22 March 2019
By David Palmer, Co-Fund Manager HC Verbatim Portfolio 5 Income Fund
Asia is undergoing a demographic transition. As incomes expand and family size decreases, it is heading for ageing patterns comparable to those of Western economies. Unlike in previous years, families can no longer rely on their offspring for financial support in retirement. In addition, Asian governments do not provide public pensions and healthcare, leaving saving for retirement and health insurance coverage in the hands of individuals and the private sector. This combination of long-term trends with limited government intervention creates an attractive opportunity for a few selected life and health insurance providers.
The market for savings and protection is vast and underpenetrated
The ageing of Asia is driven by thematic change and is inevitable. It is anticipated that Asia’s over-65 population will almost triple by 2050, to a staggering 700 million people. With limited government provision of pensions, individuals are left with significant pension protection gaps. Notably, by 2050, China will need to have saved 120 trillion dollars and India 85 trillion dollars to meet the retirement needs of their populations. However, life insurance savings penetration is modest, even in the highest income economies.
Source: Prudential Investor Day
Health insurance presents a similar revenue growth opportunity. As individuals are left with the financial responsibility for their health care needs, out-of-pocket health expenditures are large, amounting to around half of the total health cost. The same number is in the low teens for most developed economies. Once again, the market is critically underpenetrated, with less than 3% of individuals having private health coverage. Notably, the health protection gap in 2017 was estimated to be 1.8 trillion dollars, evidencing the size of the market opportunity.
Source: Prudential Investor Day
Finally, robust economic growth is resulting in galloping wealth creation, of about 5tn dollars per year. However, Asian savers lack investment options for their savings. Mutual fund penetration is in in the low teens, a fraction of markets, such as the US where penetration is close to 100%. Notably, countries such as Singapore, Hong Kong and Taiwan already have wealth levels compared to those in western countries, while China, Malaysia, Thailand, Indonesia and India are catching up quickly.
Life insurance companies are taking advantage of these opportunities
An underinsured middle class, together with a rapidly ageing population, create a vast market opportunity for life insurance providers operating in Asia. Savings products, wrapped as life insurance policies, are addressing pension saving needs. In addition, life insurance contracts can have health insurance features, providing coverage for critical illness and accident. Finally, wealth management has become increasingly available, addressing the financial needs of the most affluent segments of the population.
What makes Asian life insurers good investments?
Besides growth opportunities, Asian life insurers have excellent business economics. The industry is concentrated and enjoys deep moats, allowed by high quality brands and hard to replicate agency and bank assurance networks. Brands have been established over many years, by building a reputation of timely and accurate payment of claims. A new entrant will not be able to replicate this without significant time and investment. Capital requirements are low, as products have very limited investment return guarantees, since investment risk is on the side of the policyholder. This presents a sharp contrast with European and especially American life insurers, where capital-intensive products make equity performance hostage to macroeconomic variables and financial market sentiment. In addition, insurance policies sold in Asia cover risks that are statistically predictable and stable, namely mortality and critical illness, which is another contributing factor to the lower capital intensity. Consequently, protection products have higher margins, allowing for higher profitability. In summary, this is a very distinct business model from US or European insurers, as the capital light nature of products makes Asian life insurers comparable to a commission broker.
What can go wrong in Asian life insurance?
Despite the very positive picture, the Asian life insurance market is not without risks. Growth opportunities are increasingly biased towards mainland China, exposing companies to the specific political, regulatory and economic risks of this vast country. That said, this market presents the largest revenue opportunity, not only for its size, but also by prospective changes in ownership of foreign subsidiaries, allowing for full ownership. This will permit complete strategic control, which should translate to accelerated revenue growth. Hong Kong is another large but risky market, due to its special relationship with mainland China, namely as a savings hub for US dollar exposure. Finally, the risk of an Asian pandemic cannot be discarded. However, we are reassured by the prolific use of reinsurance, especially of mortality and critical illness risks. This should protect the Asian life insurers from severe losses by effectively distributing these risks across the global insurance industry.
How are Sarasin’s clients benefiting from these opportunities?
Our investors are exposed these attractive dynamics through our investments in AIA and Prudential. These two companies combine high quality management, robust revenue growth, solid product portfolio (focusing on savings and protection) and a balanced distribution network, comprising of both agency and bank assurance. We have considered investing in mainland Chinese insurance, but their questionable corporate governance structures, opaque reporting and pervasive government interference in management, lead us to regard them as inferior value creating opportunities. Finally, we have also considered investing in the industry’s third biggest player, the Canadian insurer Manulife. We were attracted by the distinctive wealth management proposition in its John Hancock franchise. However, the unpredictable nature of its US long-term care business has kept us back.
The most attractive global insurance opportunity
Asia presents the most extraordinary investment prospects in global insurance. This group of investments has robust thematic underpinnings, namely ageing, which will propel growth in pensions, health and life insurance, as well as wealth management. In addition, equity holders should benefit from low risk business models, fee based revenue streams, together with highly reputed management. For these reasons, we expect Asian life insurance to remain a core holding in our portfolios for the foreseeable future.
The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. This article is for information only and should not be deemed as advice.