Deutsche Bank Markets Research Asia Hong Kong Banking / Finance Insurance Industry China Insurance Sector Date 14 April 2016 Forecast Change Low interest rates – why China will not be a repeat of Japan/Taiwan Staying positive – Negative spread concerns overdone ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Esther Chwei Research Analyst (+852 ) 2203 6200 esther.chwei@db.com Lexie Zhou Research Associate (+852 ) 2203 6180 lexie.zhou@db.com Key Changes Company Target Price Rating 0966.HK 27.40 to 30.80(HKD) - 1336.HK 33.70 to 36.20(HKD) - 1508.HK 2.56 to 2.42(HKD) - 2318.HK 48.80 to 51.90(HKD) - 2601.HK 36.60 to 39.40(HKD) - 2628.HK 27.80 to 29.90(HKD) - 601318.SS 44.10 to 46.60(CNY) - 601336.SS 30.40 to 32.50(CNY) - 601601.SS 33.00 to 35.40(CNY) - 601628.SS 25.10 to 26.80(CNY) - Source: Deutsche Bank Top picks China Life (2628.HK),HKD19.16 Buy CTIH (0966.HK),HKD17.14 Buy Source: Deutsche Bank Companies Featured China Life (2628.HK),HKD19.16 Buy Ping An (2318.HK),HKD37.55 Buy CPIC (2601.HK),HKD28.95 Buy NCI (1336.HK),HKD27.65 Buy CTIH (0966.HK),HKD17.14 Buy PICC Group (1339.HK),HKD3.35 PICC P & C (2328.HK),HKD14.30 China Re (1508.HK),HKD2.08 Hold China Life (601628.SS),CNY23.47 Buy Ping An (601318.SS),CNY31.92 Buy CPIC (601601.SS),CNY26.25 Buy NCI (601336.SS),CNY40.22 Hold Source: Deutsche Bank The expectation of prolonged low interest rates in China has resulted in a sector de-rating due to concerns that Chinese life insurers could repeat the negative experience of their Taiwan (TW) and Japan (JP) counterparts. We disagree. Our analysis of the issues leads us to conclude that the sector is well placed thanks to a relatively mild rate decline, low guarantee rates, sufficient long-term assets (>10 years) to cover fixed-rate liabilities, a high proportion of par policies (semi-flexible cost) and low penetration. We believe the sector should benefit from strong growth and lower cost pressure amid declining rates. We reiterate our positive view. Top picks: China Life and Ch Taiping. Why China is unlikely to repeat Taiwan/Japan’s experience The negative spread issues in TW/JP were severe for three key reasons: (1) a prolonged high interest rate environment in the 1980s-1990s during a high-growth phase of the TW/JP life insurance markets resulted in high guarantee rates (HGR), which was followed by (2) a severe interest rate decline of ~13.1ppt in TW (1982-2004) and 8.5ppt in JP (1980-1994) and (3) by the time interest rates stabilised at low levels (early 2000s), the TW/JP life markets were relatively mature, with 11.4% and 6.4% penetration, respectively, making it harder for insurers to dilute in-force policies with new, low-GR policies. The situation facing Chinese life insurers now is very different, in our view. Reasons why Ch life insurers are well placed for low interest rates We believe Chinese life insurers are well placed for the following reasons: (1) the low GR in China, with listed insurers averaging 2.5-2.8% vs. current 10-year government bond yields of 2.9%; (2) a relatively mild rate decline, with current bond yields (down 1.8ppt since end-2013) within the historical range, albeit at the low end; (3) sufficient long-term bonds (>10 years) to cover fixed-rate liabilities, as evident by the substantial bond gains recorded in 2015, with average bond yields of 4.7% in 2015; (4) the high proportion of par policies (>80%), which allows insurers to pass on inv yields pressure, and we note a high correlation between China Life’s par dividends and its total inv yields historically; and (5) the current low penetration of 2.4% (similar to JP in 1970 and TW in 1987), which allows ample room for the sector to grow protection policies and ease reliance on inv spreads. In fact, we believe that the current low deposit rate environment should boost insurance sales and lower insurers’ liability cost pressure, with policyholders more inclined to accept lower returns. Reiterating Buy on all life insurers; valuations too cheap to ignore We raised our target prices by 6-12% on the back of stronger-than-expected 2015 results (please refer to pages 12-13 for details). We see significant value (31-80% upside potential) with the