Alleghany Corporation (Y)
Alleghany is an insurance holding company based in New York City. Alleghany has a rich and colourful history dating back to 1929. While the composition of Alleghany’s businesses have changed over the years, Alleghany’s modus operandi as an opportunistic yet conservative investment company remains the same. Over recent years the Company has developed a core focus in property and casualty insurance.
Alleghany’s largest shareholders are the Kirby Family and Alleghany continues to operate very much like a private company. Management don’t provide conference calls and rarely give media interviews. This makes scuttlebug on the company difficult and explains why Alleghany receives no analyst coverage. They have recently received some favourable press in Barrons.
Alleghany’s philosophy
This is stated on the front page from their website. It can be summed up into the following key aspects.
1. “Objective is to create stockholder value” over the long term ie. By growing book value per share at a double digit pace.
2. “ownership and management of a small group of operating businesses and investments, anchored by a core position in property and casualty insurance.”
3. “operating businesses function in an entrepreneurial climate as quasi-autonomous
enterprises.”
4. “Conservatism dominates management philosophy.”
5. “relatively few interests in basic financial and industrial enterprises” ie. concentration of investment resources.
Current Management & Insider ownership
Alleghany’s current CEO is Weston Hicks. Weston has done a solid job in his brief time as CEO although it is hard to properly assess his performance in a period of just under 3 years. Prior to joining Alleghany Weston was CFO of Chubb and prior to this a top-ranked insurance industry analyst and former managing director at J P Morgan securities. John Burns is Chairman (Allan Kirby former Chairman retired in 2006)and was extremely successful as Alleghany’s former CEO. John Burn’s continued involvement on the strategic and investment front is positive.
The Kirby remain the largest shareholders. Management are rewarded appropriately with stock incentives to achieve long term growth in book value and returns on equity. So the interests of shareholders and management appear properly aligned although the closed nature of management is not ideal from a corporate governance perspective.
Alleghany’s subsidiaries
Insurance subsidiaries
The core focus of Alleghany is property and casualty insurance. Its subsidiaries include:-
RSUI Group led by CEO James Dixon is the largest and most important insurance subsidiary , it underwrites specialty insurance in the property, umbrella/excess, general liability, directors and officers liability, or “D&O,” and professional liability lines of business .
RSUI was severely tested during the severe Hurricane season of 2005 by storms Katrina and Wilma , suffering US $303 million in pre-tax catastrophe losses . RSUI has since taken actions to reduce its loss exposures on a risk by risk basis and reviewed its overall book of business.
RSUI is Alleghany’s largest subsidiary writing $560 million in net written premiums for the first nine months to September 30 2007. The underwriting profit reported is $164 million with a 69% combined ratio. For 2006, the numbers were $503 million premium, $149 million profit and 70% combined ratio.
With over $900 million in surplus, RSUI is achieving in excess of a 15% return on equity.
Darwin Professional Underwriters (55% majority ownership, listed ticker “DR”) – specialist insurer focused on professional liability insurance and related lines
Stephen Sills is the CEO and he had a great track record. He was founder and former CEO of Executive Risk which was eventually sold to Chubb Corp. He has brought a number of his colleagues into Darwin from Executive Risk. Darwin’s growth and performance to date has been excellent, Weston Hicks CEO commented in the Annual report 2006 “Darwin Professional Underwriters has grown from a start-up managing agency to a publicly-listed insurance underwriting company in less than four years, producing almost $250 million of gross written premium in 2006 …The company is emerging as an innovative force in the specialty insurance marketplace, and we believe it has excellent long-term prospects.”
Darwin Professional is facing considerable headwinds in the form of softer pricing in the professional liability area with declines of over 10% in most lines. However, Darwin has been able to successfully increase its written premium by 6% in the most recent third quarter of 2007.
Darwin and insurance industry continues to benefit from a more favourable claims environment which will continue to place downward pressure on their loss expenses. Darwin has been conservative with reserving, recording much higher IBNR than its actual loss claims experience , this is likely to result in continuing favourable loss reserve releases as recent quarters have demonstrated. Its most recent combined ratio for the quarter end 30 September 2007 was 85% versus 96% for the year earlier.
Alleghany spun-off Darwin Professional in 2005 but retains 55% ownership. In August it did register an 8K which gives Alleghany the opportunity to sell down this stake but as of 30th September 2007, no stock had been sold. At 7th December 2007, Alleghany’s stake was valued at $235 million versus $202 million at 30th September 2007. Darwin has from the very beginning been an excellent investment for Alleghany with great prospects.
Capitol Transamerica Corporation or “CATA” (consisting of Capitol Indemnity, Platte River and Capitol Specialty)
CATA is a specialty insurer based in Madison, Wisconsin and led by David Pauly CEO who has done an excellent job since his appointment in 2003 at growing CATA’s profitability. CATA wrote a combined ratio of under 90% in 2006 and CATA’s statutory surplus was around $250 million as at 30th December 2006. Around 72% of their gross written premium was property and casualty and the remainder commercial surety.
They wrote $189 million in gross written premium in 2006 recording an underwriting profit of $19.1 million versus $173 million and $15.6 million in 2005. The difference was primarily due to favourable reserve releases pre-tax of $13.6 million in 2006 and $5.1 million in 2005. It is worth noting that in 2004 CATA reported a $8.9 million underwriting loss due to reserve strengthening of $10.6 million related primaril to construction defect claims. CATA exited the construction lines of its commercial surety business in 2004.
CATA continues to benefit from favourable reserve releases in 2007. For the first nine months ended 30th September 2007 it has written $162 million in GWP with $19.5 million in underwriting profit recording a combined ratio of 86%. This is due largely to $14million pre tax reserve releases in 2007 compared to $11million for same period 2006.
Employers Direct Corporation - EDC & Homesite Group (minority ownership – 33%)
Employers Direct Corporation was acquired by Alleghany in July for $192 million and EDC writes workers compensation insurance on a direct basis in California. It appears to have grown rapidly since 2002 and continues to be managed by founder and CEO Jim Little.
Alleghany took a 33% ownership stake in Homesite, a monoline home insurance provider, for $120 million in December 2006. For further discussion of Homesite I can recommend readers review pages 8-9 of the Plymouth Rock Assurance Annual shareholders letter for 2005 (as an aside I recommend reading Chairman Jim Stone’s letters as they are full of insightful wisdom on the insurance business).
Alleghany’s acquisition of Homesite and EDC signals their intention to build a diversified group of insurance holdings including strategic stakes such as Homesite.
Alleghany Properties
During 1994, Alleghany sold Sacramento Savings Bank which it had acquired in 1989. As part of the deal Alleghany purchased the real estate and related real estate assets of Sacramento Bank. The total book value of these properties in the Sacramento region of California was $22.6 million at December 2006 and consisted of 345 acres of land classed for multi-family residential and commercial use. During 2006 Alleghany sold 59 acres having a book value of approximately $5million for a net gain on sale of $23 million.
It is fair to conclude Alleghany’s real estate is probably worth over $120 million or $13 in excess of its book value. However, given the housing downturn particularly in the Sacramento housing market, Alleghany may not seek to fully realize this value in the short term and will likely wait patiently for the housing market to improve.
Investment Portfolio
Alleghany’s investment approach can be summed up by the following quote from Weston Hicks & F M Kirby 2005 annual report… “While we continue to pursue suitable acquisitions, we are working to grow Alleghany’s capital by investing in public equity securities when we see the opportunity to earn at least a 10 percent after-tax return…. Our investment approach, however, is first and foremost downside risk in orientation; we seek a non-diversified equity portfolio in which the core investments have measurable and limited downside, with significant potential upside to be realized over a three- to- five year investment horizon.”
Alleghany’s $1.2 billion equity portfolio is a concentrated one, dominated by a $400 million stake in railways through Burlington Northern , a $205 million shareholding in insurance via Darwin Professional and another $300 million or so invested in an assortment of energy oil and gas producers. Weston described in his 2006 annual report that they were pleased by the hedged nature of their investment portfolio as energy and railway holdings are cyclical and work as a hedge against their bond portfolio which will tend to perform better during an economic downturn.
Based on Alleghany's annual report for 2006, Alleghany's $3 billion bond portfolio is conservative consisting mostly of highly rated or liquid debt securities. Over 73% of bonds hold a AAA rating with just 1% having no rating or below investment grade.
Valuation and Conclusion
Currently as of 7th December Alleghany trades for $420 a share. Alleghany’s stated book value is $294 per share. Alleghany’s real estate is probably worth another $12+ per share more than its book value. So at over $300 per share the price to book value is around 1.4x.
They should earn over $30 per share in 2007 which puts the PE at 14x earnings. Note the PE takes no account of their minority investment of $400 million in Burlington Northern or $120 million stake in Homesite. Therefore growth in book value is a better way to look at Alleghany, and insurers generally, given it includes increases in the market value of their equity securities.
Their book value has grown around 8.7% over 5 years ending 31st December 2006. However, in the last 5 years Alleghany’s business has transformed considerably, from having $1.3 billion in cash and invested assets and no insurance subsidiaries in 2001 to $4.1 billion and three insurance subsidiaries and another significant investment in another insurer as at December 2006. Cash and invested assets should reach $5billion or $546 per share by 31st December 2007 with no debt leverage and 25% invested in equity investments.
Alleghany’s insurance subsidiaries are capable of doing a 15% ROE. If they can do an underwriting profit of $15-20 per share and a 5% after tax return on $546, it would be reasonable to expect they can compound book value at a higher rate of 12-15% going forward. For 2006, Alleghany reported a 15% increase in book value and for the first nine months of 2007 a 12.2% increase in book value. It seems reasonable they can grow their book value at 12-15% for the next 2-4 years.
The main risks here are heightened hurricane activity over the next few years and softer insurance pricing. There is also the risk of lower interest income but this would be balanced by increase in the value of their bonds & equity securities.
If the current credit crunch continues through 2008 with a resulting economic slowdown, Alleghany is well positioned to opportunistically take advantage of distressed selling & its strong balance sheet with no debt leverage means it is well-insulated from the credit market problems.
In conclusion, fair value for Alleghany would be around 1.5x its book value of $300, or $450 per share. In terms of buying Alleghany shares I believe they represent good value below 1.2x book or below $365 per share.
Please note: The opinions expressed above reflect authors own opinions/point of view and are not intended as investment advice and should not be relied upon as such.
References: Alleghany annual and interim reports.
Disclosure: I have positions in Alleghany (Y) and Darwin Professional(DR)
Sunday, December 9, 2007
Thursday, December 6, 2007
David Einhorn speech - Heilbrunn Center for Graham & Dodd Investing
17th Annual Graham & Dodd Breakfast
David Einhorn’s Prepared Remarks
October 19, 2007
This an excellent discussion by David Einhorn about why the current credit crisis goes beyond subprime and is really a reflection of poor lending standards ... in David's words "There has been a colossal undercharging for credit across the board."
Bond insurers and guarantors such as MBIA & Ambac have also played their part in contributing to this credit mess.
Here is the link...
www.blog.valueinvestingcongress.com/2007/11/06/david-einhorn%e2%80%99s-transcript-from-helbrunn-center-for-graham-dodd-investing/"
David Einhorn’s Prepared Remarks
October 19, 2007
This an excellent discussion by David Einhorn about why the current credit crisis goes beyond subprime and is really a reflection of poor lending standards ... in David's words "There has been a colossal undercharging for credit across the board."
Bond insurers and guarantors such as MBIA & Ambac have also played their part in contributing to this credit mess.
Here is the link...
www.blog.valueinvestingcongress.com/2007/11/06/david-einhorn%e2%80%99s-transcript-from-helbrunn-center-for-graham-dodd-investing/"
Credit Crunch – Issue of Funding - Insurance Companies & Banks
During AIG’s meeting with investors on 5th December 2007 , Martin Sullivan commented “AIG does not rely on asset-backed commercial paper or the securitization markets for its funding. We have the ability to hold devalued investments to recovery _ that's very important."
Martin’s comment really highlights a critical distinction between an property and casualty insurance company and a commercial bank or mortgage thrift and why I believe this credit crunch will have a lesser impact on the former rather than the later. Two qualifications here , firstly I am limiting my comments to property & casualty insurers not bond and mortgage insurers and secondly some property and casualty insurers have weaker balance sheets than others and will be impacted to a greater extent by current credit conditions.
Insurance companies mostly fund their debt purchases from the pool of policyholder premiums they collect, known as the float. They are not dependent on the commercial paper or securitization market, like Capital One that securitizes its credit-card receivables, nor do they depend on GSEs like Fannie or Freddie to raise more funding for the business, like Countrywide.
An insurer can’t suffer a “run on the bank”. E-trade and Countrywide have both faced this potential scenario recently. Both companies have been forced to publicly defend their liquidity in the press and to shore up their balance sheets with dilutive capital raisings.
For insurers generally, funding using insurance premiums is all fine and good provided you are underwriting with the strictest discipline. Float is a wonderful thing provided it comes with a zero cost!
Disclosure: I own AIG shares
Martin’s comment really highlights a critical distinction between an property and casualty insurance company and a commercial bank or mortgage thrift and why I believe this credit crunch will have a lesser impact on the former rather than the later. Two qualifications here , firstly I am limiting my comments to property & casualty insurers not bond and mortgage insurers and secondly some property and casualty insurers have weaker balance sheets than others and will be impacted to a greater extent by current credit conditions.
Insurance companies mostly fund their debt purchases from the pool of policyholder premiums they collect, known as the float. They are not dependent on the commercial paper or securitization market, like Capital One that securitizes its credit-card receivables, nor do they depend on GSEs like Fannie or Freddie to raise more funding for the business, like Countrywide.
An insurer can’t suffer a “run on the bank”. E-trade and Countrywide have both faced this potential scenario recently. Both companies have been forced to publicly defend their liquidity in the press and to shore up their balance sheets with dilutive capital raisings.
For insurers generally, funding using insurance premiums is all fine and good provided you are underwriting with the strictest discipline. Float is a wonderful thing provided it comes with a zero cost!
Disclosure: I own AIG shares
Wednesday, December 5, 2007
An attack on free speech in China
It is the goal of my blog to provide financial opinions strongly supported by factual evidence, however controversial or opinionated my articles may be.
I can only do this in a democratic society that supports free speech. I believe that free speech is one of the most fundamental rights that we have.
So it was very disappointing to recently to read an article on the WorldHealth Care blog www.worldhealthcareblog.org that discussed the closure of the China Development Brief, a newsletter reporting NGO issues, by the Chinese government authorities. Furthermore, Nick Young the author of this newsletter has been banned from re-entering the country.
According to the Australian publication "The Age", Nick Young reported that a senior official had told him "You can be the Government of China's friend or our enemy; there is no other way."
China appears focused on only presenting the State of their Country in a positive way to the outside world. Of course many countries even "democratic" ones have & will attempt to engage in media manipulation, but the closure of an independent media news is an extreme form of censorship which no citizen no matter what their political beliefs are should accept or tolerate.
In talking about his goal with the China Development Brief, Nick Young recently wrote...
"I have always argued that it is important to get coherent, informed and independent Chinese voices into international debates about China—rather than those debates being dominated by Western voices that are often ill-informed and unsympathetic to the real difficulties of governing this huge and complicated country—and I hoped that China Development Brief could come to offer the world at large “the best in Chinese thinking on social development, in plain English.”
China's Government needs to realise that free speech promotes openness and transparency. It is also key to China's own economic development. Given that most of China's largest companies are majority owned by the Chinese Government it does create concern in my view that this same organisation and majority shareholder is supporting the censorship of independent news services in China.
Lets us hope that this manipulation of the media is not also extending into the corporate arena and that reported financials produced by large Chinese corporates is accurate and complete and is not being presented in a way to support a positive view of China's corporate health by the global investment community.
Ratefinancials is a highly respected New York-based forensic research firm. Recently they issued a report (September 2007) entitled 'Government Controlled Entities Masquerading as Independent Public Companies’ which was critical of the ten largest NYSE-listed Chinese companies by market capitalization. They received “Poor,” or “Very Poor,” ratings for their accounting, quality of earnings, and governance.
Victor Germack, the founder and president of RateFinancials was quoted as saying
"Investing in publicly traded Chinese companies at the end of the day is a crapshoot that requires blind and unfounded faith that the PRC will ultimately put the best interests ofshareholders ahead of political and other considerations,” said Victor Germack, founder andpresident of RateFinancials. “These companies are government-controlled enterprises masquerading as independent public companies and it is virtually impossible to adequately assess their financial condition given their poor level of disclosures. Given the inherent risks of these companies, it’s both surprising and disappointing that they are allowed to trade on the NYSE.”
The fast pace of economic growth that China is experiencing potentially offers exciting opportunities for investors I genuinely believe that. There are Chinese companies with wonderful businesses. But there needs to be good corporate governance. In most countries, political bodies that majority own public companies tend to let politics interfere with decisions about the business.
Given, the censorship tendencies shown by the Chinese government it is in investors interests for the Chinese Government to sell its majority ownership in these various Chinese public companies as soon as possible. It is also imperative that the Chinese Authorities embrace the notions of transparency and openness in all aspects of government as this is critical to China's future and economic development.
I can only do this in a democratic society that supports free speech. I believe that free speech is one of the most fundamental rights that we have.
So it was very disappointing to recently to read an article on the WorldHealth Care blog www.worldhealthcareblog.org that discussed the closure of the China Development Brief, a newsletter reporting NGO issues, by the Chinese government authorities. Furthermore, Nick Young the author of this newsletter has been banned from re-entering the country.
According to the Australian publication "The Age", Nick Young reported that a senior official had told him "You can be the Government of China's friend or our enemy; there is no other way."
China appears focused on only presenting the State of their Country in a positive way to the outside world. Of course many countries even "democratic" ones have & will attempt to engage in media manipulation, but the closure of an independent media news is an extreme form of censorship which no citizen no matter what their political beliefs are should accept or tolerate.
In talking about his goal with the China Development Brief, Nick Young recently wrote...
"I have always argued that it is important to get coherent, informed and independent Chinese voices into international debates about China—rather than those debates being dominated by Western voices that are often ill-informed and unsympathetic to the real difficulties of governing this huge and complicated country—and I hoped that China Development Brief could come to offer the world at large “the best in Chinese thinking on social development, in plain English.”
China's Government needs to realise that free speech promotes openness and transparency. It is also key to China's own economic development. Given that most of China's largest companies are majority owned by the Chinese Government it does create concern in my view that this same organisation and majority shareholder is supporting the censorship of independent news services in China.
Lets us hope that this manipulation of the media is not also extending into the corporate arena and that reported financials produced by large Chinese corporates is accurate and complete and is not being presented in a way to support a positive view of China's corporate health by the global investment community.
Ratefinancials is a highly respected New York-based forensic research firm. Recently they issued a report (September 2007) entitled 'Government Controlled Entities Masquerading as Independent Public Companies’ which was critical of the ten largest NYSE-listed Chinese companies by market capitalization. They received “Poor,” or “Very Poor,” ratings for their accounting, quality of earnings, and governance.
Victor Germack, the founder and president of RateFinancials was quoted as saying
"Investing in publicly traded Chinese companies at the end of the day is a crapshoot that requires blind and unfounded faith that the PRC will ultimately put the best interests ofshareholders ahead of political and other considerations,” said Victor Germack, founder andpresident of RateFinancials. “These companies are government-controlled enterprises masquerading as independent public companies and it is virtually impossible to adequately assess their financial condition given their poor level of disclosures. Given the inherent risks of these companies, it’s both surprising and disappointing that they are allowed to trade on the NYSE.”
The fast pace of economic growth that China is experiencing potentially offers exciting opportunities for investors I genuinely believe that. There are Chinese companies with wonderful businesses. But there needs to be good corporate governance. In most countries, political bodies that majority own public companies tend to let politics interfere with decisions about the business.
Given, the censorship tendencies shown by the Chinese government it is in investors interests for the Chinese Government to sell its majority ownership in these various Chinese public companies as soon as possible. It is also imperative that the Chinese Authorities embrace the notions of transparency and openness in all aspects of government as this is critical to China's future and economic development.
Tuesday, December 4, 2007
Valuing an Insurance Company – using Cash & Investments per share
Bruce Berkowitz & the Fairholme Fund have a great track record & I thought it would be worth discussing Bruce’s approach to valuing insurance companies.
Here is an excerpt from an interview with Businessweek in (October 2000), Bruce talked about his approach to valuing Markel Corporation(MKL).
"Look, the key concept for insurance companies is to take a look at the investments per share. And you can find companies where the investments per share are significantly higher than the stock price. Markel has roughly $400 per share of investments. If they can break even on their underwriting and only make a 5% after-tax investment return, that's $20 per share. Not bad for a company at $140 per share (in market price).
So the trick is to have that investment leverage and at the same time break even or make an underwriting profit. And it's hard for people to see it. These are not easy companies to understand."
Calculating the cash and investments a company has per share and determining what return they are likely to achieve is an excellent way to value an insurance company.
At the time Markel Corp had shareholders equity of around $94 per share, the price to book value was around 1.5x. With cash and invested assets of over $400 they had a 4:1 leverage. So using a 5% return after tax would be equivalent to a 20% return on equity & growth in book value.
Bruce Berkowitz also discussed a number of important issues that really go beyond the financials. He described Markel’s approach to underwriting as very disciplined & he knew Markel had honest and capable managers and had a great track record of growing their book value at 20% + compounded since the mid-80s.
Lets see how the investment thesis panned out?
By December, 2006 book value had grown to $230 per share which was a 15% compounded growth return from $94. Nevertheless, by December 2006 investors re-rated Markel’s price to book value to 2x and shares rose to $480 from $140. That’s a shareholder return of over 20%. So investors put a quality premium on Markel for its consistency and long term record of 20% +book value growth.
Conclusion
Bruce Berkowitz used a big margin of safety and even though his investment thesis was not exact (no thesis ever is!) it still gave a very favourable outcome. Hurricane Katrina & reserving issues with various acquisitions did conspire to limit the book value growth rate. However, Markel’s book value growth over 20 years remains at an excellent 23% so it is worth being wary looking at 5 year time frames as book value growth is lumpy in the insurance business.
Disclosure: I own shares of Markel (MKL) & Fairholme Fund (FAIRX)
Here is an excerpt from an interview with Businessweek in (October 2000), Bruce talked about his approach to valuing Markel Corporation(MKL).
"Look, the key concept for insurance companies is to take a look at the investments per share. And you can find companies where the investments per share are significantly higher than the stock price. Markel has roughly $400 per share of investments. If they can break even on their underwriting and only make a 5% after-tax investment return, that's $20 per share. Not bad for a company at $140 per share (in market price).
So the trick is to have that investment leverage and at the same time break even or make an underwriting profit. And it's hard for people to see it. These are not easy companies to understand."
Calculating the cash and investments a company has per share and determining what return they are likely to achieve is an excellent way to value an insurance company.
At the time Markel Corp had shareholders equity of around $94 per share, the price to book value was around 1.5x. With cash and invested assets of over $400 they had a 4:1 leverage. So using a 5% return after tax would be equivalent to a 20% return on equity & growth in book value.
Bruce Berkowitz also discussed a number of important issues that really go beyond the financials. He described Markel’s approach to underwriting as very disciplined & he knew Markel had honest and capable managers and had a great track record of growing their book value at 20% + compounded since the mid-80s.
Lets see how the investment thesis panned out?
By December, 2006 book value had grown to $230 per share which was a 15% compounded growth return from $94. Nevertheless, by December 2006 investors re-rated Markel’s price to book value to 2x and shares rose to $480 from $140. That’s a shareholder return of over 20%. So investors put a quality premium on Markel for its consistency and long term record of 20% +book value growth.
Conclusion
Bruce Berkowitz used a big margin of safety and even though his investment thesis was not exact (no thesis ever is!) it still gave a very favourable outcome. Hurricane Katrina & reserving issues with various acquisitions did conspire to limit the book value growth rate. However, Markel’s book value growth over 20 years remains at an excellent 23% so it is worth being wary looking at 5 year time frames as book value growth is lumpy in the insurance business.
Disclosure: I own shares of Markel (MKL) & Fairholme Fund (FAIRX)
Monday, December 3, 2007
Disclosure note
In my haste to publish my last article "Life Insurance in China" I omitted in the disclosure note that I do hold shares of AIG.
I have amended this disclosure but for completeness I am also posting this notice.
I have disclosed this AIG position in a prior article also.
apologies & cheers
I have amended this disclosure but for completeness I am also posting this notice.
I have disclosed this AIG position in a prior article also.
apologies & cheers
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.
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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