When a company’s share price drops suddenly, there can be any number of causes. But when an entire industry’s valuation takes a tumble, there’s a good chance that new regulations have given investors a shock.
Certainly, it’s new rules that are behind the recently volatile performance of Chinese insurance stocks. Earlier this month, the insurance regulator announced that it planned to remove controls on interest rates for some life insurance contracts. The result was a sell-off, with insurance stocks taking severe one-day losses. On the first full day of trading after the announcement (July 12) China Life fell by 4.5% and China Pacific Insurance dropped by 5.8%, against an overall 0.8% fall in the Shanghai index. (Shares in the other big Chinese insurer, Ping An Insurance were suspended, pending an announcement.)
The market reaction goes to show how rate controls are linked to profitability. They cap the assumed interest rate that an insurer gives to its policyholders (in effect, a guaranteed rate of return), which is currently set at 2.5%.
The higher the assumed interest rate, the more attractive the life insurance product is to customers. So the fear is that once the cap is removed, competition in the sector will heat up, as insurance companies vie to offer better rates. Some firms may win more business, of course. But investors seem to fear that the industry in general is heading for a profits squeeze, as it begins to pay out more to its policyholders.
The cap was originally introduced to stop this from happening, reports Caijing. In the late-nineties, insurance companies used high assumed interest rates to make their products more attractive in an attempt to capture market share. Some were offering rates as high as 10%. The problem was that during the same period, the central bank was lowering the benchmark interest rate to as low as 2.25%. It became increasingly difficult for the insurance companies to make up the difference between what they had promised their policyholders, and the rates they were getting on their cash.
In 1999, the regulator intervened by imposing the 2.5% cap. But in 2004, the central bank started to raise interest rates. By the end of 2007, fixed deposit rates were at 4.14%, making life insurance less attractive to potential customers.
The companies most likely to benefit from the new rules are the small and medium-sized firms, one actuary told Caijing. He said that they will use the cap removal to release cheap new products, which will force larger companies to reduce the prices of their policies.
Some analysts think that investors did the right thing: “The short-term negative impact on life insurers is fairly obvious,” Olive Xia of Core Pacific Yamaichi told Bloomberg. “The market will need some correction in valuations to digest the impact.”
But there are limits to the recent liberalisation: it only affects what the regulator calls “traditional” life insurance policies – those where the premium is set when the policy contract is written. Xia says these account for less than 20% of the market by premiums.
Other analysts told Bloomberg that profits in the industry would drop by 8%, with Ping An Insurance the least affected, because traditional assurance accounts for just 9.7% of its total premiums (compared to 45% for China Life and 50% for China Pacific).
© ChinTell Ltd. All rights reserved.
Exclusively sponsored by HSBC.
The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.