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Morningstar | Weakening Underwriting Profitability Continues in PICC P&C's 1Q

Thanks to improved investment income, the year-on-year decline in no-moat PICC P&C's first-quarter net profit narrowed to 3.6% from 22% in 2018. Quarterly results were mixed, with accelerating growth in premium income and a reduction in commission expenses. However, we’re a bit disappointed to see a rising combined ratio. The combined ratios of auto insurance and nonauto insurance climbed to 99% and 97.4% in the first quarter from 96.7% and 93.4% in the year-ago period. Given that the results are largely in line to deliver our expectation for 17% full-year growth, we retain our HKD 9.50 fair value estimate. The shares appear about fairly valued, trading at a 7% discount to our fair value estimate. The shares are trading at a low valuation level at 1.2 times 2019 price/book value compared with a range of 1-4 times since 2011. Given intensifying competition and deepening pricing reform in the auto insurance market, we are concerned that the underwriting margin of the company's core auto insurance business is facing increasing downward pressure.

The combined ratio increased to 98.2% from 95.3% in the year-ago period. This was attributable to a 3-percentage-point increase in the claim ratio while the expense ratio remained relatively flat. Competition in the auto insurance business remained fierce. Growth in auto insurance premium remained flat at 3.6% versus 3.9% in 2018. We expect 4% growth for the full year as the government’s policies to boost auto consumption should translate to a modest pickup in car sales in the following quarters. We have yet to see meaningful improvement in PICC’s auto insurance underwriting profitability, as the combined ratio is estimated at 100.2%, flat with the level during the second half of 2018 and higher than the 96.7% in the first half of 2018. We suspect this was attributable to a higher claim ratio due to lower average contract pricing as a result of ongoing auto pricing reform and increased competition. Commission expense saw a 7-percentage-point decline to 16% of total premium as the tightened rules managed to contain aggressive commission paid to distributors. However, we suspect much of the overpaid expenses were disguised as other operational expense, leading to the expense ratio holding steady at around 34.2% compared with the year-ago quarter.

Nonauto insurance premium continued its strong growth momentum, with premium growth further accelerating to 39% versus 28% in 2018 and representing 49% of total premium versus 42% in the year-ago period. The strong growth was partly due to strong seasonality and the government’s promotion of policy-related insurance such as agriculture insurance and critical illness insurance. Credit guarantee insurance is also a major growth driver, but we’re a bit concerned about its underwriting risks given rising defaults on the peer-to-peer platform and credit card loans. The company started to make impairment expense related to such product for the first time in the past quarter, putting additional pressure on the overall combined ratio.