Among the ruins of one of the biggest victims of the financial crisis, we have found a pearl in the Orient – built on American entrepreneurship and a strong focus on shareholder value. AIA has unique opportunities to reap the rewards of higher growth with the added benefit that the Chinese central government has issued national ambitions that will serve as fuel on the fire.
With a 100-year history in China, the logo still stands tall on the Chinese headquarters by the river bank in Shanghai. We view AIA as being in a strong position to meet the rapidly growing demands of the attractive Chinese market for life and health insurance.
AIA operates its insurance business on 18 Asian markets, and generally speaking, the company is a market leader with strong market shares. The markets range from Australia and New Zealand to China, Hong Kong and Singapore. For many years ahead, the growth will be particularly driven by the presence in China and Hong Kong. Those markets are expected to provide approximately 90 percent of the growth in earnings from customers signing new insurance policies. It is also worth noting that the annual growth is expected to remain in the double digits.
Currently, Hong Kong and China represent seven out of ten dollars in value of new business, with Hong Kong leading the way by generating more than four out of those seven dollars. By 2020, however, China is expected to be the market with the strongest contribution to growth in value of new business, while Hong Kong, due to larger in force premium will contribute more to the GAAP earnings.
The expected development is based on a massive demand for insurances in China – the Chinese have significantly less insurance cover than private individuals in the West. The central government has stated that increasing the insurance cover is a national objective. The insurance penetration is currently at about two percent of GDP, and the government’s objective is to reach five percent in 2020. Even if this is reached, the Chinese will still have less insurance cover than Western populations.
Health insurance as an driver of earnings
Today, the proportion of medical costs covered by the state is low, and this results in the Chinese having to maintain significant savings held in cash. If a family does not have ample cash savings, they cannot pay the potential medical costs and hospital bills – unless, of course, they have taken out health insurance. At the same time, the Chinese are facing major issues with hospitals filled to capacity and a shortage of doctors. If you have an AIA insurance, your contact person will help to place you as quickly as possible at the best available hospital. The insurance thus does not only cover the financial aspect of illness, but it also helps the insured get a better course of treatment. These are merely some of the good reasons why Asians should get health insurance via AIA.
Health insurance is the largest product offering by AIA in China – it is estimated to represent almost half of the annualised new premiums (ANP). For AIA, as an insurance company, there are major advantages to the health insurance products: earnings are high and stable, and the required provisions to cover future injuries are low, as the claims can be determined when the year is over. The health insurances thus do not cover all future injuries – they only cover what takes place while the customer keeps paying their insurance premium. A strong indication of the higher earnings levels is that the value of new business amounts to more than 85 dollars per 100 dollars of ANP in China. This is compared to a level of around 60 dollars per 100 dollars in ANP for all of AIA. Insurance policies based on annual and recurring payments amount to more than 90 percent of the total premiums per year.
Today, AIA is the only foreign insurance company in China that fully owns its Chinese business. The company operates in five Chinese regions that are among the five wealthiest regions in the country measured by GDP. By operating in only five regions, AIA has planted its flag in fewer locations than, for example, Prudential Plc, which is licenced to operate in a total of 18 regions. However, Prudential Plc owns just half of its business in a joint venture, as the other half is owned by a local Chinese partner.
Strong alignment of interests creates an impressive amount of earnings
The regulatory framework of the financial sector in China is about to open up for the possibility of foreign companies being allowed to own the entirety of their Chinese businesses. This might be an opportunity for AIA to expand to more regions. However, there are good and compelling arguments for AIA benefitting from focusing on expanding its market in the current five regions where. Despite having operated there for several years, there are still significant untapped business opportunities.
The insurance products are distributed through two channels. 70 percent of ANP is from AIA’s own agency, which is the largest in Asia measured by the number of full-time sales agents. This channel continues to generate significant growth. One of the strengths in the company’s own agency is, that there is a strong correlation between the interests of the individual agents and AIA – and thus, there is a major focus on selling the profitable health insurance products. The result of the strong infrastructure can be seen by the fact that its own agency has value-of-new-business margins of 60 percent.
The remaining insurance policies are mainly distributed from AIA’s collaboration with the global bank, Citi. This collaboration provides Citi with the option to sell AIA’s products together with its banking products on the markets of South East Asia. Here the value of new business is also quite attractive – it amounts to more than 40 dollars per 100 dollars of ANP. This is an attractive way for AIA to have a presence in several markets where, using its own agency, is initially not deemed to be the best way to proceed.
AIA was founded in 1919 by an American, Cornelius Vander Starr. A few years prior, he travelled from his native California to Asia, as he was keenly interested in and curious about the Far East.
Even during his childhood, Vander Starr had demonstrated an ambitious character, and he was constantly looking for business opportunities. This resulted in him for a time selling car insurance on the streets of San Francisco. When he arrived in China, with only small savings in his pocket, he soon saw the opportunities for starting an insurance company – and not long after, this included a life insurance company. In Vander Starr’s view, this was perfect for the Chinese families, as the close familial ties and traditions could make it easier to convince them of the advantages of buying an insurance that could offer financial support to the remaining family in the event of a death.
An entrepreneurial American with a long term view
At this point in time, the vast majority of insurance companies in China were British, and they ran their insurance businesses with the conservative approach of a banker. Vander Starr had a salesman mentality, and he therefore looked high and low for business opportunities. In his view, there were great advantages to life insurances – due to the development of Chinese society, including better hygiene, he expected that the life expectancy of the Chinese would increase significantly – but the prices for insurance were high and calculated on the basis of a life expectancy of under 30 years. This was the business opportunity of a lifetime, and Vander Starr, of course, wasted no time in seizing it.
The insurance business that Cornelius Vander Starr created eventually came to include many other business areas than life insurances – for example, general
insurance, fire insurance, disaster insurance and much more. The company ended up being named American Insurance Group – or as commonly known, AIG.
Large parts of AIG were not nearly as value-creating or long-term attractive as the Asian part. When the financial crisis really struck in during the autumn of 2008, AIG had become too deeply and too extensively exposed to financial derivatives derived from the housing market in the United States. This was illustrated in the book and the subsequent movie called The Big Short. These financial problems resulted in the US government having to transfer more than 80 billion US dollars to AIG, and as a result, it assumed an ownership stake of approximately 80 percent. The US government was therefore able to demand that the company must reduce its risk exposure.
As part of this risk reduction, the management decided to split its international businesses into two pillars – the Asian pillar, now known as the American International Assurance Company (AIA), was one of them. At first, the Federal Reserve in New York assumed control in June 2009, and in the autumn of 2010, AIA was listed on the Hong Kong stock exchange. These were turbulent times, but as it turned out, there was also a silver lining.
AIG’s problems resulted in “the best and brightest” (the Asian business) being given autonomy. As a footnote to this story, Prudential Plc – which we are also co-owners of – fought to acquire AIA before it was listed in Hong Kong. However, agreement could not be reached on the price, and the shareholders of Prudential Plc did not see the same potential as management of the British insurance company did.
Hungry competitor underestimated the earnings potential
When the New York Federal Reserve assumed temporary ownership of AIA in the autumn of 2009, Mark Tucker, a Brit, joined as CEO. Mark Tucker had previously been in a similar role at British Prudential Plc where he had successfully built the Asian subsidiary – in fact, with inspiration from AIA’s early success. Mark Tucker worked towards increasing the focus on value of new business more than insurance premiums.
At AIA, where AIG’s senior management had been significantly more focused on the volume of earned premiums, they now started focusing on gaining as much expected earnings as possible per sale. This change in sales focus has succeeded in raising the earnings from less than 35 dollars per 100 dollars in first-year earned premiums to more than 60 today. This, together with significant growth in premiums of more than 15 percent per year from 2010 to 2018, has resulted in growth in value of new business of almost 25 percent per year – this means that earnings are more than 5.5 times higher today than the level when the business listed in 2010. The shareholders of Prudential Plc probably did not expect this, as they voiced their opinion against the previously attempted takeover.
Since 2010, there has been a strong focus on cleaning up the sales staff, so that it is only the best sales agents with the right business focus that works for AIA. This has been a major factor in the profitability of the business increasing significantly in the same period – and that both sales and earnings per agent have made extremely positive contributions to this.
Many of the customer-facing activities such as selling or renewing insurance policies, claims for damages and follow-ups and the ongoing contact with customers can today be done digitally. This may be an advantage when the distance from the customers to the nearest AIA office can be quite far in the large Asian countries or if the customer is extremely busy. Thus, technology is used to optimise as many things as possible and in turn make it as simple as possible for all parties – and from AIA’s perspective, it leads to processes that can be streamlined far better. Virtually all insurance policies in China today are sold digitally.
AIA’s long history in its core markets has helped build a strong and valuable reputation. This reputation can both be used in the sales process, as it establishes trust and credibility, but it can also act as a strong pull factor for skilled and highly competent sales agents.
Manager with 40 years of industry experience
Together with Mark Tucker, Mr. Ng Keng Hooi also came onboard – he had been the head of operations for a number of South East Asian countries at Prudential Plc. Today, Mr. Ng Keng Hooi is the CEO of AIA, and with his more than 40 years of experience of working with life insurance products, he has many opportunities to drive AIA forward towards even more value creation.
The American legacy of the company has contributed to creating a significant ‘Western’ focus in terms of corporate governance, with its strong focus on creating long-term economic value for the shareholders. At AIA this means, among other things, large investments in long-term initiatives that are assessed at being capable of increasing the opportunities for creating value. The untapped potential in the company’s markets is not projected to be fully exploited in the next few decades, and therefore it is important to continually improve the foundations of the business.
AIA’s balance sheet is conservative. There is significant free surplus, estimated at around eight billion US dollars amounting to approximately seven percent of the market capitalization. Over time, this capital can either be invested or tied to new business or paid out to shareholders via dividends. The divided per share is currently almost 1.2 Hong Kong Dollars, equivalent to a direct yield of almost two percent. Many Western insurance companies pay higher yields, but generally speaking, they do not have the same impressive opportunities for growth, and thus, they have less reasons to retain the shareholders’ capital. Despite all this, an AIA share costs less than 16 times the current year’s earnings. The dividend has been growing at an annual rate of 17 percent since the company was listed in 2010. There are many indications that this growth can continue.