At a premium

At Shanghai’s Expo last year, People’s Insurance Company of China (PICC) had the honour of representing their industry with a pavilion.

Visitors started out with an introduction to the insurance business.

So far, so yawn.

But then they were then led into a separate room and told to grab on to a series of metal supports.

And just as well. What followed was a show of disastrous proportions – literally – as scenes of just about every misfortune imaginable loomed up for audience review.

Forest fires, landslides and storms, and even a floor-trembling earthquake all kept visitors wide-eyed in attention.

Creative stuff, although PICC Group will be hoping that its forthcoming IPO does a less successful job in alarming its audience of prospective investors.

The planned listing, expected to raise between $5 billion and $6 billion, already has problems enough. Market conditions are terrible – the Hang Seng index in Hong Kong has dropped nearly 15% in the last three months.

That is annoying, as a PICC insider told the Economic Observer since everything is ready for going to market.

But if the company does manage to pull off its dual-listing in Shanghai and Hong Kong, it stands a good chance of being China’s largest IPO in 2011. The deal will not only be significant in quantitative terms, it is also expected to be the first in a new wave of IPOs in the industry.

Launched in 1949, PICC was the first insurance company in the People’s Republic. The group now oversees 10 insurance and non-insurance subsidiaries, including PICC Property and Casualty (already listed in Hong Kong), PICC Life and PICC Asset Management.

(China Life was originally part of PICC too, before being split off ahead of its 2003 IPO. Initially China Life focused on life insurance, while PICC on property and casualty. However, since then PICC has moved into life, and China Life into property and casualty.)

In 2010, PICC Group delivered its best results yet, with overall profits of Rmb7.3 billion. This year profit is expected to exceed Rmb10 billion ($1.56 billion), reports China Securities Journal.

Mind you, not all subsidiaries are created equal: “PICC Property and Casualty is the major asset of the PICC Group,” an analyst from a securities dealer told Capital Week. And in the first half of 2011, this one subsidiary took a 37.3% share of the Chinese non-life insurance market, with premium revenue worth Rmb91.4 billion. Its strong performance is one of the main selling points of the PICC Group IPO.

Others urge caution. “PICC Property and Casualty is the best subsidiary by performance, but its growth rate has already peaked,” Jiao Wenchao of China Securities, told Capital Week.

“PICC Life, however, shows a very strong growth rate.”

This begs the question of why PICC at group level wants to go public during some of the most volatile market conditions seen since the financial crisis.

The answer lies in solvency margins. Similar in concept to the capital adequacy ratios now demanded of banks, these thresholds require insurers to be able to cover potential claims to customers out of their asset base. They also require a minimum threshold in asset surplus. An insurer with a ratio above 150% can invest in capital markets, while a company scoring between 100% and 150% will need to show the regulator plans for avoiding insolvency. Anything less than 100% means regulatory penalties.

The problem for fast growing insurers like PICC Group is the rapid increase in premium income brings with it new calculations on potential claims at a time when replenishment of registered capital may be progressing more slowly.

This means that a number of insurers are struggling with their solvency adequacy ratio. In 2010, nine insurers failed to meet the regulatory requirements, which led to a round of capital-raising by the industry.

At the end of 2010, the solvency adequacy ratio of PICC Property and Casualty was 115%. PICC Life and PICC Health were at 124% and 115% respectively.

Best in the industry is China Pacific at 298%, according to HSBC data.

The shortfall at PICC Property and Casualty was resolved – for now – when the National Social Security Fund became an investor in PICC Group, injecting Rmb10 billion into the company. The company also issued a secondary bond raising Rmb5 billion. The combined proceeds of these deals allowed it to announce a solvency adequacy ratio of 159%, the first time it had scored above 150% since 2007.

But this is not a long-term solution for PICC as a group: as the business keeps growing, there will be a constant need to restock capital. And since the banking regulator has made it harder for insurers to issue secondary bonds, it looks as though stock market listings are the best way of sourcing large amounts of new capital.

“The only long-term arrangement is to open the channel for financing by listing,” agrees Jiao at China Securities. “If the channel cannot be opened in the coming two years, the insurance industry will see higher systematic risk.”

Restocking capital levels is also a factor in New China Life Insurance plans to raise as much as $4 billion in a dual-listing in Shanghai and Hong Kong in the coming weeks. China’s fourth largest life insurer, New China Life is hoping that its IPO will mark a return to form, after a prolonged period of strife.

In 2006, the company’s chairman was fired (and later charged) for the suspected embezzlement of at least Rmb260 million, reports the Financial Times. The newspaper also mentions that for some time, the company had lacked a “functioning” board of directors, before coming under regulator scrutiny in 2009 for solvency issues. Despite this, it managed to grow premium income at an annual rate of 40% between 2005 and 2010.

With growth like that, it is not hard to see why insurers are keen to ensure that they are stocked up with capital – even if it means that they have to go to market at an unfavourable time.

In the first half of 2011, income from premiums for insurance companies rose by 13% to Rmb805.6 billion, of which Rmb569.7 billion was from life insurance and Rmb236 billion from property.

Yet the industry continues to trail its more sophisticated peers in other countries. “Even after three decades of development, the sector remains immature and plagued by questionable practices and basic business models,” reports FinanceAsia.

There are signs of progress, especially on the investment side, where the regulator is considering broadening the options from the current, more limited scope of domestic stocks, bonds and funds. Derivative products in Hong Kong are also a possible addition. China Life Insurance has also acquired a licence to set up a private equity fund, the first in the industry to do so.

Equity research from HSBC on the sector has noted for a while that “life insurers remain unloved and grossly undervalued”, although it has still urged caution from investors, noting the rising cost of sales agent workforces, as well as uncertainty in some of the regulatory outlook. Growth rates have also slowed this year, on the cloudier economic forecast.

As a result, a report out last weekwas counselling caution, cutting target prices across the sector by an average of 15%. But for long-term value investors, the sector should still be seen as a rich hunting ground, the HSBC team insisted. PICC will be hoping that its own IPO is greeted in a similar vein.

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