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After Chaucer deal, China Re faces hard road in building life insurance business

China Reinsurance (Group) Corp. is likely to set its sights on building a presence in life insurance now that its purchase of U.K. reinsurer Chaucer PLC is underway, and an acquisition is the likeliest way forward, observers said.

China Re Chairman Yuan Linjiang said in April that the company would seek to acquire a midsize reinsurer in a developed market and that having a life insurance offering would help bolster investor interest, pointing to the company's low valuation compared to other Chinese insurance groups. The Chinese reinsurance group is majority state-owned, but has a free float of just over 15% on the Hong Kong Stock Exchange.

"It is a feature of reinsurance companies to have relatively low return on equity [compared to primary insurers] and we feel we are undervalued [by investors]," Yuan told reporters at the time.

China Re made its midsize reinsurance play in September in announcing its plan to acquire London-headquartered Chaucer, which executives said would boost the Chinese company's influence at Lloyd's of London and in the specialty insurance market.

"Chaucer has ... good operating results and this is helpful to improve China Re's ROE," China Re President He Chunlei said during an investor presentation in September. Chaucer's annualized ROE in the first half was 9.9%, compared to 6.2% at China Re for the same period.

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Boosting ROE with life insurance operations

That relatively low ROE relative to other listed Chinese insurers is why China Re is not a popular stock among investors, a Hong Kong-based investment director told S&P Global Market Intelligence. The investment director holds China Re shares in his portfolio.

Since pricing its IPO at the top end of its indicative range in October 2015, China Re has traded below its HK$2.70 listing price virtually since it began trading. It closed down 2.8% at an all-time low HK$1.39 amid a broad market sell-off Oct. 11, and is down nearly a quarter since late May alone.

Another factor deterring investors is the complexity of reinsurance, compared to life insurance, which also has more visible growth prospects in China owing to an aging population and growing disposable income, the investment director said.

"Financially, it is the right thing for China Re to do to acquire a life insurance unit," said Ken Shih, research director at DBS Vickers Securities in Hong Kong. "Life insurance [business] has longer-term liabilities and hence higher financial leverage ratios, which could in turn benefit ROE."

China Re is the only large Chinese insurance group without a life or health primary insurance unit. As of June 30, approximately 75% of the company's net profit came from its property and casualty reinsurance and life and health reinsurance segments, while just over 20% of net profit was generated by its primary P&C arm.

"If China Re wants to improve its ROE, it makes sense for them to obtain a unit with higher ROE," Shih added.

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China Re told S&P Global Market Intelligence that it has always paid attention to investment opportunities in the domestic primary life insurance segment.

However, the company is unlikely to obtain a domestic life insurance license of its own, as the China Banking and Insurance Regulatory Commission has not issued any such licenses since January 2017.

This means China Re will likely look to acquire an existing life or health insurer in the country.

"China Re has been looking to acquire a life insurance license for a long time," an investment banker familiar with the matter told S&P Global Market Intelligence. "But they haven't been able to find a suitable [target]."

A Hong Kong-based portfolio manager, whose insurance stock portfolio does not include China Re, noted that life insurance is a long-term business, and any acquired company may not be earnings-accretive in the short term. Should China Re proceed with an acquisition, the portfolio manager said he will judge the deal by the size of the life insurer's agent force and the quality of in-force policies.

The investment director said acquiring a primary life or health insurance unit will improve China Re's financials, but investors will then "naturally" compare China Re with groups like Ping An Insurance (Group) Co. of China Ltd. and China Pacific Insurance (Group) Co. Ltd., which have sizable and established life insurance units.

"The gap is significant" between China Re and those companies, the investment director said. "I won't expect an immediate revaluation story."