Life Insurers' Risk and Expense Margins to Improve Slightly
The author is an analyst of NH Investment & Securities. She can be reached at michelle.cho@nhqv.com. -- Ed.
Non-life insurance firms saw double-digit (y-y) NP decline for the past two years. However, their earnings are set to make a meaningful turnaround from 2Q20, backed by: 1) improving auto and long-term risk loss ratios, thanks to Covid-19 (2Q20); 2) full-fledged auto loss ratio improvement on past auto premium hikes (2H20); and 3) stabilizing expense ratios amid easing new contract competition.
At life insurance players, while risk and expense margins are to improve slightly, interest margins are to deteriorate sharply. Covid-19 benefits and cost-savings efforts should drive improvement in risk and expense margins, respectively. However, interest spreads should worsen, affected by the sustained interest rate decline since early-2020, with large-scale provisioning of guarantee reserves likely required in 4Q20.
Insurance shares could emerge as attractive defensive stocks if 2H20 economic improvement fails to meet expectations. Noting loss ratio cycles and earnings sensitivity to interest rates, non-life players are likely to be highlighted. We recommend Hyundai M&F as a sector top pick.
[Non-life] Auto loss ratio improvement cycle kicking in
Three rounds of auto insurance premium hikes have occurred: +3~4% in Jan 2019; +1~2% in Jun 2019; +3~3.5% in Jan 2020. In light of the time gap between premium hikes and earned premium improvement, auto loss ratio was expected to improve from 4Q20. That said, the improvement cycle appears to have kicked in earlier than expected, thanks to widespread adoption of social distancing amid the Covid-19 pandemic; according to press reports, auto loss ratio at the top three non-life insurers stood at 92% in Jan, 87% in Feb, 79% in Mar, and 80% in Apr. While the chances of an additional premium hike within 2020 look low, 2020 loss ratio should improve thanks to the previous increases.
Long-term risk loss ratio to show y-y improvement
In our view, long-term risk loss ratio is to benefit the most from the Covid-19 pandemic. As the spread of Covid-19 has encouraged the public to comply with strict hygiene practices and restrain from unnecessary hospital visits, overall insurance claims have declined. Noting the average one-month time lag between hospital visits and insurance claim applications, the decline in long-term risk loss ratio stemming from Covid-19 should become more pronounced from 2Q20; in particular, strong improvement is likely for April and May. Loss ratio is to rebound once the Covid-19 pandemic is over; however, considering that daily hygiene practices have become routine among many people, insurance claims are unlikely to exceed last year’s level. Around the MERS crisis in 2015, risk loss ratio improved by about 10%p.
New contract competition to ease from 2020
Non-life players look seriously fatigued from the intense new contract competition observed between 2018 and end-2019. Following the lead of Meritz F&M (Dec 2019), top-tier non-life companies have refrained from engaging in intense new contract competition by reducing commissions to GA(general agency)s. The decline in face-to-face contact due to Covid-19 has also contributed to easing market competition. While drivers’ insurance sales increased over April and May, the phenomenon should prove temporary, with little impact on overall new contracts and expense. Expense ratio is to improve in 2020, on: 1) greater deferral of policy acquisition costs; 2) reduced new contracts; and 3) GA commission rate cuts; average expense ratio is estimated to improve 1.1%p y-y to 21.9% in 2020.
Earnings to rebound
In 2020, the non-life sector is to enjoy a meaningful earnings rebound, following two years of tepid earnings and double-digit NP decline. Combined 2020 NP at the five non-life firms under our coverage is to rise 35.2% y-y to W1,951.1bn. By company, NP is to climb 19.7% y-y for Samsung, 19.4% y-y for DB, 58.9% for Hyundai (18.9% excluding Gangnam building disposal gains), 12.2% y-y for Meritz, and TTP for Hanwha.
Main earnings growth drivers include: 1) low-base effect; 2) benefits from the Covid-19 pandemic (1H20); 3) auto insurance earnings turnaround (2H20); and 4) expense ratio improvement. Potential risks include: 1) a rise in medical insurance claims in 2H20; and 2) a y-y decline in disposal gains (high-base effect). Barring the unexpected, non-life sector earnings should continue to improve in 2021 on sustained improvement in auto loss and expense ratios.
[Life] Risk and expense margins to improve, but deteriorating interest margins to weigh on earnings
Risk margins: Having risen steadily since 2019, loss ratio should stabilize in 2Q20, thanks to Covid-19 benefits (fewer hospital visits → reduced insurance claims). Average 2020 loss ratio at four coverage life insurers is estimated to decline 0.4%p y-y to 84.4%.
Expense margins: A slight y-y improvement is likely, thanks to: 1) low risk of intense new contract competition (focused on GA commissions); and 2) cost savings efforts across the industry.
Interest margins: A falling market rate is posing a threat by: 1) raising guarantee reserve burden for variable insurances (a portion of 1Q20 provisions to be reversed in 2Q20, but large-scale additional provisioning to be required in 4Q20 due to interest rate decline); 2) weakening interest spreads, due to decline in investment yields; and 3) limiting end-year LAT surplus, embedded value (EV), and VIF. That said, 2020 NP and dividend should vary by company, depending on each play’s non-interest income sources and non-recurring profit levels (eg, disposal gains).