China Insurance Sector:Rising new money yield further alleviates negative spread concern

What’s new: Our New Money Yield Tracker suggests a continued rise in the weighted average new money investment yield for China insurers in January 2017. (See P10-11of When the tide turns: 7 themes for 2017 , 5 January 2017, for the calculation method used for our Tracker).

    What’s the impact: New money yield on a steady recovering trend. For January 2017, our New Money Yield Tracker stood at c.4.3%, 36bps higher than 3 months ago and 4bps higher than in December 2016 when the system liquidity in China was seasonally tight. The steady trend in new money investment yield was attributable to the continued rise in risk-free rates in China, though the corporate bond credit risk spread narrowed MoM from a panic level in December 2016. Rising wealth management product (WMP) investment yields also helped the growth of the new money investment yield.

    Negative-spread concern further lifted. We have been calling for an upward trajectory in market interest rates in China since mid-November 2016 (See What does a Trump presidency mean for China Financials?, dated 10 November 2016). PBOC’s recent open-market operations confirm the interest rate upcycle. Over the past 2 years, concerns over the potential negative spread from the market’s low interest rate expectations have remained the main negative for the sector. Now that the rising yield trend is confirmed, we think such concerns will likely be further alleviated.

    Reserve top-up pressure will likely peak in 1H17. We expect the reserve top-up pressure on China life insurers to likely peak in 1H17, alleviating the negative impact from the reserve top-up on the 2017 bottom line. On our estimate, if the treasury spot rate goes up by 100bps in 2017, 4Q17 could see the 750-day average rate movement enter positive territory. If the treasury spot rate does not increase further from what it is now, Chinese life insurers should see a positive YoY impact on their reserve top-up from 3Q17 onwards, in our view.

    What we recommend: We believe our top pick since late-2016, NCI (1336HK, HKD40.75, Buy [1]), is in the best position to benefit from both the life insurance industry turnaround and the company-level premium-mix transformation. We also continue to recommend China Life (2628HK, HKD24.45, Outperform [2]), which we had upgraded on 5 January.

    How we differ: We had downgraded Ping An (2318HK, HKD42.10, Hold [3]) on 5 January due to the asset quality and capital headwinds we see for Ping An Bank in 2017, and the fact that the financial conglomerate will benefit less from the life industry turnaround.