insurers' loss ratios to improve this year despite the additions of commercial motor insurance (CMI) pricing trial areas: while premium rates have fallen in some provinces, improved risk pricing appears to allow larger insurers to have better risk selection for motor insurance, and the China Insurance Regulatory Commission (CIRC) remains relatively strict in keeping overall competition under control.
EVIDENCE China Re P&C's COR was 98.9% in 2015 (+0.9% YoY) and China Continent's COR was 101.3% in 2015 (+1.5% YoY). While we await further disclosure on actual Tianjin losses, we estimate losses for China Re were around Rmb300m for the P&C re business and about Rmb500m for the primary P&C business in 2015. Excluding the impact of Tianjin explosions, we estimate the COR for China Re P&C and China Continent to be 98.0-98.5% and 99.1-99.3%, respectively, last year.
WHAT'S PRICED IN? China Re is trading at only 0.8x 2016E P/BV. We believe downside risk to its margin has been priced in. We expect China Re's combined ratio to improve in 2016, excluding the impact from Tianjin explosions and a loss ratio improvement in the primary P&C industry.
Combined ratios fell in 2015 due to Tianjin explosions…
Affected by the Tianjin warehouse explosions, China Re's CORs for its P&C and primary P&C businesses deteriorated in 2015. For China Re P&C, COR was 98.9% in 2015 (+0.9% YoY) and 99.7% in H215, while China Continent's COR was 101.3% in 2015 (+1.5% YoY) and 104.4% in H215.
China Reinsurance (Group) Corporation 20 June 2016 7
Figure 6: China Re P&C's historical combined ratio Figure 7: China Continent's historical combined ratio
110% 110% 103.2% 101.3% 99.0% 98.6% 98.0% 98.9% 98.3% 99.8% 100% 100%
90% 90%
38.6% 80% 34.1% 37.9% 80% 40.9% 38.3% 38.2% 40.8% 45.9%
70% 70%
60% 60%
64.0% 64.6% 50% 58.1% 60.2% 61.0% 50% 60.2% 59.0% 55.4%
40% 40% 2012 2013 2014 2015 2012 2013 2014 2015 Loss ratio Expense ratio Loss ratio Expense ratio Source: Company data Source: Company data
While we await the company to provide more disclosure on actual Tianjin losses, we estimate the losses were around Rmb300m for China Re’s P&C business and about Rmb500m for its primary P&C business. We estimate that excluding the impact of Tianjin explosions, CORs for China Re P&C and China Continent in 2015 to be 98.0-98.5% and 99.1-99.3%, respectively.
Figure 8: China Re's actual CORs and UBS estimates excluding Tianjin losses
China Re P&C H115 H215 2015 COR (actual) 98.0% 99.7% 98.9% COR (UBS estimates excluding Tianjin losses) 98.0% 97.9-98.9% 98.0-98.5% China Continent H115 H215 2015 COR (actual) 97.9% 104.4% 101.3% COR (UBS estimates excluding Tianjin losses) 97.9% 100.2-100.6% 99.1-99.3%
Source: Company data, UBS estimates
For the primary P&C industry, we expect the combined ratio to fall for the first time in three years
We expect major P&C insurers' loss ratios to improve in 2016, despite the additions of CMI pricing trial areas: while we anticipate falling premium rates in some provinces, improved risk pricing appears to allow larger insurers to have better risk selection for motor insurance, and the CIRC remains relatively strict in keeping overall competition under control. Considering the impact of the Tianjin blast in 2015, we believe 2016 could be the first time in three years that the industry COR falls.
CIRC announced that the pilot programme for the CMI pricing regime has been extended to a further 12 provinces/cities (Tianjin, Inner Mongolia, Jilin, Anhui, Henan, Hubei, Hunan, Guangdong, Sichuan, Qinghai, Ningxia and Xinjiang) from the original six (Heilongjiang, Shandong, Guangxi, Shaanxi, and the cities of Qingdao and Chongqing), starting January 2016.
The 18 pilot areas' total P&C insurance premiums amounted to about 50% of China’s total in 2015 (the original six areas accounted for 15%; the 12 newly
China Reinsurance (Group) Corporation 20 June 2016 8
added cities accounted for 35%). The new pilot areas cover a variety of provinces across the country.
We estimate the premium rates in trial areas fell by 10-15% in 2015. However, major insurers still reported decent CORs for the year, with Ping An at 95.6%, The People’s Insurance Company of China (PICC) at 96.5% and China Pacific Insurance (CPIC) at 99.8%, due to improved loss ratios.
Industry-wide loss ratio has improved
In our view, the decline in claim frequency can be attributed to the no-claims discount system in the CMI programme. We expect major P&C insurers' loss ratios to improve in 2016 with increased CMI trial areas, while the underwriting expense ratio might face more pressure under the CMI programme.
Our discussions with major insurers and reinsurers YTD continue to point to similar trends. P&C industry data shows the gross loss ratio decreased by 13bps YoY in 2015, from 52.6% in 2014 to 52.5%. Moreover, we believe the CIRC remains relatively strict in keeping overall competition under control.
Figure 9: P&C industry gross loss ratio
56% 6% 5.50% 56% 5%
55% 4%
55% 3% 2.50% 54% 2%
54% 1%
53% -0.13% 0% 53% -1%
52% -2%
52% -2.80% -3%
51% -4% 2012 2013 2014 2014
Indsutry wide loss ratio YoY change (%) - RHS
Source: CIRC, CEIC, UBS
China Reinsurance (Group) Corporation 20 June 2016 9
China Re UBS Research
PIVOTAL QUESTIONS return
Q: Will China Re remain profitable under intensified competition?
UBS VIEW
Likely. China Re used to be the only domestic reinsurer in China but more reinsurers have been licensed in recent years. Although we expect competition to intensify in China’s reinsurance industry, risk pricing remains key to reinsurers’ profitability. In our view, China Re's key advantage is its extensive industry/client data, which is likely difficult to replicate, as the company has been in the market longer than any competitors. We also believe China Re’s database supports a more accurate pricing model, allowing the company to stay ahead of its peers in risk pricing and product development. We expect China Re to remain profitable even under intensified pricing competition.
EVIDENCE The number of registered reinsurers in China increased from three in 2003 to eight in 2014. The CIRC issued three more reinsurance licences recently, to Taiping Reinsurance, PICC Reinsurance and Foresea Reinsurance.
As the only domestic reinsurer in China before 2015, China Re has established a strong client base with long-term relationships, covering 93% of insurance companies in China, including PICC P&C, CPIC P&C, Ping An P&C, China Life, Ping An Life and New China Life (NCI). We believe its extensive industry/client database could provide China Re with a more accurate pricing model and help it remain ahead of its peers in risk pricing and product development, which will help China Re to maintain stable growth momentum in next few years.
WHAT'S PRICED IN? China Re is trading at 0.8x 2016E P/BV. This compares with its Chinese P&C peer PICC P&C, which is trading at 1.4x 2016E P/BV. We believe the market is pricing in weak premium growth and low margin for China Re. With its strong pricing model and extensive industry/client data, we believe China Re has a competitive advantage in risk pricing and profitability.
New reinsurers in the market, but China Re has competitive advantages
China Re was the only domestic reinsurer in China before 2015. The CIRC recently issued three reinsurance licences, to Taiping Reinsurance, PICC Reinsurance and Foresea Reinsurance, taking the number of registered reinsurers in China from three in 2003 to 11 in 2016 YTD (four domestic and seven foreign).
Although we expect competition to intensify in China’s reinsurance industry, risk pricing remains key to reinsurers’ profitability. In our view, China Re's key competitive advantages are: 1) solid product development ability with the largest actuarial database in China; 2) strong position to capture potential growth from new business areas; 3) international exposure that diversifies risk and optimises its portfolio; 4) comprehensive distribution channel that covers its large client base with long-term relationships; and 5) diversified financial model. We believe these could help support China Re’s profitability even amid greater pricing competition.
China Reinsurance (Group) Corporation 20 June 2016 10
(1) Solid product development ability with the largest actuarial database
We believe one of China Re's key advantages over its overseas competitors is that it has been a leader in China's reinsurance market for decades and thus has accumulated extensive industry/client data. We think this database is hard to replicate and helps China Re stay ahead of its peers in product development by supporting a more accurate pricing model.
Furthermore, China Re has been an administrative and active rule maker in various industry organisations and has helped built the actuarial database for China's P&C reinsurance market. Together with its technical advantage in data analysis, we believe the company has the ability to develop unique risk models and provide comprehensive risk solutions for clients and tailored reinsurance agreements based on features of underlying insurance products.
(2) Well positioned to capture growth potential in emerging business
In August 2014, the State Council and the CIRC issued 10 new guidelines to promote the reform of the insurance industry. According to the company, China Re has intensified efforts to expand into emerging business areas, such as critical illness medical insurance, tax-preferred health insurance, credit insurance and critical catastrophe insurance. According to company announcement, in July 2015, it sponsored the first catastrophe bond linked to China earthquake risk in the international capital market, which was a breakthrough for China Re in using alternative risk transfer instruments.
China Re is a key member and co-founder of China Agricultural Reinsurance Pool (CARP), China Urban and Rural Residential Building Earthquakes Catastrophe Insurance Pool and China Nuclear Insurance Pool, and assists in designing their products and operation processes. CARP is the principal channel for agricultural reinsurance arrangements in China. We expect China Re to benefit from the potentially rapid growth of this emerging business.
Figure 10: China Re's agricultural reinsurance premium and as a share of total domestic P&C reinsurance premiums
3,500 11% 11% 12%
3,000 10% 8% 2,500 8% 2,000 6% 6% 3,227 3,227 1,500
2,240 4% 1,000 1,501 500 2%
0 0% 2012 2013 2014 2015
Agricultural GWP (Rmb mn) As a % of total GWP in domestic P&C Re Source: Company data
China Reinsurance (Group) Corporation 20 June 2016 11
(3) International exposure diversifies risk and optimises business portfolio
Overseas premiums accounted for 17% of China Life Re's total premiums in 2015 (28% in 2014), and 7% of China Re P&C’s 2015 total (6% in 2014). We think premiums from overseas help diversity China Re’s insurance risks and optimise its business portfolio, allowing it to better serve domestic companies or insure their overseas business expansion under the central government's "One Belt, One Road" initiative.
Accelerated Rmb internationalisation has significantly boosted demand for Rmb- denominated insurance products, in our view. China Re has established cross- border Rmb reinsurance businesses in Hong Kong, Macau, Singapore and Taiwan. We expect the company to leverage its leading market position to provide more competitive Rmb-denominated reinsurance products in existing overseas markets and to explore new ones. Figure 11: Overseas premiums as a percentage of China Figure 12: China Re P&C's overseas premiums by Re P&C and Life's total premiums geography in 2015
45% 41% China Re P&C Africa Oceania 40% 38% 0% 0% Americas 35% 20% 30% 28%
25% Europe 20% 17% 42% 15%
10% 8% 7% 5% 6% 5% 0% 2012 2013 2014 2015 Asia China Re Life China Re P&C 38%
Source: Company data Source: Company data
(4) Comprehensive distribution channel covers large client base with long- term relationships
China Re has a strong client base with long-term relationships, covering 93% of the insurance companies in China, including PICC P&C, CPIC P&C, Ping An P&C, China Life, Ping An life and New China Life. We expect the distribution channel to support stable business growth momentum at China Re in the next few years. China Re P&C's domestic reinsurance business is mainly written on direct sales and only a small portion is underwritten through brokers. In 2012, 2013, 2014 and 2015, original premium income from direct sales was Rmb23.3bn, Rmb27.3bn, Rmb28.5bn and Rmb28.9bn, respectively, accounting for 96.5%, 96.2%, 97.4% and 97.4% of China Re’s P&C original premium income. Due to the nature of the life and health reinsurance business, China Life Re is mainly underwritten through the agency channel.
China Reinsurance (Group) Corporation 20 June 2016 12
Figure 13: Domestic P&C reinsurance business by distribution channel
100% 3.5% 3.8% 2.6% 2.6% 95%
90%
85%
80% 96.5% 96.2% 97.4% 97.4% 75%
70%
65%
60% 2012 2013 2014 2015 Direct Brokerage Source: Company data
(5) Diversified financial model
With P&C reinsurance and life reinsurance as its core operations, China Re has a diversified business that also covers other key segments of the insurance value chain, such as primary P&C insurance, asset management and insurance brokerage, domestically and internationally. We are positive about the financial holding company (FHC) operational model in China as, by removing market barriers among financial subsectors, a FHC can benefit from group cross-selling synergy and economies of scale.
We believe China Re will benefit from its product mix from multiple business lines based on the rapid growth of both the primary insurance and reinsurance markets. We think China Re’s mix can also help it better confront unexpected single market volatility risk due to changes in the economic or regulatory environments.
Figure 14: China Re's GWP breakdown Figure 15: China Re's net profit breakdown
100% 100%
19% 90% 90% 24% 19% 30% 29% 30% 33% 28% 80% 80% 6% 15% 70% 70% 26% 13% 60% 60% 27% 27% 25% 28% 28% 50% 50% 11% 26% 26% 40% 40% 30% 30% 45% 45% 20% 44% 44% 42% 39% 20% 40% 32% 10% 10% 0% 0% 2012 2013 2014 2015 2012 2013 2014 2015 P&C Re Life Re Primary P&C P&C Re Life Re Primary P&C Asset Management Other Note: Intersegment part is excluded in calculation. Source: Company data Note: Intersegment part is excluded in calculation. Source: Company data
China Reinsurance (Group) Corporation 20 June 2016 13
China Re UBS Research
WHAT'S PRICED IN? return
China Re's one-year forward P/BV 1.4
1.3
1.2
1.1
1.0
0.9
0.8
0.7 Jan 16 Jun16 Feb 16 Feb Apr16 Dec15 Nov15 Mar 16 Mar May 16
PB +1 sd Mean -1 sd
Source: UBS estimates
As China Re is the only listed reinsurance group in China, we believe listed financial groups and global large-cap P&C and reinsurance companies are its comparable peers.
The stock is trading at 0.8x 2016E P/BV (global reinsurance peers are at 0.9x and primary P&C companies are at 1.3x). We believe China Re has a lower risk profile and thus deserves a valuation premium over global reinsurance peers. We think the large contributions from auto insurance and life reinsurance support its lower risk profile and that China Re also faces lower long-tail liability insurance risks than its global peers.
We believe current valuation does not factor China Re's strong premium growth potential under China's low cession rate and support from new solvency system. With its strong pricing model and extensive industry/client data, we expect China Re to have a competitive advantage in risk pricing and profitability.
The share price has declined by 37% since its listing, underperforming the HSI and HSI Financial indices by 24% and 18%, respectively. We believe the downside risk to margin deterioration has been priced in. We expect China Re's combined ratio to improve in 2016 without the impact from the Tianjin explosions and a loss ratio improvement in the primary P&C industry.
The stock is trading in line with global reinsurance peers and at a discount to primary P&C companies. Given our strong premium growth outlook for China Re and its improving profitability, we believe its current valuation is attractive.
China Reinsurance (Group) Corporation 20 June 2016 14
Figure 16: Valuations
Market Current share price implied PT implied 3yr avg cap P/BV (x) P/BV (x) ROE (%) Company US$m 16E 17E 16E 17E (16-18E)
China Insurers
China Re Group 1,498 0.88x 0.82x 1.32x 1.22x 9.4 PICC 25,646 1.35x 1.19x 1.73x 1.53x 17.0 China Life 59,810 1.14x 1.08x 1.49x 1.42x 9.6 Ping An 84,982 1.52x 1.30x 2.18x 1.86x 17.7 CPIC 30,305 1.44x 1.34x 2.15x 1.99x 11.2 NCI 16,181 1.06x 0.94x 1.94x 1.72x 14.9 CTIH 6,355 0.65x 0.58x 1.75x 1.56x 11.7 PICC Group 16,456 0.85x 0.75x 1.12x 0.98x 13.6 AIA 69,248 2.19x 2.02x 2.86x 2.64x 11.5 Simple average 40,477 1.26x 1.14x 1.93x 1.74x 12.9
Reinsurance
Aspen 2,748 0.84x 0.79x 0.96x 0.91x 9.1 Axis 4,933 0.90x 0.85x 0.88x 0.84x 7.8 Everest Re 7,332 0.90x 0.85x 0.98x 0.93x 9.4 Greenlight 731 0.75x 0.66x 1.19x 1.05x 13.0 Munich Re 30,365 0.80x 0.77x 0.88x 0.84x 7.3 RenaissanceRe 4,839 1.07x 1.01x 1.13x 1.07x 10.1 Swiss Re 31,167 0.95x 0.93x 1.04x 1.01x 9.3 Validus 3,770 0.99x 0.96x 1.07x 1.04x 10.7 Simple average 10,736 0.90x 0.85x 1.02x 0.96x 9.6
P&C
ACE 58,175 1.22x 1.15x 1.30x 1.23x 18.1 Allstate 25,279 1.31x 1.26x 1.36x 1.30x 11.7 PICC 25,646 1.35x 1.19x 1.73x 1.53x 17.0 Progressive 18,621 2.36x 2.19x 2.81x 2.60x 17.6 QBE 11,550 1.16x 1.10x 1.33x 1.26x 9.6 Samsung F&M 10,689 0.99x 0.89x 1.31x 1.17x 8.0 Travelers 32,968 1.31x 1.25x 1.28x 1.22x 13.7 XL Group 9,376 0.77x 0.72x 0.90x 0.85x 8.8 Simple average 24,038 1.31x 1.22x 1.50x 1.39x 13.1
Note: Data as at close of 17 June 2016. Source: Bloomberg, UBS estimates
China Reinsurance (Group) Corporation 20 June 2016 15
China Re UBS Research
return UPSIDE / DOWNSIDE SPECTRUM
1508.HK Price HK$1.74 BVPS (Rmb) P/BV Upside to Downside 2016e Implied 6 to 1 3.50
3.00 +73% 2.50 3.01 = 1.93 x 1.3x Upside: 2.60 = 1.77 x 1.2x Price Target: +49% 2.00
1.50 1.52 = 1.66 x 0.8x Downside: -13% 1.00 0.50 17 Jun +12 mo. 0.00 2014 2015 2016 2017
Value drivers P&C Re GWP P&C Re average Primary P&C Primary P&C (2016-18E) CAGR combined ratio GWP CAGR average COR HK$3.01 upside 13% 96.5% 24% 98.0% HK$2.60 base 11% 97.8% 18% 98.5% HK$1.52 downside 4% 99.2% 11% 100.0% Source: UBS estimates
We estimate risk to the current share price is skewed (6:1) to the upside
China Re is trading at HK$1.74 (as of 17 June 2016).
Upside (HK$3.01): In our upside scenario, we assume 10%/15%/15% GWP growth for the P&C reinsurance business in 2016/2017/2018 (base case: 6%/13%/13%), based on rapid growth in China Re’s international reinsurance operations and domestic agricultural, engineering and liability business lines. We assume healthier-than-expected underwriting profit and 96.5%/96.5%/96.5% COR for P&C reinsurance (base case: 98%/98.0%/97.5%). We assume GWP growth of 25%/24%/24% for the primary P&C business in 2016/2017/2018 (base case: 19%/18%/17%). We assume better-than-expected primary P&C COR of 98.0%/98.0%/98.0% (base case: 99.0%/98.5%/98.0%). We would derive a valuation of HK$3.01 per share.
Base (HK$2.60): Our HK$2.60 SOTP-based price target implies 2016E/2017E P/BV of 1.32x/1.23x and 2016E/2017E PE of 16.0x/13.6x.
Figure 17: SOTP valuation
Attr value Stake Attr value P/EV P/BV PE
(Rmb m) (%) (Rmb m) 2016E 2017E 2016E 2017E 2016E 2017E Methodology
Life Re 19,196 100.0 19,196 1.20x 1.04x 1.30x 1.08x 9.1x 6.6x At 1.2x EV P&C Re 29,064 100.0 29,064 1.51x 1.38x 1.51x 1.38x 16.7x 15.9x Disc. to DCF value China Continental 22,602 93.2 21,061 1.86x 1.65x 1.86x 1.65x 15.5x 13.6x Disc. to DCF value Asset management 588 100.0 588 1.00x 0.99x 1.00x 0.99x 230.2x 115.9x At book Group business & excess capital 29,353 100.0 29,353 At book
Group 99,262 1.30x 1.22x 1.32x 1.23x 16.0x 13.6x
Number of shares (m) 42,480
Price target (Rmb/sh) 2.34
Price target (HK$/sh) 2.60
Note: Attr = attributable. Source: UBS estimates
China Reinsurance (Group) Corporation 20 June 2016 16
We cut our NPAT estimates for 2016/2017/2018 by 33.9%/29.4%/22.8%, as:
. We lower 2016/2017/2018 investment yield assumptions to 4.3%/4.3%/4.2% to reflect our conservative interest rate and market outlook. We believe reinsurers are more sensitive to interest rate and market movements than life insurers, as their portfolios are subject to more short-tail risks.
. We lower GWP growth forecasts for China Re P&C from 13.5%/11.2%/10.3% to 6.1%/13.2%/13.1% for 2016/2017/2018, due to weaker-than-expected auto reinsurance premium growth. However, we expect China Re P&C to deliver better a combined ratio of 98.0%/98.0%/97.5%.
. We raise GWP growth estimates for primary P&C from 13.3%/11.8%/11.0% to 19.1%/17.5%/17.1% for 2016/2017/2018, as China Continent is active in expanding market share. We expect the subsidiary to remain profitable in 2016-18 and deliver a combined ratio of 99.0%/98.5%/98.0%.
. For China Re’s life and health reinsurance business, we forecast EV to grow 15% over 2016-18, with a ROEV of 15%.
Figure 18: Forecast revisions
GWP and policy fees 2016E 2017E 2018E New 92,208 108,187 126,966 Old 100,448 114,836 129,648 Change -8.2% -5.8% -2.1%
Total investment income 2016E 2017E 2018E New 6,781 7,125 7,620 Old 9,869 10,306 11,355 Change -31.3% -30.9% -32.9%
Net profit 2016E 2017E 2018E New 6,218 7,313 8,806 Old 9,401 10,356 11,414 Change -33.9% -29.4% -22.8%
Investment asset 2016E 2017E 2018E New 162,032 172,039 185,518 Old 174,839 190,769 208,613 Change -7.3% -9.8% -11.1%
Total Investment yield 2016E 2017E 2018E New 4.28% 4.27% 4.26% Old 5.87% 5.64% 5.69% Change -1.59% -1.37% -1.4%
BV 2016E 2017E 2018E New 75,162 81,012 88,057 Old 82,510 92,866 104,280 Change -8.9% -12.8% -15.6%
Source: UBS estimates
China Reinsurance (Group) Corporation 20 June 2016 17
Downside (HK$1.52): In our downside scenario, we assume GWP for the P&C reinsurance business will grow 1.0%/5.0%/5.0% in 2016/2017/2018. We also assume a P&C Re combined ratio of 103.0%/100.0%/99.5% in 2016/2017/2018. We assume GWP for the primary P&C business will grow 12.0%/10.3%/10.0% in 2016/2017/2018. We forecast worse-than-expected primary P&C combined ratios of 102.0%/100.0%/99.0% in 2016/2017/2018. In this case, we also assume that affected by low interest rates and A-share market volatility, China Re's investment yield would fall to 3.0% in 2016-18, versus our base case assumption of 4.3%. This would imply a valuation of HK$1.52 per share.
China Reinsurance (Group) Corporation 20 June 2016 18
China Re UBS Research
return COMPANY DESCRIPTION
Market Cap US$1.50bn NPAT by segment (2015)
Shares Outstanding 6,679m (ORD)
Industry Insurance, full-line Others Region China 28% P&C Re 32% Website www.chinare.com
China Re is a domestic reinsurance group in China. Through its subsidiaries, it provides domestic property and casualty (P&C) reinsurance, life and health reinsurance, Primary P&C primary P&C, asset management, insurance intermediary, 14% Life Re international P&C reinsurance, agriculture and nuclear 26% insurance services. Its subsidiaries are China P&C
Reinsurance, China Life Reinsurance, China Continent Source: Company data Insurance (a primary insurer), China Re Asset Management,
Huatai Insurance Agency, China Re UK and China Re
Underwriting Agency.
Industry outlook China’s insurance market is moving into a new era of risk- based pricing. We expect continued product reforms, price deregulation and new risk insurance launches (such as public liability and health insurance products) to significantly increase the risk transfer and diversification of primary insurers. The implementation of a new solvency system, China Risk Oriented Solvency System (C-ROSS), should further strengthen the role of reinsurers in China’s financial system, in our view.
China Reinsurance (Group) Corporation 20 June 2016 19
Forecast returns
Forecast price appreciation +49.4%
Forecast dividend yield 2.0%
Forecast stock return +51.4%
Market return assumption 9.2%
Forecast excess return +42.2%
Valuation Method and Risk Statement We believe the key risks for China Re include: maximum event retention (MER) risk from catastrophes and specific risks; changing solvency regulations; and the potential softening of premiums as a result of rising global reinsurance capacity. China Re is also exposed to general country, industry and policy risks that affect Chinese insurance and global reinsurance companies.
Our price target is based on a sum-of-the-parts methodology.
China Reinsurance (Group) Corporation 20 June 2016 20
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China Reinsurance (Group) Corporation 20 June 2016 21
UBS AG Hong Kong Branch: Bob Leung; Judy Chen. Company Disclosures Company Name Reuters 12-month rating Short-term rating Price Price date
China Reinsurance (Group) Corporation2, 4, 5, 6, 7 1508.HK Buy N/A HK$1.74 17 Jun 2016
Source: UBS. All prices as of local market close. Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date 2. UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the past 12 months. 4. Within the past 12 months, UBS AG, its affiliates or subsidiaries has received compensation for investment banking services from this company/entity or one of its affiliates. 5. UBS AG, its affiliates or subsidiaries expect to receive or intend to seek compensation for investment banking services from this company/entity within the next three months. 6. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and non-investment banking securities-related services are being, or have been, provided. 7. Within the past 12 months, UBS Securities LLC and/or its affiliates have received compensation for products and services other than investment banking services from this company/entity. Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk, please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Investment Research. China Reinsurance (Group) Corporation (HK$) Price Target (HK$) Stock Price (HK$) 4 . 00
3 . 00
2 . 00
1 . 00
0 . 00 6 5 5 4 4 3 3 2 2 1 1 6 5 5 4 4 3 3 2 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------r l r l r l r l r l r t t t t t n n n n n p c u p c u p c u p c u p c u p a J a J a J a J a J J - J - J - J - J - A O A O A O A O A O A ------1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Buy No Rating
Source: UBS; as of 17 Jun 2016
Additional Prices: PICC Group, HK$3.01 (17 Jun 2016); China Life Insurance, HK$16.42 (17 Jun 2016); Ping An Insurance (Group), HK$33.75 (17 Jun 2016); China Pacific Insurance - H, HK$25.95 (17 Jun 2016); New China Life Insurance - H, HK$26.30 (17 Jun 2016); China Taiping Insurance, HK$13.72 (17 Jun 2016); PICC Property and Casualty, HK$13.42 (17 Jun 2016); AIA Group, HK$44.60 (17 Jun 2016); Aspen Insurance Holdings, US$44.94 (17 Jun 2016); Everest Re Group, Ltd., US$175.39 (17 Jun 2016); Greenlight Capital Re Ltd, US$19.61 (17 Jun 2016); RenaissanceRe Holdings Ltd., US$113.10 (17 Jun 2016); Swiss Re, CHF80.75 (17 Jun 2016); Validus Holdings, LTD., US$46.36 (17 Jun 2016); Muenchener Rueckversicherungs, €150.45 (17 Jun 2016); Allstate Corp., US$66.42 (17 Jun 2016); Progressive Corporation, US$31.81 (17 Jun 2016); QBE Insurance Group, A$11.40 (17 Jun 2016); Samsung Fire & Marine Insurance, Won265,000 (17 Jun 2016); Travelers Companies, US$111.86 (17 Jun 2016); XL Group plc, US$32.29 (17 Jun 2016); Source: UBS. All prices as of local market close.
China Reinsurance (Group) Corporation 20 June 2016 22
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China Reinsurance (Group) Corporation 20 June 2016 23
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