Hong Kong braces for insurance mega-IPO

Commetary: PICC Group faces hard sell

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By Craig Stephen

HONG KONG (MarketWatch) — Hong Kong is trying to break a famine in new stock listings with one its biggest IPOs in two years. But as the up-to-$3.6 billion listing of Peoples Insurance Co. Group of China prepares to float, it’s less clear if there’s much to tempt investors.

Despite recent strength in Hong Kong’s equity market, investor sentiment remains fragile. Absorbing this listing looks ambitious for a number of reasons.

A key issue is the size of the offering. This looks like a big ask despite cornerstone investors being lined up to soak up $1.3 billion of the paper. AIG Group AIG +0.43%   is in for a hefty $500 million.

Reuters Enlarge Image

PICC Group management pose for photos before attending an investors meeting in Hong Kong earlier this month.

A more fundamental issue for investors is why do they need to own PICC Group in the first place?

On the face of it, having exposure to China’s largest general insurer sounds appealing — it should merit being a core holding for many institutional investors.

The problem is investors already have it: PICC listed its property-and-casualty unit in 2003 in Hong Kong, as PICC P&C HK:2328 -0.39%   PPCCY +4.06%  .

What is coming now is the parent. The big difference appears to be it now also includes a life business, which was launched in 2005. So effectively, you’re buying the PICC Group vehicle for exposure to its new life business.

But it is less clear how attractive this business is. While it does appear to have grown at a brisk pace — now ranked fifth in terms of new premiums in the first nine months of this year — earnings quality is under the spotlight.

For one, it is heavily weighted towards single-premium savings products. It’s easier to ramp up sales of these faster than traditional life products, being similar to bank term deposits. But as a rule of thumb, mainland Chinese insurance companies find this business lower quality and more challenging to generate profits.

The insurer needs to be able to generate higher returns over a short duration, which can be demanding when bank deposit rates are lowered, as we saw earlier this year. The other side of the coin is that rising bank deposit rates can lead to these single-premium products being redeemed early, as savers opt for better savings rates.

For these reasons, China’s life-insurance industry has being trying to shift growth to traditional life or long-term saving products.

Here PICC Group lags well behind its rivals. Eighty-six percent of its life business came from single-premium products in 2011. This compares unfavorably to China Life HK:2628 -0.44%   LFC -0.54%  at 36% or Ping An HK:2318 +0.43%   PNGAY -1.69%  at 17%.

Another potential area of weakness is a reliance on bank distribution for policy sales. China’s huge banks are typically in a strong position to drive a hard bargain on bancassurance-distribution agreements. Again PICC Group lags behind its peers. It generates 69% of sales through banks, which puts it well above China Life at 46% and Ping An at just 10%.

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At the moment PICC still gets about 90% of its core business from its property and casualty insurance, so life is relatively small.

There are also some uncertainties facing its core general insurance business as the industry prepares for deregulation and more competition.

At the moment with auto insurance for example, it is heavily regulated to the extent the government sets mandated pricing levels that ensure profitability. Reform is expected within the next year, according to reports cited by Barclays Capital. One consequence of this is you can expect more price competition, which could challenge profitability for incumbents like PICC.

Investors will look for clarity on this and exactly where new capital will be deployed — life insurance or general insurance?

Another consideration is that an impressive line-up of cornerstone investors is not always the best indication of secondary-market value of the shares. This deal has 17 cornerstone investors in total.

Regulators in Hong Kong have raised concern before that cornerstone investors can accrue value in other ways, not reflected in the share price. For instance, AIG’s subscription of $500 million includes a commitment to form a life-insurance joint venture by the end of May next year. Otherwise it can sell its stake.

Another factor that could weigh on valuations is the company’s structure. Investors are effectively being asked to buy a group parent company, which often leads to a holding-company discount. One way to rectify this would be to delist its existing Hong Kong subsidiary, although the company has ruled this out, say Macquarie analysts.

It looks as if the main reason PICC Group is listing in this form is to raise capital as its solvency ratio comes up against regulatory thresholds, according to reports. For investors to come to the table, pricing of the issue will need to be keen. After all, there are plenty other choices among straight life companies.