PICC Group Target (HKD): 5.10 Upside: 4.30 Initiation: A Life Less Ordinary

Financials / China1339 HK10 January 2013household consumption (please see Page 50, appendixII: economic reforms for details)Examples of policy-driven growth include: 1) thecompany’s Changde Model (2007), which established anew model for developing an agricultural insurancebusiness. By leveraging on its co-operation with thegovernment, PICC Group has full access to itscustomers’ information and saves businessdevelopment costs, and 2) the Zhanjiang Model(2009), which established a new model in China’shealthcare system, with the government andenterprises cooperating to improve the governing ofrural area insurance, as well as building basic medicalcentres, and providing more tailor-made insuranceproducts. PICC Health, a subsidiary of PICC Group,accounted for 89% of the healthcare insurance marketin China (compared with 6% for Ping An Health) in2011, on our estimates.Initiation: a life lessordinaryPrimed to benefit from China’s newurbanisation strategyInvestment summaryFounded in 1949, PICC Group is a leading insuranceconglomerate in China, with a 35% share of the non-lifemarket and a 6% share of the life-insurance market forthe 11 months ended 30 November 2012.Deregulation should present opportunitiesDeregulation trends over the past few years should bepositive for the development of the China insurancemarket over the medium term, as: 1) there is nowincreased investment scope for the life insurers, andless reliance on the China equity market, and 2) thequalified P&C insurance companies are allowed to setauto-insurance pricing.We believe its balanced business structure will benefitthe group’s ROE. As at the end of 1H12, about 45% ofPICC Group’s assets were in the P&C business, whichwe believe has higher earnings visibility, better revenuegrowth during periods of market weakness, and hasresulted in stronger capital through earnings than hasbeen the case for the pure life insurers. Regarding theposition of the life business, PICC Life and PICC Healthare more sensitive to market conditions, but we believethey should see higher long-term premium growth giventhe limited take-up of protection and healthcareinsurance products in China currently.The China Insurance Regulatory Commission (CIRC)announced detailed measures to broaden theinvestment options for insurance companies on 22October 2012. These included raising the investmentweighting limit on financial products andinfrastructure projects, while the number of stockmarkets in which the companies can invest wasincreased to those in 45 countries from Hong Kongonly previously. Deregulation is likely to reduce thelife-insurance companies’ reliance on the China equitymarket.Benefiting from a new urbanisationstrategyChina is in the process of implementing a newurbanisation strategy (with the main of improvingpeople’s welfare), driven by: 1) demographic changes(an increasingly ageing society and dependency ratio),and 2) wage inflation. These, together with moreinvestment in machinery and automation, aretransforming the country into a capital-intensiveeconomy from a labour-intensive one. That said, theprevious urbanisation strategy, which focused on themigration of labour from rural areas, is in the processof being changed.We believe auto-insurance pricing deregulation willfundamentally benefit the industry as it will providebetter service and insurance protection to customers.Meanwhile, only qualified P&C insurers can set theirown auto-insurance pricing, and the insurancecompanies’ new rates have to be approved by the CIRC.We believe the impact on auto-insurance pricederegulation will be less than the market believes as thederegulation only applies to qualified P&C insurers. Inour view, the new price regime will benefit PICC themost, given the company’s large customer database,economies of scale, and a nationwide network that willenable the company to cherry-pick those customerswith good risk-reward profiles.PICC Group has benefited from the premium growth,on the back of supporting government policies relatingto the development of social welfare in rural areas.Ongoing urbanisation should reduce the wealth gapbetween the urban and rural areas, in particular,granting migrant workers more welfare rights. Daiwaexpects these improved welfare rights to improve-6-

Financials / China1339 HK10 January 2013We initiate coverage on PICC Group with a Buy (1)rating. Our six-month target price of HKD5.10 is basedon our SOTP valuation, with an implied 2.6x 2013EPBR, and a sustainable ROAE of 20%. This is higherthan the sector average of 2.3x 2013E PBR (based onthe Bloomberg consensus forecasts) given its highersustainable ROE that we forecast.Rate cut makes policy more attractiveOver the long term, insurance businesses tend toperform well in a rising interest-rate environment: aperiod of declining interest rates can lead to reducedinvestment returns and investment income. However,the two recent interest-rate cuts in China (in June andJuly this year) might not necessarily have beennegative for the insurers in the short term, as: 1) theresulting reduced returns from alternative investmentchannels should see demand for insurance productsincrease over the short term, and 2) fixed-incomeinvestments may see mark-to-market gains due tointerest-rate declines. In addition, the life-insurancecompanies rely more on investment income than theP&C insurers. Daiwa currently believes there will betwo interest-rate increases in China in 2013.Risks to our investment case Stock-market volatility. Investment returnsfrom capital markets account for an important partof our earnings forecasts. However, the fact that thegroup is less reliant on investment incomecompared with the other China life insurers shouldhelp sustain its ROAE. P&C margin pressure. We believe autoinsurance pricing deregulation and wage hikes willput pressure on the P&C margin, and that thecombined ratio will rise gradually. Given that PICCGroup sees a higher revenue contribution from itsP&C business compared with the other China lifeinsurers, fiercer-than-expected premium pricecompetition or further regulatory changes wouldimpact our earnings forecasts. Bancassurance. New rules for the bancassurancechannel could continue to affect premium growthin 2013. We note that the bancassurance channelaccounted for 89% of PICC Life’s 2011 first-yearpremium (FYP) income. Embedded value: PICC Life’s and PICC Health’sembedded values are more sensitive to investmentyield changes compared with the other listed Chinalife insurers as they have higher equity investmentweightings and higher available-for-sale positions.For example, we estimate that the EV for PICC Lifeand PICC Health would increase by respective 6%and 7% if we were to increase our investment-yieldassumptions for both by 25bps, compared with a4% increase for the listed major China life insurers(based on published actuarial reports).Balanced business structurePICC Group’s solvency ratio (a ratio that the Chinaregulators use to monitor insurers’ capital positions),was 156% at the end of 1H12, in line with the regulatoryrequirement of at least 100% and an optimal level of150%. We view the structure of the company (as at theend of 1H12, 45% of the group’s total assets were in theP&C business and 54% were in the life and healthbusinesses) as being more resilient in terms of capitalthan the pure life-insurance companies due to thefollowing.1) The P&C business has more ways to improve thesolvency margin than life business. For example, theP&C business can use reinsurance to reduce theconcentrated risks relating to catastrophes and relievecapital.2) We believe the P&C business has higher earningsvisibility, better volume growth in a downturn, andstronger capital generation than the life-insurancebusiness. In our view, the integration of the lifebusiness should allow PICC Group to achieve higherROEs and provide a considerable cushion in a cyclicaldownturn.Higher sustainable ROE than for the purelife insurersInvestment strategiesWe believe PICC Group has achieved strong long-termstrategic value from implementing integrationsynergies among its subsidiaries. This, together with itsgeographically diverse distribution network, solidgovernment relationships and highly recognised brandname across the PRC, have positioned it well to benefitfrom the growing business opportunities throughoutthe economic cycle.2013 outlook & 2012 reviewOur analysis shows that the China life insurers’ averageshare-price performance was in line with the MSCIChina Financials Index in 2012, a reverse from theunderperformance in 2011. Despite slower premiumgrowth, volatile earnings, and the cautious outlooks ofthe company managements, the China life insurers’share prices rose by an average of 26.5% over 2012.-7-

Financials / China1339 HK10 January 2013 improved to 98% for 2010 and 94% for 2011 (from103% for 2008).Weak premium growth in 2012, but productstrategies could help the China insurers resumepremium growth in 2013: life-premium growthslowed due to competition from wealthmanagement products and changes inbancassurance regulations in 1H12. However, webelieve premium growth is likely to be better in1H13, driven by short-term savings-type productswith lower margins, while more policy-drivengrowth opportunities in 2H13 should sustainpremium growth. PICC Life should enjoy higherpremium growth compared with the industryaverage when there’s a rebound in the A-sharemarket. China Insurers: absolute (3.2)(26.5)2010(35.1)20112012MSCI China Financial IndexSolvency ratio. The ratio should remain acceptablein 2013: most of the China life insurers’ earningswere affected by higher-than-expected impairmentlosses in 1H12, specifically from their equityrelated investments. As such, many life insurers,including Ping An, China Life, and New China Lifeissued sub-debt throughout 2012 to strengthentheir solvency positions. However, the smallerChina life insurers might face more capitalpressure as they are approaching their sub-debtissuance limit, which is set at 50% of their netassets. PICC Group’s solvency ratio is higher thanthe 200% (versus the regulatory optimalrequirement of 150%) following its IPO inDecember 2012.26.5China Life InsurersSource: Bloomberg, DaiwaNote: China life insurers include China Life, Ping An, CPIC, China Taiping and New ChinaLife (except in 2010); figures for China life insurers are market cap weighted average China Insurers: absolute performance comparison(%)403020100(10)(20)(30)(40)(50)EV: despite the volatile earnings of the China lifeinsurers, the value of new business (VNB) grew at alow single-digit percentage in 1H12. And most ofthe China insurers have guided for 5-10% VNBgrowth in 2013. Those companies with strongagent networks should derive better VNB growth,but structural problems (wage inflation anddeclining client demand) remain.31.829.626.823.916.29.03.4(2.2)(39.5)China Life(26.5)(31.6)CPIC(41.1)Ping AnNew ChinaLife2011(39.7)ChinaTaipingPICC P&C2012MSCIChinaFinancialIndexSource: Bloomberg, Daiwa China Insurers: share-price performance 2012(%)6040 Rate cycle and share-price performance: China lifeinsurers are early beneficiaries in a rising interestrate cycle. For example, China Life outperformed itsMainland peers in 2005 and 2006 on the back ofbetter premium growth, as most of its insuranceproducts are wealth-management products thatenjoy higher growth in bull market. We present thecorrelation charts below.200(20)(40)Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12China LifeCPICChina TaipingMSCI China Financial IndexSource: Bloomberg, DaiwaFollowing the outperformance in 2007, PICC P&Cunderperformed most of the China life insurers over2008-09, when the company’s business facedirrational price competition. Over 2010-11, P&Cbusiness price discipline continued to improve afterthe CIRC intervened (Guideline No.70 in 2008). Assuch, PICC P&C outperformed its peers in the laterpart of the rate-hike cycle, and the combined ratio-8-Ping AnNew China LifePICC P&C

Financials / China1339 HK10 January 2013 China Insurers: share-price performance China Insurers: share-price performance 9Jun-09Dec-08Jun-08Dec-07Jun-07Dec-06Jun-06Dec-051 yr lending rate - RHSPing AnPICC P&CChina LifeChina TaipingMSCI China Financial Index179.7118.494.452.034.0PICC P&CChina TaipingPing AnChina LifeSource: Bloomberg, DaiwaSource: Bloomberg, Daiwa China Insurers: share-price performance (2005) China Insurers: share-price performance 0)(30)China LifeMSCI ChinaFinancial IndexPing AnChina TaipingChina LifePICC P&CChina TaipingMSCI ChinaFinancial IndexPing AnSource: Bloomberg, DaiwaSource: Bloomberg, Daiwa China Insurers: share-price performance (2006) China Insurers: share-price performance (2009)(%)350300MSCI ChinaFinancial Index(%)120287.6250110.6100203.520067.5MSCI ChinaFinancial IndexPICC C P&C205000China LifePing AnChina TaipingMSCI ChinaFinancial IndexPICC P&CChina TaipingSource: Bloomberg, DaiwaSource: Bloomberg, Daiwa-9-Ping AnChina Life

Financials / China1339 HK10 January 2013 China Insurers: share-price performance (2010)(%)706050403020100(10)(20)(30) China Insurers: share-price performance 010(3.2)0(17.2)PICC P&CPing AnCPIC3.45(4.8)China LifeCPICMSCI China China Taiping China LifeFinancialIndexPing An MSCI China New ChinaFinancialLifeIndexSource: Bloomberg, DaiwaSource: Bloomberg, Daiwa China Insurers: share-price performance 2011Valuation PICC P&COur SOTP-based six-month target price of HKD5.10 forPICC Group implies a 2.6x 2013E PBR, which is higherthan the sector average of 2.3x 2013E PBR (based onthe Bloomberg consensus forecasts) given the higherthan-average sustainable ROE of 20% that we forecast.(2.2)(26.5)(31.6)PICC P&CChinaTaipingMSCI ChinaFinancialIndexSource: Bloomberg, DaiwaCPIC(39.5)(39.7)China LifeChinaTaiping(41.1)Ping AnWe value PICC P&C at 2.2x PBR, its life-insurancebusiness at 1.9x PEV, its health-insurance business at2.4x PEV and its asset-management business at bookvalue.If we were to strip out the current market cap for PICCP&C (69% ownership equals CNY77bn as at 8 January2012) from the group’s current valuation, this wouldimply an average 2.2x PEV for the life-insurance andhealth-insurance business.- 10 -

Financials / China1339 HK10 January 2013 Global valuation comparison: life insurersBloombergcodeTaiwan2882 TT2881 TT2888 TT2823 TTShareAbsolutepriceMKT PerformanceDividend yield(localcap(%)PBR (x)PER (x)ROE (%)Leverage (x)(%)EPS growth (%) PEV (x)curr.) (USDm) 2011 2012 FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E2011Company NameCurrencyCathay Financial *Fubon

franchise should deliver strong earnings visibility, capital generation, and premium growth amid the slower economic environment. Catalysts We forecast PICC Group's ROAE to range from 18% to 21% for 2012-14, supported by PICC P&C's business, which has a dominant 35% share of the market. Meanwhile, PICC Group's relationship with the PRC