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Morningstar | PICC Group’s Life Insurance Margin Turned Positive Despite Contraction in NBV

No-moat PICC Group’s first-half results posted 2.3% year-on-year premium growth, representing 52% of our full-year forecast and in line with our expectation. Upside surprise came from improved underwriting margins of life and health insurance business, with operating margins rising to CNY 1.53 billion and CNY 22 million from a loss of CNY 140 million and CNY 12 million, respectively. The turnaround of the life insurance segment was attributable to lower claim expenses as the business structure improved. This was not an easy task, considering struggling industry conditions. We have made no changes to our key assumptions but have lowered our fair value estimate to CNY 4 from CNY 4.30 per share to reflect the latest Chinese yuan/Hong Kong dollar exchange rate. Trading at a 12% discount to our fair value estimate, the stock is slightly undervalued, but we suggest that investors get in with a sufficient margin of safety. Our DCF-based fair value estimate implies 1.4 times 2018 price/book for its P&C insurance business, versus an average of 1.5 times forward price/book for PICC P&C since the beginning of auto insurance pricing reform in 2015. Our fair value estimate also implies zero valuation for its life and health insurance segments, to factor in its weaker-than-peer fundamentals for its life insurance business.

P&C, life, and health insurance business contributed 68%, 28%, and 3% of total premium income, respectively, and 89%, 11%, and 0.2% of net profit. Along with industry peers, life insurance premium and new business value contracted 16% and 21.5%, respectively, on stricter regulations. While the company’s NBV margin improved strongly to 27% from a low base of 14% in the year-ago period thanks to product mix optimization, this level remained lower than the 35%-42% range of CPIC and Ping An. Agent headcount contracted 18% to 209,712 by mid-2018, which is the largest headcount contraction among listed Chinese insurers we cover. Though management noted that headcount growth turned positive in May and June, we expect its agent force expansion will face mounting challenges, given weakening agent productivity.

The results of the P&C segment indicated a healthy improvement in premium growth and investment return. Contrary to peers, PICC P&C’s net investment return and gross investment return slightly improved to 4.2% and 5.2% despite fluctuating market conditions. The company’s prudent investment approach was evidenced by its lower-than-peer investment return volatility over the past five years. Year-on-year premium growth increased to 17% from 11.6% in the year-ago period. Market share further gained 0.9 percentage points to a record high at 34%, thanks to slowing industry growth as competition intensified. The strong premium growth was driven by 34% growth in nonauto insurance, which contributed 40% of total premium, while auto insurance grew 3.9%.

Underwriting profitability dropped slightly, with the combined ratio rising 40 basis points to 95.8%. This was attributable to 30-basis-point and 10-basis-point respective increases in the claim and expense ratios. By product line, the auto insurance combined ratio rose 70 basis points to 96.7%. Despite the drop in underwriting margin, the company maintained the lowest costs among peers, which posted 97.2% and 98% respective combined ratios for Ping An and CPIC.

Nonauto insurance lines were the bright spot of the results, with premium and profits growing 33% and 40%, respectively. Major profit contributors were agriculture, commercial property, and liabilty insurance, which contributed 21%, 12%, and 9%, respectively. Agriculture insurance premium surged 64% and the combined ratio dropped by 4 percentage points to 88.9%. However, the commercial property combined ratio deteriorated by 4 percentage points to 86%, continuing its upward trend of the past two years. We expect weaker underwriting profits for nonauto insurance in the second half due to seasonal patterns, while the auto insurance margin is likely to see slight improvement, given the increasing proportion of high-quality customers. As a result, the combined ratio is likely to climb to over 16% but should remain below the 17% level in 2017.