Poca Wander Stock
One man’s misery is another man’s gain, the old saying goes. Or perhaps “one man’s uncertainty” is more apt in the case of ZhongAn Online P & C Insurance Co. Ltd. (OTCPK:ZZHGF, OTCPK:ZZHGY, 6060.HK), which is cruising through China’s prolonged economic slowdown on strong demand for its insurance. The company is setting itself apart from many other businesses that are suffering by making money from products that guard against various types of uncertainty.
Last week, ZhongAn said it collected 2.4 billion yuan ($333.4 million) in gross written premiums last month, up about 20% from January 2023. That’s slower than the 37.5% year-on-year increase the company posted for the figure in the first half of last year, but still respectable, especially in the face of China’s current economic headwinds that are causing consumers to grow increasingly cautious.
In fact, the latest monthly growth marks a big improvement over January 2023, when ZhongAn’s gross written premiums increased just 1.5% year-on-year before the pace picked up in the following months. The company’s gross written premiums for all of 2023 rose 25% to 29.5 billion yuan.
Here we should note that the strong start to this year could also be partly due to timing, since the long Lunar New Year holiday fell in February this year but was in January last year. That means we’ll probably need to wait for February data before making a final call on how 2024 is beginning for this provider of innovative insurance products.
ZhongAn’s shares rallied 10% in the two trading days after its latest announcement amid a broader stock market rally after the Lunar New Year holiday. But like most China plays, its shares are still down about 27% this year.
Founded in 2013 by Alibaba, Tencent and financial heavyweight Ping An Insurance, ZhongAn made a name for itself in its early days for a product covering costs for returning goods purchased on Taobao, Alibaba’s popular online marketplace, which falls into its “digital lifestyle” business. Over the years, it has been trying to beef up other products types, especially health insurance, which has become one of its two biggest product lines, along with digital lifestyle products.
In the first half of last year, the digital lifestyle segment accounted for the lion’s share of ZhongAn’s revenue growth. During the six months, its gross written premiums from such products surged nearly 53% year-on-year — the fastest growth rate among its major business lines, to account for about 40% of its total gross written premiums, compared to 35% for health insurance.
Digital lifestyle products may continue to drive ZhongAn’s revenue growth. Fees for such products are generally small, so they’re unlikely to worry cost-conscious buyers seeking protection against problems with their online purchases, even in the weak economy in China is currently experiencing as slumping property and stock markets sap household wealth.
The digital lifestyle segment also includes travel insurance, which can cover anything from flight delays to hotel cancelations. Demand for such products may grow as Chinese consumers engage in “revenge travel” – a sector that is holding up better than most after three years of Covid restrictions. In an encouraging sign for ZhongAn, official data showed that tourism spending in China during this month’s Lunar New Year holiday grew by more than a third from last year and even exceeded the level in 2019, the last year before the pandemic.
Profitability challenges
ZhongAn is doing relatively well when it comes to growing its revenue, but profitability can be quite a bit trickier. For starters, margins for digital lifestyle products are much lower than for the company’s other business lines. Although operating expenses are relatively low for digital lifestyle products, ZhongAn paid out more than 68% of gross written premiums from that category in claims and associated costs in the first half of last year.
As a result, the so-called combined ratio — all payouts for claims and other expenses as a proportion of gross written premiums — was 99.8% for digital lifestyle products. Put differently, the company pocketed a meager 20 cents in profit from every $100 in gross written premiums from these products. By comparison, the ratio for health products was substantially better, at 92.5%.
Since the margin for the digital lifestyle segment is low, its growth can actually hurt ZhongAn’s profitability if it greatly outweighs increases in sales of other product types. That said, ZongAn’s overall insurance margin has been continuously improving since the company made an underwriting profit for the first time ever in 2021. In the first half of last year, its combined ratio improved by 0.7 percentage points to 95.8% from a year earlier.
Investment income, a key contributor to insurers’ overall profit, is another big variable for ZhongAn. The company is taking a conservative approach to investment, allocating the vast majority of its assets to fixed-income investments, which are safer than equities that have been quite volatile recently. At the end of June, fixed-income investments accounted for more than 82% of ZhongAn’s total investment assets, up from about 78% a year earlier.
In its interim report, ZhongAn said it will keep the proportion of its fixed-income investment steady. That will certainly help to shield the company from volatility in stock prices, which in the past resulted in big swings in its earnings when it was much less risk-averse than now.
But in China’s current low-interest environment, this investment strategy poses its own challenges. Yields on debt investments will continue to be low, and could fall even further if China’s central bank cuts interest rates this year – something many expect to happen. Just this Tuesday, the central bank cut a key interest rate in an effort to shore up the property sector.
Likely reflecting the growing difficulties of boosting returns on its investments, 15 analysts polled by Yahoo Finance expect ZhongAn’s profit to fall by 8% this year, even as they forecast 13% revenue growth.
ZhongAn shares currently trade at a decent forward price-to-earnings (P/E) ratio of about 11, far higher than the 3.5 for Ping An Insurance (2318.HK; 601318.SH; OTCPK:PNGAY). That indicates investors seem to favor ZhongAn, perhaps with good enough reason due to its focus on smaller, more affordable products that are likely to weather China’s economic downturn better than traditional products like life insurance.
Disclosure: None.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
