Searching for a company holding a dominant share of an underdeveloped market in the world's fastest-growing economy? No, I'm not talking about wireless behemoth China Mobile (NYSE:CHL) -- though there's a strong investment thesis to that story -- but rather about China Life Insurance (NYSE:LFC), the largest player in China's nascent life insurance market.
I know, I know . it sounds as though I need insanity coverage to be writing about a Chinese insurance company at a time when the pundits (and I use that term loosely) on CNBC and elsewhere are advocating a general rotation out of emerging-market stocks and into large-cap defensive plays. Well, call me Foolish, but I believe that China Life offers an extremely attractive risk/reward ratio to long-term investors who can see "the forest through the trees" because of its 44% share of the domestic life insurance market, the rapid growth of China's middle class, and an easing of government restrictions on certain types of investments.
Let's take a gander, shall we?
The Chinese life insurance market
To say that the Chinese life insurance market is in its infancy is akin to saying the ocean is wet. According to a Swiss Re report titled World Insurance in 2004: Growing Premiums and Stronger Balance Sheets, China had just a 1.9% share of global premium volumes at the end of 2004 -- pretty minuscule when you consider China's population of 1.3 billion -- with insurance premiums per capita of $27.30 and a premium-to-GDP ratio of just 2.14%. To put these numbers in perspective, the global average for premiums per capita stood at $292.20 while the premium/GDP ratio averaged 4.53%.
Obviously, there's a fair amount of room for growth, especially when you toss in the rapid growth of China's middle class into the equation. A recent McKinsey report estimates that the ranks of the lower middle class in China will reach some 290 million by 2011 and that China will boast a middle-class population of 520 million by 2025, with consumer purchasing power in excess of $2.5 trillion.
While that's hardly quantifiable, I have to believe that most Chinese citizens are well aware that their government-promised safety net is fraying and are looking for ways to protect their financial futures. Just look at the situation in the U.S., where the General Accounting Office reports that by 2029, the Social Security Trust Fund will be exhausted. Life insurance plans, annuities contracts, accident coverage, and health insurance policies play into such scenarios. And I expect that, armed with their increasing purchasing power, the Chinese will increase their demand for these products over the coming years.
If the potential of burgeoning demand growth wasn't enough of an enticement, let's not forget the recent easing of governmental restrictions on the types of investments that Chinese insurers are allowed to make. In no particular order, these include, among others, the ability to invest in domestic corporate bonds, purchase shares in the domestic stock market, use foreign currency-denominated insurance funds to make deposits in foreign banks, and purchase shares of Chinese companies listed on foreign exchanges.
Since the Chinese Insurance Regulatory Commission has capped the maximum guaranteed rate that life insurers can commit to payout on new policies at 2.5%, the easing of investment restrictions should allow life insurers to generate investment yields substantially ahead of their obligations and add to their bottom lines.
Let's not forget that the Chinese government has recently been raising interest rates as well, a factor that should increase the income of insurers' domestic bank deposits, or that a strengthening renminbi will allow insurers to get a greater bang for their buck in overseas investments.
Ok, enough of the generalities. Now on to specifics -- namely, China Life.
China
Life Insurance
China Life is the largest life insurance company in China by virtually any metric: It holds a 44% share of total life insurance premiums (its largest competitor, Ping An, has a mere 16% share), operates in 31 different provinces, and has a total base of more than 250 million policyholders.
The company has an unrivaled distribution network, employing 640,000 exclusive agents in 12,000 field offices offering individual policies, and a further 12,000 reps in 3,700 branch offices handling group policies. In addition, China Life has been diversifying its distribution channels, primarily through more than 89,000 outlets in commercial banks, post offices, and savings cooperatives -- not to mention its recent $580 million purchase of a 12% stake in Citic Securities (at a 38% discount to market price), a purchase that in the longer term will allow China Life to distribute its products via brokerage channels as well.
While many of the effects of the government's easing on investment restriction have yet to fully trickle down to China Life's bottom line, the trend is clear. The company reported investment yields of 3.9% in 2005, up from 3.4% in 2003, and well ahead of the average 2.23% rate of return offered to policyholders.
The combination of strong growth in written premiums and policy fees (up 22% in 2005) with the above-mentioned increases in investment yields allowed China Life to post a 30% increase in net profit for 2005 to $1.16 billion, or $1.72 per American Depositary Receipt. Going forward, Citigroup (NYSE:C) is projecting an average growth rate in earnings per share of approximately 24% through 2008, an estimate I find conservative, given the increasing investment opportunities mentioned above, as well as China Life's ability to increase its non-traditional distribution channels.
One further issue I'd like to address before turning to valuation is that China Life recently received an all-clear from the Securities and Exchange Commission concerning an informal inquiry launched back in April 2004 with regard to accounting issues related to its IPO. With this perceived cloud lifted, the company should have an easier time pursuing its ongoing plans to sell stakes to two or three strategic investors. If history is any guide, these investors will pay a hefty premium for their stakes in such a dominant player, a premium that could perhaps be used to issue a special dividend.
Valuation
After the recent run-up, shares of China Life aren't exactly cheap -- they trade at around 19 times fiscal 2007 estimates of $3.30 and around 3.3 times book value -- when compared with the likes of American International Group (NYSE:AIG), which trades at 10 times fiscal 2007 estimates and a mere 1.7 times book. That being said, I believe that China Life's greater growth prospects and its superior return on equity deserve such a premium. I would urge investors with a long-term outlook and a sizable level of risk tolerance to take a look at one of China's premier financial plays.
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Fool contributor Will Frankenhoff is enjoying his time writing for the Fool more than he enjoys playing golf, reading The Financial Times, or taking a nap. He does not own shares in any of the companies mentioned above and welcomes your feedback. The Motley Fool has a disclosure policy.
