Ping An Insurance was founded in in 1988 in Shenzhen when it was still a sleepy fishing village bordering Hong Kong. It was chosen as the “experimental city” by the late Chinese leader Deng Xiaoping as China opened its economy to global capital markets and competitive forces.
The current CEO and Chairman of Ping An Insurance, Dr. Peter Ma, seized the opportunity to found China’s first private life and P&C insurer which has grown to become the second largest in the country. Since public listing in Hong Kong in 2004, Ping An’s financial track record has been impressive growing book value per share at around 22% per annum.
Ping An’s earnings multiple is approximately 10x for a 18-20% growth profile. Despite its operational excellence, the company is not immune to concerns regarding the Chinese economy as a weak macro environment may directly feed through to weaker life insurance sales and weigh on the banking system via higher non-performing loans (NPL’s).
The Chinese credit cycle of 2012-2016 has left the country with a debt overhang but it was the growth in “shadow loans” made by the weakest banks that was most worrisome. Whilst the sheer level of debt (~250% of GDP) is reason enough to pause, it’s worth highlighting the pace at which it was acquired, and thus the potential for misallocation. Most official corporate loans in China are risk-weighted at around 100% whilst shadow loans can be disguised as investments allowing for a much lower 25-35% risk-weighting, higher leverage and less PBOC scrutiny. This form of credit extension amassed at the peak to over 20 trillion RMB (USD$2.5 trillion) and posed a systemic risk to the financial health of the Chinese economy.
There is no denying that China faces challenges in dealing with this issue. Given the lack of disclosure or any standard requirement for impairment recognition with shadow loans, it’s not possible to accurately estimate NPL ratios. However, given historical provisions at the banks we can estimate that current provisioning is around RMB 150 billion or equivalent to 70 basis points of shadow loans (for on balance sheet corporate loans this has been more like 6%). Should the regulator impose stricter impairment recognition standards on these shadow loans to say a 5% loss rate, total system losses would be around RMB 1 trillion and the shortfall would be around RMB 850 billion ($125 billion USD or 100 basis points of GDP) – a large number but manageable from a national perspective. In our hard landing scenario, which attempts to provide more context in a sluggish economic environment, the loss rates are closer to 12% or around 2-2.5% of GDP.
In response to this debt overhang, over the course of the last three years China has implemented strict measures to control excesses in the shadow banking system, including forcing banks to re-classify shadow loans as traditional corporate loans (thereby bringing the loans back under regulatory scrutiny), take on more non-performing loans as over-capacity industries shut down, and reduce their reliance on wholesale funding to alleviate liquidity pressures. In the longer-term, monetary conditions are likely to remain structurally tight, with cyclical easing phases as we’re experiencing now, as longer-term policy remains committed to working off these excesses and supporting the transition from capital-intensive industrial to capital-light consumption and services driven growth. Hence, the sentiment pendulum swings from euphoria to fear on the topic especially as financial deleveraging in 2017 and 2018 led to a tightening in overall credit conditions. As a result, the Chinese economic cycle remains relatively stop-start which should be factored into investors’ considerations.
Multiple ways of winning
Competitive dynamics & Product cycle
China has become the second largest life insurance market in the world after the United States. During periods of economic slow-down, comparisons start with ex-growth markets like Japan where lower bond yields weighed on insurance earnings. The concerns around Japan are sound, a life insurance market that has reached full penetration and coverage, though are less relevant in China where life insurance penetration is still very low.
At USD 9,000, China’s GDP per capita has reached a level where the demand for life insurance typically accelerates. Demand is further supported by government policies that promote the self-funding of retirement and healthcare. Further, the top 5 players control 60% of the market and a stringent license/capital regime protects incumbents from irrational competition.
Ping An has approximately 184 million retail customers, the bulk of which are in middle class (80 million) earning between US$15k- $30k with a significant portion of affluent customers (52.5 million) earning $35k and above.
TABLE 4: Ping An customers and contracts per customer by segment
|Number of Customers (M)||Contracts per Customer|
|High Net Worth Individuals HNWI)||0.19||11.30|
|Notes: (1) Mass customers are those with annual income below RMB100,000, middle class customer RMB100,000-240,000 and affluent customers above RMB240,000. HNWIs have personal assets of RMB10 million or more. (2) The numbers of customers may not match totals due to rounding.|
Source: Ping An Insurance
Ping An’s opportunity is three-fold. Firstly, coverage per customer relative to income is very low (the average critical illness coverage is around $23k USD) by global standards. For example, most developed economies achieve coverage of around 3-5x income, hence the organic opportunity within the existing customer base.
Secondly, there is a clear benefit to cross-selling as each new product generates disproportionately higher incremental profit. Hence Ping An’s rationale for to acquiring a bank. For example, customers who have both mortgage and life insurance are more likely to be loyal and the actuarial assumptions of lapse rates come in better than expected.
Finally, Ping An continues to acquire new customers in a highly efficient manner and with one-third of all new customers in 2018 coming from its online eco-system, a competitive advantage that no other financial services company in China can match.
In 2017, Chinese regulators began to tighten up the sales of short-term wealth management products (WMP) that promise high yield and allow redemptions as early as after one year. This reduced the competitive pressure from smaller insurers that primarily use price to compete for sales. Additionally, the Regulator has pressured incumbents to focus on long-term protection products and the upskilling of their tied agency teams. However, selling life insurance is not an easy task with many agents leaving the job within the first twelve months. Having access to superior data and a depth of product improves sales success, enhancing margins and insurance commissions. Given Ping An’s lead in technology and depth of product offering, a typical Ping An agent enjoys a 20-25% higher commission income than a competitor life insurance agent. This high-quality sales channel has shielded Ping An from industry fluctuations and provided a stable source of premium growth.
Management and Financial
Testament to the Founder’s vision, Ping An has built a financial supermarket and its management capabilities are exemplified by its early and consistent investment in technology to build sustainable competitive advantage, especially on customer acquisition costs. The company employs around 80,000 IT staff, of which 25,000 are IT developers. Further, over the last decade, the group has allocated approximately 1% of revenues to fintech incubation, equivalent to USD$7 billion cumulatively. After several years of investment in areas such as Artificial Intelligence, Cloud and Blockchain, the fruits are now beginning to show with Lufax and Autohome contributing towards profits.
Style and Macro
Life insurance consumption is akin to other forms of “aspirational” consumption, as household wealth grows demand typically becomes structural rather than cyclical, especially as middle-class households seek a private safety net to the supplement the public one. Ping An represents an opportunity to invest in this structural trend but also to invest in a management team that have delivered superior growth and shareholder returns.
Margin of safety
Whilst insurance franchises across the world are complex, we can observe a relationship between PE and Return on Equity and on this basis Ping An Insurance appears attractively valued, especially given its superior outlook for growth.