Nowhere to Hide: ZhongAn Hammered by Stock and Bond Bloodbaths

Key Takeaways:

• ZhongAn warned that it lost as much as 750 million yuan in the first half of 2022, reversing a year-ago profit, due to a drop in its investment income and foreign-exchange losses
• The digital insurer made its first-ever underwriting profit last year, but its profitability still depends heavily on investment income

By Warren Yang

ZhongAn Online P&C Insurance Co. Ltd. (6060.HK) has come a long way since its creation less than a decade ago, evolving into a respectable name in the insurance space from what seemed like a high-profile gimmicky start. Yet for all its achievements, the company’s heavy reliance on volatile investment gains remains its Achilles’ heel.

That vulnerability was magnified in the first six months of this year as prices of both stocks and bonds plunged amid raging inflation, undermining ZhongAn’s investment portfolios across both asset classes. Last Wednesday, ZhongAn warned it expects to post a net loss of between 650 million yuan ($96 million) and 750 million yuan in the six months to June, a near complete 180-degree turn from a profit of about 604 million yuan for the year-ago period.

ZhongAn blamed “gloomy” sentiment in capital markets for a significant decrease in investment income, as well as the dollar’s appreciation against its Chinese counterpart that resulted in foreign-exchange losses related to its holdings of bonds denominated in U.S. dollars. In a separate filing, the company said its board will meet Aug. 25 to approve the official version of its interim results, which are typically published later the same day.

The insurer didn’t provide much further detail on the specifics behind its plunge into the red in the first half of 2022. But it’s not hard to see how the six months could have been a nightmare for ZhongAn and insurers in general, whose profits often rely to differing extents on returns from investing the income they collect from their policyholders.

The company, created in 2013 by Alibaba-affiliatedBABA Ant Group, Tencent (0700.HK) and Ping An Insurance (2318.HK; 601318.SS), made its first-ever profit from underwriting insurance policies last year, meaning there was some leftover money from premiums it collected after all claims and expenses were paid. That milestone signified improvements in ZhongAn’s capability to manage risks and costs while growing revenue.

But ZhongAn’s underwriting profit last year was tiny, at just 75 million yuan, out of 20.4 billion yuan in gross written premiums. That compares with 2 billion yuan in investment income, which was the primary contributor to its profit last year. It’s not clear whether the company continued to make an underwriting profit in the first half of this year. But the large loss flagged by ZhongAn in its profit warning indicates any such profit clearly was too small to offset the drop in investment income.

In short, ZhongAn remains at the mercy of market movements despite its improving ability to turn a profit from insurance underwriting. And “gloomy” may understate how bad those conditions were in the first half of 2022. Stocks everywhere tanked, with the S&P 500 Index having the worst first half since 1970 with a 20% decline. At the same time, surging inflation prompted the U.S. Federal Reserve and other central banks to launch an aggressive series of interest rate hikes, sending bond prices lower.

No Shelter

About 40% of ZhongAn’s assets at the end of last year were in a range of investments, including equity and bond funds, with roughly another 52% equally split between fixed-income products and “other investments” consisting of wealth management products and trusts. The company changes the composition of its investment portfolio all the time, so it likely shifted its assets around in the first half as well. But with both stock and bond prices sliding, there was probably nowhere to hide.

ZhongAn’s assets included about $766 million in U.S. dollars at the end of last year, exposing the company to currency risks.

Investors will only see the magnitude of ZhongAn’s investment losses so far this year nearly two-thirds of the way into 2022 due to Hong Kong’s requirement that all companies only report their results twice per year.

But insurers listed in most other markets report results on a quarterly basis, which can provide a preview of what’s to come for ZhongAn. Ping An, one of China’s top names, suffered an investment loss of 22 billion yuan in the first quarter, compared to a gain of 15 billion yuan a year earlier. German insurance giant Allianz (ALV.DE) reported a 71% plunge in income from investment operations after expenses. But both Ping An and Allianz still made net profits for the first quarter because their underwriting profits and other income sources were sufficient to offset their bad investment performances.

ZhongAn also has operations other than insurance and investment, including a virtual bank in Hong Kong, but none of them are profitable. So, until those operations start making profits, the only way for the company to reduce its vulnerability to capital market volatilities is to continue expanding its insurance business.

ZhongAn gained prominence in its early days with policies covering costs for returning goods sold on Taobao, Alibaba’s online shopping service that’s similar to eBay EBAY. But that business may also be slowing at the moment because of a sharp slowdown in China’s economic growth, stemming from a combination of Beijing’s strict Covid-19 control policies, a property slump and troubles overseas like global inflation. 

ZhongAn’s monthly disclosures on gross written premiums indicate that its year-on-year revenue growth in the first half slowed to well below 10% compared with 45% in the first half of last year.

The company’s stock was down 10% through Tuesday in the four trading days following its first-half profit warning. The shares have lost about two thirds of their value since their 2017 IPO. But the stock still fetches a price-to-earnings (P/E) ratio of about 22, far higher than less than 8 for Ping An. ZhongAn’s P/E ratio looks even loftier compared to other Chinese fintech stocks, such as a meager 1.8 for LexinFintech (LX.US). 

ZhongAn’s current valuation suggests that investors remain quite optimistic about its prospects, even though they may be well advised to manage their expectations due to its exposure to market turbulence. At the end of the day, ZhongAn may survive the current market turmoil with relatively little long-term damage. But it will continue to be exposed to market turbulence as long as it remains highly dependent on investment income for its profits.