PICC begins pre-marketing

China''s largest property and casualty insurer hopes to raise $400 million to $500 million from its IPO.

Pre-marketing begins today (Tuesday) for what is expected to be an offering of 30% of PICC Property & Casualty Company. Early signs of strong demand will be critical to ensuring the Hong Kong listing a success, since the Chinese insurance sector is about to completely monopolise investors' attention over the coming two months.

Right alongside PICC, China Life looks set to embark on an almost concurrent offering schedule, with an analysts' meeting for its $2 billion deal scheduled to held later this week and pricing to follow two to three weeks after PICC in mid-November.

PICC's schedule will see pre-marketing wrap up in two weeks time, with roadshows commencing on October 13 and final pricing around October 29.

Morgan Stanley and CICC are joint global co-ordinators of the transaction, with Cazenove, Fox Pitt Kelton, Merrill Lynch and Nomura as co-leads onn the placement tranche. BNP Paribas Peregrine, China Everbright and CLSA are co-leads for the retail offering.

PICC is a much smaller proposition than China Life and should be able to take full advantage of the pricing leverage it will gain from the inclusion of a POWL (public offer without listing) in Japan via Nomura. This will account for up to 10% of the placement tranche, which will in turn comprise 90% of the overall offering (provided there are no clawbacks from the retail tranche).

Investors also note rumours that a strategic investor is poised to take a large proportion of the offering. Accounting for both the POWL and a strategic investment of up to 10%, this will bring the base deal size down to an extremely manageable $250 million to $300 million.

Investors say the leads are pushing two valuation metrics - price to book value (PBV), which will be used by institutional accounts and price to earnings ratio (PER), which will be used by retail. According to Chinese law, local companies must be floated above book value and preliminary estimates suggest that PICC is targeting between 1.1 and 1.4 times 2003 book.

China Life is said to be pushing for two times book, although life insurers are said to typically trade at a premium to property and casualty insurers.

Based on an issue of roughly 2.4 billion shares (30%) and a slight premium to PICC's 2003 PBV of HK$1.30 to HK$1.40 per share, the company will raise between $400 million and $500 million. There will be no dividend.

At these levels, PICC will price at a discount to international comparables, although as all who know the sector well are keen to point out, it is very difficult to make direct comparisons.

Given that so few of the major Asian insurance giants are listed, one of the main hurdles both PICC and China Life will face is a widespread lack of understanding about the sector. With China, investors also have to contend with all the regulatory and market risks associated with a country at particularly early, though fast growing stage of development.

In terms of international comparables, the leads are said to mainly be using Australian companies such as IAG and Promina. On a PBV basis, the global sector averages about 1.7 to 1.9 times book and on a PER basis 12.9 times 2003 earnings. PICC will be pitched around the 10 to 12 times level.

Where Asian comparables are concerned, there is Samsung Fire & Marine, which trades slightly below book value because of its high leverage. Some investors also highlight Fubon Insurance, now part of Fubon Financial Holdings.

Taiwan-based analysts say Fubon historically traded around 1.5 times book in the years before it was folded under the holding company umbrella. In the early days, when the country was recording similarly high growth rates to China, it traded up four to five times book.

As usual, the statistics underlying the China growth story are compelling. The country stands third behind Japan and Korea as the largest insurance market in Asia, with total premiums of RMB305 billion ($37 billion) in 2002.

Penetration rates, however, are miniscule, particularly for the non-life sector. According to Swiss Re figures, they stood at only 0.86% in 2001 compared to 4.57% in the US.

Growth has nevertheless been fast. The non-life sector has grown by a CAGR of nearly 13.5% over the past 10 years and PICC dominates with a 70% market share.

The company derives 66% of its revenues from car insurance, a segment that has always been strong because third party insurance is compulsory in China and ownership is rising fast.

A further 17% comes from commercial property insurance, which is also growing quickly as the government pushes state-owned enterprises to take out cover. The other major revenue segments are liability insurance (5%) and homeowners (3%).

Analysts say this revenue mix makes PICC difficult to stack up against international peers, since many US insurers are focused on liability cover and European insurers on catastrophe cover. Neither has proved very lucrative in recent years.

As Swiss Re again points out, the global insurance industry is estimated to have lost $180 billion, or 25% of its capital over the last two years because of a mixture of terrorist attacks, asbestos claims, mould claims, flooding and terrible equity markets, making investment returns difficult.

Alongside PICC's dominant market position, a second selling point is likely to be the company's profitability. The company has a particularly strong combined ratio - the main profitability measure for the non-life sector.

This combines the company's loss ratio (claims and reserves as a percentage of net earned premiums) and its expense ratio (underwriting expense as a percentage of net earned premiums).

Anything above 100% implies a loss and over the past two years, the global average has been 103% to 110%. PICC, on the other hand, still beats the average and recorded a combined ratio of 93.6% in 2001 (68.46% loss ratio and 25.14% expense ratio) though rising to 97.1% in 2002 (73.21% loss and 23.92% expense).

But its underwriting margin of 2.87% in 2002 is low.

One of the ways insurance companies make profits is by investing their premium income and pocketing the difference between what they pay out for the premiums and the gains they make on their investments. Unlike the life sector, Chinese property and casualty insurers do not suffer the same degree of negative spread issues, because they do not have 10-year policies guaranteeing investors unfeasibly high interest returns. Roughly 84% of PICC's gross premiums have a maturity of less than one year.

But falling equity markets have made it difficult for any global insurers to make decent investment returns and the problem is exacerbated in China by the embryonic state of the country's capital markets and restrictions on overseas investments. PICC is estimated to have made an investment return of just 2.2% in 2002.

A second major issue investors will query is PICC's undercapitalization. Like Samsung Fire & Marine, PICC is highly leveraged.

In the non-life sector this is measured as a ratio of net written premiums (NWP) to surplus. Pre-IPO PICC, recorded a ratio of 3.61 times, which means it has less capital relative to premiums compared to global peers averaging 1.29 times according to CSFB research.

Indeed, one of the main reasons for the IPO is to bolster the company's capital base and post offering, its ratio will improve to a range of 2.5 to 3 times.

During roadshows, the company is also likely to emphasise that its focus has switched from market share to profitability. Its new strategy is based around "the three centres." This involves the centralization of its 4,000 strong branches into a network of 326 profit centres.

A centralized database in place of a myriad of written ledgers should not only enable the company to improve its claims management and loss ratio, but also provide it with the kind of national platform that few new foreign or domestic entrants will be able to match. Analysts believe that over the long-term PICC's market share will fall to a mid 60% level, but they argue that premium erosion will stabilise.

Following de-regulation last year, premiums fell by up to 10% in the nine months to March. Since then, however, they have started to flatten and analysts conclude this mirrors the experience of other Asian countries where the insurance sector has been de-regulated over the past five years.