Dearth of HK insurer information offers investment risk

The insurance industry is rapidly growing in Asia, leading to a concerning development where some companies are doing well despite offering relatively low amounts of information disclosure. This creates a danger of inaccurate valuations and poor share performance, finds the latest M&E BDO ASIAMONEY Hong Kong Stars index.

  • 15 Jan 2014
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The best way for insurance companies to insure their own stock success is to commit to transparency and strong business management standards. That, at least, is the lesson to take away from the performance of three of Asia’s top insurance businesses covered in the M&E BDO Asiamoney Hong Kong Stars index.

The stock index assesses about 300 data points from each of the 19 included companies, in order to measure their commitment to openness and management professionalism, together with the performance of key financial points such as revenue and net profit. These results are then tallied into a score that M&E calls ‘management value’. Companies with a higher management value get a bigger weighting in the index, although it also takes into account their respective market capitalisations.

The index is comprised of 21 Hong Kong-listed firms that offer the best financial performance and management practices. It includes two insurance companies, AIA and Manulife, which were analysed in this survey alongside eight of the largest Hong Kong-listed insurance companies operating in the region. M&E and BDO analysed the insurance companies with the same criteria used to create the index.

In terms of general performance the Asian companies do well. Ping An Insurance tops the rankings with an overall management value to market capitalisation score of 57.7% out of 100. Hong Kong-listed Prudential is second, with 56.5% and AIA comes third, at 52%, and Manulife Financial is fourth on 50.9%.

However dig into the results further and some discrepancies arise. It quickly becomes evident that the Asian insurers do so well because of their overall financial performance, where they heavily outperform their European rivals. In contrast, Asia’s insurers are fall short of the level of information disclosure and management practices of their peers in Europe and the US.

“We’ve never before had a situation where compliance scores are lower than performance scores,” admits Bill Cox, founder of M&E, which created the criteria used for the index. “Usually compliance is easier for companies to do well in because it’s all about possessing good practices and governance. Allianz for example enjoys a ranking of 80%-90% range in compliance.”

According to the research, the top 10 European insurers are likely to possess compliance scores of 75%-80%, where 100% demonstrates perfect information disclosure, management practices and regularity of financials. In contrast, the average score of the top 10 Hong Kong-listed insurance companies is only 46%.

A big factor holding these insurance businesses back from better scores is poor transparency; investors receive far less information about these businesses than is common in Europe, which makes them hard to assess and thus hard to predict whether they will perform well as businesses and as stocks.

It’s a risk that could potentially cause misevaluations and big share corrections.

Present performance; future risks

According to the study’s results, Ping An is greatly ahead of its competitors when it comes to its financial performance, with the company boasting strong return on equity (RoE), net income and profitability to give it a financial performance score of 0.83 on an open scale out of 1.

AIA comes second in this area at 0.7, enjoying good revenues, return on assets, RoE and profitability as well. Both companies have enjoyed steadily increasing profitability between 2009 and 2012, with AIA’s rising 72.1% across the three-year period and Ping An’s expanding by 84.7%.

From a compliance perspective the two insurance companies included in the index do relatively well. Manulife Financial ranks top for compliance, with a 67.1% score, Prudential is next at 61.3% and AIA is third at 56.8%. This shouldn’t be entirely surprising; all three of these companies are or were linked to international insurers, and thus should have better disclosure standards.

But Manulife and AIA rank particularly poorly when it comes to financial risk, a term that M&E takes to mean the volatility of the companies’ financial and management performance over the past four years. Convoy Financial is deemed riskiest, with a score of 0.64, where lower is better, but Manulife Financial is second at 0.575, PICC Property & Casualty is third at 0.465 and AIA comes fourth at 0.457.

Investors into regional insurance companies might be unperturbed by the outcome, believing that less transparency and some financial risk is hardly that concerning if the end profits are high.

But for Cox this falls into the very rationale of the Stars Index, which was created as a means of demonstrating that companies that combine financial performance with good management and transparency outperform those that don’t.

“Financial performance is the equivalent of a person’s job and salary, and by this assessment these companies are doing well, while compliance and risk is more like their level of education; it ranks future prospects,” he says. “Low ranks of compliance make it harder to gauge a business and that can mean that future financial results and share prices choppier.”

Manulife falls short when it comes to the stability of its volatile net income between 2009 and 2012, in addition to weak income from investments. AIA’s score suffered from its inconsistent dividend payout and retention rates.

In contrast China Taiping and China Pacific Insurance enjoy the lowest risk score of 0.31, respectively. Prudential is third, at 0.34. BDO notes that the least risky insurance companies in Asia tend to have managed their finances through equity rather than debt, and have maintained stable levels of debt where it’s used.

Need for more information

While the insurance companies in the index perform reasonably well in terms of governance, the marked contrast of financial performance versus compliance among many of the other insurance companies offers some perplexing issues for investors.

Insurance is typically a strongly regulated sector that relies on predicting future social and demographic probabilities. In other words, the companies only succeed by employing sophisticated business models and projections. But the companies in Asia do not tend to volunteer information that they are not required to do, unlike European companies which tend to offer a great deal more analysis of their business projections and estimates.

M&E notes that useful information such as the value of new business, which measures the profits expected to come from new business and the amount of capital needed to support it, and the present value of new business, is not evenly revealed.

For example, Hong Kong’s regulators require insurance companies to follow strict solvency margins, but the companies do not have to disclose how they manage or finance their debts, which raises the risk of increased volatility of debt repayments.

China-based insurance companies were particularly at fault for substandard information disclosure. Benson Ngan, a senior associate at BDO, notes that while these companies meet their listing requirements they do not reveal much in the way of corporate social responsibility (CSR) information or compliance information that was not compulsory.

“Compliance consists of governance, or following rules and guidelines, transparency as a whole, sustainable management processes that help identify quality and risks, and some CSR,” adds Cox. “A number of insurance companies here don’t offer information unless they have to, and that makes it harder to work out their views and plans for the future.

“In general there is less transparency, ore volatility and less regulation than in Europe or in Brazil [the other major market covered by a Stars index]. That in turn increases the uncertainty surrounding their future share performance, both on the upside and the downside.”

This is a concern for investors because it makes it harder to analyse the business plans of these companies, or to really ascertain whether their prospects are good or not. “Companies like Allianz and Swiss Re post targets one year and then analyse their performance related to them the next, and investors can extrapolate costs and customer numbers and make an informed decision,” says Cox.

“Companies in Asia don’t offer that sort of detail; the impression you get is that they rely on investors to buy them mainly for their growth prospects. It’s a short-sighted view because investors don’t know whether their share value versus their business prospects and processes makes sense. And that risks creating unrealistic valuations and subsequent over-reactions.”

The industry of insurance is one that works best when the companies within it have a good understanding of social and demographic probability, which requires reliable and transparent information flows. But investors into these companies need the same.

Hopefully Asia’s insurance companies will start applying the sort of information disclosure standards to their own businesses that they demand of governments and their clients. Doing so would certainly be the best way to insure against market failure.

  • 15 Jan 2014

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