Sunday, December 2, 2007

Life Insurance in China - Investment opportunity?

Significant growth opportunity

The insurance business is one of the fastest growing industries in China. According to the CIRC (China Insurance Regulatory Commission), insurance premiums grew from from RMB 160 billion in 2000 to RMB 492 billion (US$64.7 billion) in 2005.

With nearly 1.3 billion people, a rapid increase in incomes and prosperity resulting from China’s economic boom and the curtailment of government welfare with the removal of the iron rice bowl (State welfare for life) , many Chinese citizens are rapidly seeking financial protection in the form of life and health insurance for themselves and their families and have the financial means to do so.

There is significant scope for growth in life insurance in China. When measured as a percentage of GDP, penetration rates for life insurance are only 1.7% in China compared to 4% in the US based on CIRC statistics. And premiums are small relative to world averages, the per capita premium in 2006 was around US$30 compared to the international average of US $219 . These premiums could be expected to increase at a faster rate in China as disposable incomes and economic GDP in China grows at a faster rate than the rest of the World.

As well as the opportunity to grow premiums , life insurers are increasingly being given greater scope on the investment front to boost returns. Recently, the Chinese Government has been liberalising investment mandates to permit greater overseas investments by insurers. From July, Chinese insurers are now permitted to invest 15% of their portfolio assets in overseas stocks and bonds, whereas previously they were limited to 5% .

The players & investment opportunities

The life insurance and annuities industry in China is dominated by China Life Insurance Company(LFC NYSE) with 47% market share & Ping An Insurance(2318.HK Hong Kong) with 16% and the remaining 37% shared among other insurers. American International Group (AIG) also has a life insurance presence in China through its subsidiary AIA along with other strategic Chinese investments.

The huge potential for Chinese insurance growth is more than captured by current stock prices for all listed Chinese Life Insurers. Which unfortunately makes it difficult to take advantage of this Chinese growth story if you are an investor.

Lets look at the largest life insurer in China which is also NYSE listed. China Life insurance Group has seen considerable business growth over recent years. Its total revenues including premiums and investment earnings grew from RMB 78 billion in 2003 to RMB 147 billion in 2006 and shareholders equity rose from RMB 62 billion to RMB 139 billion. At June 30 2007 , shareholders equity had increased to RMB 167 billion (US$22 billion).

China Life Insurance Group had a market cap of US$155 billion as of 3rd December 2007, based on 2006 results its PE is 54 and it trades for 7.3x sales & 8.2 x book value. This kind of valuation is too expensive for my frugal tastes even with the rapid growth in business they are experiencing. Nevertheless, due to its market leading position and franchise, China Life is a company worth keeping an eye on, particularly if there is a substantial correction in the Chinese market allowing for a more attractive and reasonable price on these shares.

I do at this stage want to express a certain caution with China Life Insurance and it comes about through a quirk in their accounting which allows Chinese Life to book unrealized gains on a portion of their equity portfolio that they classify as held for short term trading. For the June 2007 half year, US$1.45 billion pre tax of China Life’s earnings came from “net fair value gains” in equity securities out of a US$3.3bil pre tax profit. For the same period in 2006 similarly around 50% of earnings reported came from these “net fair value gains” in equity securities. I should qualify that these net fair value gains include realized & unrealized gains but I was unable to determine looking at China Life’s interim filings exactly what the percentage breakdown was.

Unlike China Life, US insurers mark to market all of their equity securities and they only report realized gains on the Income Statement when equities are sold. So US insurer reported earnings won’t be an apples to apples comparison with an insurer like China Life. I think the best way to get this comparison is probably to look at the comparative growth rates in book value per share and dividend growth.

In conclusion, I find the growth story in China very exciting, however, at this time I am unable to recommend attractively priced insurance opportunities amongst Chinese Life insurers at the present time, hopefully that will change at some point in the future.

Disclosure: I have no position in any securities mentioned except for AIG.

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