Guotai Haitong Securities Co., Ltd. has released a research report indicating that China's life insurance industry has transitioned into a new phase of asset-liability management, and recommends investors increase holdings in the insurance sector where embedded value (PEV) is broadly undervalued.
With interest rates currently at exceptionally low levels, life insurers have entered this new operational stage. Companies that have built asset-liability management frameworks based on solvency requirements and designed for medium-to-long-term interest rate risk management are poised to see significantly stronger earnings growth than peers when rates eventually recover. The market has placed excessive focus on the profit pressures under new accounting standards in a low-rate environment, while overlooking the earnings upside potential of insurers during interest rate normalization. This oversight has led to a severe undervaluation of the sector's PEV, creating an attractive opportunity to increase positions.
What's driving the shift?
Drawing lessons from European insurance history, the core competitive advantage of life insurers lies in their ability to manage asset-liability operations based on medium-to-long-term interest rate risk. European life insurance markets have experienced sustained sluggish growth in recent years, largely due to liability structures being overly adjusted to prevailing rate environments. During high-rate periods, insurers aggressively sold traditional products with high guarantees and long durations, effectively locking in elevated rates as long-term liability costs. Conversely, in low-rate phases, they shifted excessively toward market-linked products like unit-linked policies, missing out on profit improvement opportunities when rates rebounded.
China's life insurance industry has progressed through four distinct stages of asset-liability management. The period from the industry's resumption to 1999 marked the embryonic phase, characterized by increased marketization and the gradual establishment of scientific identification and measurement of long-term liabilities. From 2000 to 2017, the industry entered its early development stage, where relatively high interest rates allowed asset returns to consistently meet liability requirements, with operations primarily driven by liability growth and asset-side focus on yield matching and liquidity management.
The 2018-2024 period represented the mature phase, featuring a downward shift in long-end interest rates while the transition from C-ROSS Phase I to Phase II promoted further maturity in capital management systems. Insurers strengthened duration and yield matching by increasing allocations to long-duration bonds and moderately raising equity exposure. Since 2025, rates have fallen to exceptionally low levels, rendering duration-based matching increasingly ineffective. The industry has now entered a transformative phase where insurers with capital advantages should establish asset-liability systems grounded in medium-to-long-term rate expectations, balancing traditional and participating products on the liability side while focusing on long-term allocations to assets with substantial appreciation potential.
Understanding profit volatility in context
The high volatility in insurer profits under low interest rates should be properly understood. Insurance is inherently a long-term business. For companies with adequate solvency, asset-liability matching based on medium-to-long-term interest rate risk management will inevitably cause significant fluctuations in current-period profits under new accounting standards, even in low-rate environments. However, referencing European insurance history, the cost rigidity of low-rate traditional products and profit volatility driven by price swings in emerging industry assets are reasonable phenomena during periods of abnormally low rates. These factors should not undermine enterprise value.
Why embedded value remains the benchmark
Embedded value based on medium-to-long-term interest rate assumptions remains the most effective valuation tool. Amid current low rates, some market voices argue that EV investment assumptions should be adjusted downward synchronously, with some even suggesting that "net assets plus contractual service margin" (CSM) more fairly reflects shareholder value. Such views overlook the long-term nature of insurance operations, erroneously extrapolating current profit declines and volatility linearly into the future. The research suggests that in a low-rate environment, investors should focus on EV calculated using reasonable medium-to-long-term rate assumptions for investment returns, and recognize the investment opportunities presented by undervalued insurance stocks.
Key risks to consider
Downside risks include continued declines in long-end interest rates, equity market volatility, and changes in regulatory policies.