Weak headline profits are expected to undermine short-term sentiment on
the insurance sector. However, we believe this is widely expected by
investors and looks more than priced into current share prices. Within the
sector, we switch our top pick to Ping An (from China Life). While China
Life’s capital strength, simple investment case and upside to VNB growth
expectations remain attractive in the context of weak investor sentiment,
we believe the valuation premium that has emerged relative to Ping An is
more likely to narrow than widen from current levels. Least preferred
remains PICC despite large share price underperformance YTD.
■  Earnings – the end of the dream run. 1H08 results are expected to show
negative YoY growth due to the sharp reversal of the equity market and large
catastrophe losses. PICC appears worst positioned – we forecast a net loss of
RMB1.9 bn. Ping An is likely to be most resilient though we believe investors
should expect a sharp fall from the RMB7.1 bn profit delivered in 1Q08.
■  Balance sheet and embedded value growth stalled. The 48% slide in the
Shanghai Composite Index is expected to cause a contraction in industry
balance sheets. For life insurers, we expect a flow-on effect for embedded
values, with contraction of 13-17% forecasts for 1H08E. Solvency for the listed
insurers is expected to remain sound, though PICC may need more capital, as
we believe it may breach the maximum premium to capital ratio (4x).
■  Profit and value outlook. Analysis of premium data suggests life insurance
“new business APE’’ growth of 35-70% YoY in 1H08E, implying potential
upside to market forecasts. Margin pressures are expected to emerge,
although we believe this will be mild, reflecting changes in business mix
rather than a collapse in product level profitability. P&C sector profitability
should be close to bottoming, given the increased regulatory focus on pricing,
commissions, reserving and capital. However, we fear the P&C sector may
need to see financial distress and capital raising before evidence of
improved operating conditions emerges.