BEST S SPECIAL REPORT Our Insight, Your Advantage. Market Review April 29, 213 A 212 slowdown of premium growth may favor solvency levels over the near term. External Capital Support Has Sustained China s Non-Life Expansion Direct premium in China s non-life sector annually grew by 23% on average during 29-212. Amid rapid premium growth, non-life insurers faced solvency pressure relative to capital and surplus levels, as evidenced by the peak amount of new capital and subordinated debt issued by non-life insurers in 211 and 212. This report will analyze the factors that impact the solvency level of major non-life insurers as grouped by average capital adequacy levels over the past three years, and assess whether each sector can sustain these levels under current growth rates and operating profitability. The insurers covered in this analysis represented around 84% of China s non-life premium in 29 211 (see Exhibit 1). Major domestic non-life insurers are categorized according to their average solvency level during 29 to 211 as follows: insurers with average solvency below 1%; insurers with average solvency ranging between 1% and 18%; and insurers with average solvency greater than 18%. Analytical Contact Vivian Cheung +82-2827-3411 Vivian.Cheung@ambest. com Editorial Management Al Slavin, Oldwick The China Insurance Regulatory Commission (CIRC) measures an insurer s solvency by dividing its admissible capital (including subordinated debt issued) by the minimum capital required. This metric is determined by either the premium risk (based on net premium written) or claims liability risk (net outstanding claims reserves), depending on which is greater. It is observed that net premium risk is mostly selected as the basis to assess minimum capital required for non-life insurers. Hence net premium leverage (as measured by net premium written over capital and surplus) would serve as an indicator to the drivers of an insurers solvency level. Having said that, the stability of an insurer s net premium leverage will depend on the capital growth an insurer has generated to support its Exhibit 1 Market Share Based on Solvency Level Type (29-211) Market Share % 4 4 3 2 2 1 1 (<1%) (>1% & <18%) (>18%) Note: Insurers covered in this analysis shared about 84% of premium in 29-211. China Insurance Regulatory Commission Exhibit 2 Average Solvency Ratios for Three Largest Insurers (29-211) Company Average Type PICC P&C Co. Ltd. 137% 1 Ping An P&C Insurance Co. Ltd. 163% 2 China Pacific Property Ins Co. Ltd. 191% 3 Company Financial Reports Copyright 213 by A.M. Best Company, Inc. ALL RIGHTS RESERVED. No part of this report or document may be distributed in any electronic form or by any means, or stored in a database or retrieval system, without the prior written permission of the A.M. Best Company. For additional details, refer to our Terms of Use available at the A.M. Best Company website: www.ambest.com/terms.
Exhibit 3 Average Net Premium Growth by Solvency Type (29-211) Includes average years of operation for insurer type. 4 4 3 2 2 1 1 research years (<1%) 14 years (>1% & <18%) 9 years (>18%) Industry Average Statement File Global; company websites; A.M. Best Exhibit 4 Average Operating & Combined Ratios Based on Solvency Type (29-211) 98 96 94 92 9 88 86 84 82 8 (<1%) Combined Ratio (>1% & <18%) Statement File Global Operating Ratio (>18%) Exhibit Average Return on Equity vs. Net Premium Growth (29-211) 4 4 3 2 2 1 1 Average Return on Equity NPW Growth/ROE (<1%) Avg Net Premiums Written Growth (>1% & <18%) (>18%) Statement File Global, A.M. Best estimates 3. 2. 2. 1. 1... NPW Growth/ROE premium growth, with capital growth to be driven by retained operating profit or capital injection, or both. Premium growth of younger insurers is expected to continue and surpass industry growth over the medium term, while premium growth of insurers with comparatively longer operating histories may exhibit growth that is closer to or even slower than the market average in view of their relatively huge business size. groups on average had the shortest operating history; the group, which is dominated by PICC P&C, had the longest average operating history (see Exhibit 3). Measuring Organic Capital Growth Operating ratio, which measures the overall profitability from underwriting and investment activities and could be interpreted as the operating margin for an insurance company, is a key factor that determines an insurer s ROE, or the rate of its organic capital growth. insurers had the highest average operating ratio (or lowest operating margin ) from 29 to 211, mainly due to a relatively weaker underwriting performance as evidenced by their higher combined ratio. insurers had the lowest average operating ratio, mainly driven by a more favorable combined ratio; the group also generated the highest average ROE during the period. Although insurers reported the second most favorable average operating ratio among all types of insurers, younger insurers tended to report a lower ROE on average due to lower underwriting leverage and a small asset base during their early stage of operation (see Exhibits 4 and ). Although all three insurer types generated a decent average ROE, each was insufficient to underpin their rapid premium growth during 29 to 211. External capital support was therefore in place to maintain their net premium leverage level, particularly for insurers that generated net premium growth that was much higher than their ROEs (see 2
Exhibit ). Capital Injection a Main Growth Driver From 29 to 211, and 3 insurers strengthened their capital and surplus mainly through the increase in paid-in capital. While market leader PICC P&C dominates the analysis of insurers, capital and surplus growth was achieved through improved operating profit in 21 and 211, as well as injecting additional capital in 211. Capital injected between 29 and 211 was estimated to account for more than % of total capital and surplus as of year-end 211 for both and insurers, compared with approximately 14% for insurers (see Exhibit 6). and 3 insurers were active in this regard in 211, as insurers such as PICC P&C (), China Pacific Property Insurance Co. Ltd., China Life P&C and BOC Insurance (Type 3) conducted significant capital injections under improved market sentiment (see Exhibit 7). High premium growth by insurers in 21 elevated net premium leverage, but this was lowered with flat premium growth on top of an enlarged capital base in 211. Underwriting leverage for and 3 insurers was reduced, largely through the addition of paid-in capital from 29 to 211(see Exhibit 8). It is noted that a high level of premium leverage will translate into a lower solvency level for insurers. Therefore, insurers with high net premium leverage tended to utilize more subordinated debt to enhance their medium-term solvency. insurers, such as PICC P&C, exhibited the highest weighted average external debt leverage ratio during 29 to 211, which increased to more than % in 211 from % in 29 under the further issuance of subordinated debt in 211. insurers, which exhibited the lowest premium leverage, tend to support their solvency mainly with capital and surplus (see Exhibit 9). Recent issuers of subordinated debt demonstrated a solid business profile either as a licensed insur- Exhibit 6 Capital Injected as a Percentage of Total Capital & Surplus (29-211) Grouped by solvency type, based on capital & surplus as of year-end 211. 6 4 3 2 1 (<1%) (>1% & <18%) (>18%) Statement File Global, A.M. Best estimates Exhibit 7 Capital Injected vs. Year-End Capital & Surplus (211) Capital & Surplus PICC P&C Co. Ltd. China Pacific Property Ins Co. Ltd. Ping An P&C Ins Co. of China, Ltd. China Life P&C Ins Co. Ltd. China Continent P&C Ins Co. Ltd. Sinosafe General Ins Co. Ltd. Bank of China Ins Co. Ltd. Capital Injected 1 1 2 2 3 4 RMB Billions China Insurance Regulatory Commission, company websites and financial reports, A.M. Best research Exhibit 8 Net Premium Leverage by Solvency Type (29-211) 6% % 4% 3% 2% 1% (<1%) (>1% & <18%) (>18%) % 29 21 211 Note: (Net Premium Written/Capital & Surplus) Best's Statement File Global 3
Exhibit 9 External Debt Leverage by Solvency Type (29-211) Three-year average of external debt/capital & surplus. 6 4 3 2 1 (<1%) (>1% & <18%) (>18%) Statement File Global; A.M. Best estimates Exhibit 1a Major Subordinated Debt Issuance (211) (RMB Millions) Debt Type Company Issued Business Profile 1 PICC P&C Co. Ltd., Largest P/C insurer based on market share. 2 Sinosafe General Ins Co. Ltd. 8 Over 1 years of operating history. Annual reports, company websites Exhibit 1b Major Subordinated Debt Issuance Approved (212) (RMB Millions) Debt Type Company Issued Business Profile 2 Ping An P&C Ins Co. of China, Ltd. 3, Second largest P/C insurer based on market share. 3 China Life P&C Co. Ltd. 2, Parent China Life Group owns China s largest life insurer. 3 Sunshine P&C Ins Co. Ltd. 1, Ranked 7th in terms of direct premiums written. Annual reports, company websites 4 ance entity or with an insurance group background (see Exhibits 1a and 1b). Outlook on Insurers Capital Adequacy Although improved operating results will have a positive impact on ROE, improvement in this regard is expected to be marginal amid the continued competitive environment. Slower premium growth will instead intensify competition as well as limit improvement in cost efficiency. The relaxation of the investment cap on bonds and equities, as well as the broadening of the investment channel to private equities, unsecured bonds, hybrid and convertible bonds and real estate investments, may enhance investment yield. But insurers will need proper tools to manage the embedded investment risk. As rapid premium growth had been the key factor that pressured insurers capital adequacy over the past few years, a slowdown of industry premium growth in 212 may somewhat favor insurers solvency level over the near term. Assuming a stable level of operating profitability (equivalent to the 29-211 average) with premium growth similar to 212, and insurers should generate ROEs that outpace premium growth over the next year or two, enabling them to maintain or moderately improve current solvency levels organically in the short term. insurers will be required to remain prudent in managing premium growth to maintain stable solvency levels in view of their relatively lower historical ROEs than those of insurers in general. The overall solvency of insurers is expected to improve moderately in 212 as insurers within this group had issued either subordinated debt or new equities during the year. However, the group s overall solvency level is expected to decline after 212, as its younger insurers may continue pursuing high premium growth that exceeds their historical ROE over the next year or two. Their solvency level should remain above 1%, the minimum level required to qualify for minimal regulatory supervision by CIRC. All in all, insurers with a track record of generating sound ROE will have a higher buffer to pursue a growth strategy that exceeds industry growth and maintain their
solvency through organic capital growth. Otherwise, external capital will be required to support their excessive business growth in the near term. Exhibit 11 Direct Premium Growth (29-212) From a longer term perspective, insurers with high external debt leverage will encounter solvency pressure due to the proportional depreciation on the admissible value of the subordinated debt after its fourth year before maturity (see Exhibit 11). Insurers with high financial leverage will need to find new sources of capital to replace or repay their subordinated debt issuances over the long run, which could lead to issuing further equity. The relaxation on insurance groups issuance of subordinated debt may enhance the permanency of capital injections for non-life insurers owned by insurance groups, as the subordinated debt can be issued at the group level and cascade into non-life subsidiaries as permanent capital. However, non-life insurers with weak affiliates (particularly life insurance affiliates) may not benefit from this new rule, as the parent insurance group may choose to allocate the funds raised from subordinated debt issuance to entities with higher and more imminent capital needs rather than the non-life entities. If those funds are not allocated based on riskbased returns, but merely based on the weakness of current capitalization within an organization, pressure will mount on other profitable operations to service the debt. In the future, the anticipated migration to a Solvency II (or risk-based capital) standard in 21 or 216 may trigger another round of new capital-raising activities, as the new regime may tighten solvency requirements regardless of the rate of industry premium growth. RMB Billions Direct Premium Written 6 4 3 2 1 Year-over-Year Growth 4 29 21 211 212 China Insurance Regulatory Commission 3 2 2 1 1 % Change Exhibit 12 Admissible Value of Subordinated Debt Subordinated debt will depreciate on a proportional basis. % of Debt Value Years Before Maturity Discounted > 4 years % > 3 years & < 4 years 2% > 2 years & < 3 years 4% > 1 year & < 2 years 6% < 1 year 8% China Insurance Regulatory Commission
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