On May 10, the inevitable happened. Oversea-Chinese Banking Corporation (OCBC) announced plans to acquire the shares in Great Eastern Holdings G07 (GEH) that it does not already own for $25.60 per share, valuing the transaction at $1.4 billion. This is the third offer OCBC has tabled for GEH, the first being in 2004.
The issue was not whether the privatisation was prompted by an increasingly vocal group of minority shareholders; the latest IFRS 17 accounting standard or the 20th anniversary of OCBC turning GEH into a subsidiary.
The issue for investors of both companies was about capital, valuations and outlook. GEH’s minority shareholders campaigned to raise awareness about GEH’s total shareholders’ value and the lack of liquidity that caused it to trade at a discount to peers.
Analysts have highlighted the privatisation offer’s modest earnings and ROE accretion. Despite the privatisation offer, GEH’s valuations are lower than some other listed life insurance companies. Based on Table 1, although GEH’s offer price is at a discount to the embedded value of the average of these listed insurance companies, the offer price is at a premium to their average P/E, P/B and ROE valuations.
The OCBC offer works out at a premium of 36.9% above GEH’s undisturbed price as of May 9, a 40% premium to GEH’s three-month volume-weighted average price (VWAP) but just a 27.7% premium to GEH’s five-year VWAP. In terms of valuation, OCBC is offering just 0.7 times embedded value of $36.59 but 1.54 times P/B.
The problem is that the new IFRS 17 accounting reporting standard shaved a couple of billions off GEH’s shareholders’ equity. However, the offer price still represents 15.6 times GEH’s FY2023 ended December 2023 earnings per share.
See also: ‘Not cheap’, ‘no value’ but market excited: OCBC’s GEH bid divides analysts
On May 10, OCBC’s group CEO Helen Wong said GEH is a trusted brand, which is older than OCBC itself. “Great Eastern is 115 years old. It has more than 16 million policyholders and has served multiple generations with the largest agency force [of 35,000] in Singapore and Malaysia. Our relationship with GEH is 66 years old, meaning we have partnered with them since 1958.”
Based on the timetable provided by OCBC on May 10, the Independent Financial Adviser’s (IFA) comments and recommendations to GEH’s independent directors will be in the circular from GEH to its shareholders after OCBC’s offer document is dispatched, which has to be no later than May 31.
See also: AIA targets higher dividends; Prudential aims for 15%-20% CAGR
Recent life insurance deals
Life insurance is a complex and long-term business, just ask any actuarist. Regular premium policies require careful consideration and production. GEH’s single premium policies, like its 100th anniversary special offer, have been highly successful.
Despite trading at a premium to some of its listed peers, OCBC’s offer price at 0.7 times embedded value makes GEH the cheapest acquisition in the past 20 years. The second cheapest acquisition in the past 20 years is by HSBC of AXA at 0.8 times embedded value in 2021.
Some 20 years ago, OCBC paid almost twice the current valuation, at 1.3 times embedded value in 2004 and 1.5 times embedded value in 2006. While the 2004 offer comprised a share swap and a selective capital reduction, 2006’s offer was an all-cash deal.
In comparison, the most recent life insurance transaction was the acquisition of AmMetLife by none other than GEH. It paid AmBank RM1.2 billion ($344 million) for AmMetLife, which included a bancassurance agreement. In FY2023, AmMetLife had a net asset value and net profit of RM1 billion and RM76 million respectively. The GEH offer valued AmMet Life at about 1.1 times P/B and 14.5 times P/E although AmMetLife’s embedded value is not publicly available.
Earlier this year, press reports had emerged on whether shareholders of privately-held FWD’s, who include Richard Li, son of Hong Kong’s wealthiest billionaire Li Ka-shing, are planning an IPO. The figure bandied about was for an IPO market cap of US$10 billion ($13.53 billion). Last year, the valuation of FWD, as indicated by Bloomberg, was US$9 billion. Whatever it is, FWD’s FY2023 embedded value stands at US$5.68 billion and any plans to list are likely to be at, around or higher than this value.
Based on transactions of Singapore life insurance companies since 2000, GEH’s offer price is below the average Price/Embedded Value and lower than the lowest Price/Embedded Value.
See also: Another possible delisting hastens calls for SGX revival
What is embedded value?
Life insurance companies differ from banks, which are pretty straightforward in terms of how they are valued. Capital ratios comprise common equity tier-1 (CET-1), additional tier-1 and perhaps tier-2 capital levels.
Risk-weighted assets are more difficult to value. This is evident in the different risk weights assigned to simple products such as mortgages by different banks. And, of course, different geographies may require different levels of capital and different risk weights for their loans and other types of assets.
Unlike banks, which are usually measured using P/B, earnings, dividends or the Gordon Growth Model and rated using CET-1 ratios and so on, investors in insurance companies usually look at embedded value, new business value (there are different definitions of this) and ratios based on embedded value and shareholders’ equity.
Embedded value is a combination of shareholders’ equity (or net asset value) and the value of the in-force business. A discounted cash flow (DCF) based model measures future profits for the latter.
Some market observers have pointed out that “embedded value or EV is a concept”. If the discount rate is changed, EV can be lower, they say. There are different standards for EV. For FY2023, GEH raised its discount rate by 25 basis points for Singapore and Malaysia to 6.25% and 8% respectively. Discount rates in Indonesia were stable at 12.5%. Observers have pointed out that interest rates have probably peaked and could start to fall sometime in 2H2024 and this could have a positive impact on embedded value.
Among the most expensive acquisitions in recent years was the acquisition of First Capital Insurance by Mitsui Sumitomo Insurance Group (MSIG) In 2017. According to an announcement by MSIG, it acquired FCI at 3.3 times book. Both insurers are involved in general insurance. At the time, FCI was Singapore’s largest commercial property and casualty insurer. MSIG is a non-life insurer.
Singapore Life (Singlife), once a start-up insurtech company, has become more mainstream through several M&As. Singlife prided itself on being a low-cost insurance provider through purely online avenues. Eventually, Singlife needed more capital and had to merge itself into Aviva, paying 1.5 times embedded value for the merger. Sumitomo Life acquired Singlife at 1.6 times embedded value.
The life insurance business requires capital and longevity and GEH has both. It is 116 years old and its capital adequacy ratio (CAR) is twice that of the regulatory requirement, which is 100%.
Changes in reporting standards
A list of life insurance transactions since 2000 is in Table 2. Life insurance companies have been impacted by two main changes in the past 10 to 15 years. The first occurred over the years — from 2010 to 2018 — around risk-based capital and solvency. The minimum CAR required by the Monetary Authority of Singapore (MAS) is 100% but it is likely higher. Ong Chin Woo, one of GEH’s minority shareholders, calculates that the minimum regulatory CAR for most insurers is 135% on average. GEH, Income, Prudential and AIA are defined as domestic systemically important insurers (D-SII).
In September 2023, MAS said that “a 25% capital add-on will apply, increasing a D-SII’s higher and lower supervisory intervention levels, as well as CET-1 and tier-1 capital requirements. This add-on replaces the 25% high impact surcharge applicable to the four D-SIIs under the existing framework”. This may take GEH’s regulatory CAR requirement to as high as 160%. Before issuing $500 million in medium-term notes and according to the circular issued by GEH in March, its CAR was 204.9%.
Separately, the switch to IFRS 17 from IFRS 4 shaved $2 billion, or 20%, off GEH’s shareholders’ equity of $10 billion as reported in FY2021.
Last year, two items stood out during a briefing on IFRS 17, which replaces IFRS 4. The first was the change in the level of equity upon transition (as of Jan 1, 2022). Shareholders’ equity has been lowered to $8.1 billion. The term contractual service margin or CSM, which represents the expected unearned profit of in-force business, was introduced and calculated as $7.3 billion. When added to CSM, the total of IFRS 17 shareholders’ equity plus CSM worked out to be $15.4 billion.
New business profit is no longer recognised immediately on the income statement. Instead, future projects are recognised in the CSM on the balance sheet. The CSM is then released into the income statement over the life of the insurance contract as services are provided.
This lessens the impact of mark-to-market gains and losses but lowers GEH’s NAV. This also affects OCBC’s own net profit, which will be less volatile because of GEH’s less volatile earnings. GEH will likely contribute $180 million to $200 million per quarter at a run rate. In 1QFY2024, this was $260 million, and this, along with trading income, boosted OCBC’s net profit to $1.98 billion or $2 billion excluding amortisation, well above the Street’s forecast of $1.73 billion.
While NAV at the end of 2021 was $21.19 per share, it was $16.66 per share at the end of 2023. Embedded value was as high as $38.57 per share in FY2021 but was $36.59 per share by the end of FY2023.
During the May 10 briefing, questions about GEH’s impact on OCBC’s capital were asked. In OCBC’s FY2023 Pillar 3 disclosures, OCBC’s regulatory CET-1 capital stood at $47.24 billion before adjustments. After adjustments, CET-1 was $37.68 billion. Among the regulatory adjustments was a $4.88 billion deduction for subsidiaries, including insurance subsidiaries.
OCBC federation’s tightrope
In 2004, OCBC’s then-CEO David Conner, fresh from Citigroup when it was asked to divest insurance arm Travelers because of new regulations in the US, decided to replicate the financial conglomerate model at OCBC. To do that, GEH’s shareholders were offered a share swap and a capital reduction. This resulted in OCBC owning 83% of GEH. The tranche came from the Lee family, who were the largest shareholders of OCBC.
At that time, the transaction valued GEH at 1.5 times embedded value. Subsequently, to privatise GEH, Conner and his team offered the minority shareholders of GEH, who comprised mainly of a branch of the Lee family led by Lee Thor Seng, and the Wong family, who are descendants of former GEH chairman SQ Wong and unrelated to group CEO Wong.
Conner is long gone from OCBC but the business model continues. Some OCBC observers point out that the banking group sees itself as a federation comprising commercial banking, wealth management and insurance. If GEH is fully privatised, OCBC will have two subsidiaries in Singapore — Bank of Singapore and GEH. These, coupled with commercial banking, will have their own business domains, focusing on yields. The harvests from these plots could mature at different times, providing OCBC with income stability.
Since coming on board, Wong’s priority has been to create a “One Group” model where different parts of the bank support one another, both geographically and across business units, particularly in wholesale banking. Given the new geopolitical landscape, this makes sense as companies look to “friend-shoring” in Vietnam, Malaysia, Thailand and Indonesia. The friend-shoring phenomenon, also termed China +1, has Wong and OCBC cementing together its various geographies to help Chinese companies looking to set up manufacturing and other facilities in Malaysia and Indonesia.
In prepared remarks, Wong alludes to the synergies between OCBC and GEH. “There has been a strong synergistic relationship. With GEH working with us, we can customise a full suite of investment, insurance and estate planning solutions for our customers. When we look at offering products to our customers, insurance is intrinsic. Our insurance company incentivises us to sell more insurance products. In turn, our insurance division has benefited from our corporate customer base. More importantly, GEH’s earnings contributed to us over the years,” she explains.
The wealth management piece of the puzzle could work well with insurance in plans known as Universal Life for the private banking segment. Over at HSBC, HSBC Life Singapore launched the HSBC Life Diamond Prestige Index Universal Life, an indexed universal life plan that offers life insurance protection and investment for the affluent market.
HSBC says the high-net-worth (HNW) and ultra-high-net-worth (UHNW) segments have been growing rapidly, and the number of HNW and UHNW individuals globally is expected to triple between 2016 and 2026. In Singapore, the HNW/UHNW individual population is expected to more than double to about 600,000 during the same period. In addition, more than US$18.3 trillion in wealth is forecast to be transferred by 2030, including US$2.5 trillion in Asia.
Wong was formerly the chief executive of HSBC in China. “Rising Asian wealth is fueling demand for wealth enhancement and preservation solutions. Insurance fits neatly into wealth preservation. Also, OCBC’s One Group approach has allowed us to put everybody together to form holistic product offerings over the years,” she adds.
No synergies, say DBS, UOB
OCBC is alone in featuring the federation-type business model. Despite OCBC acquiring Wing Hang Bank in 2014, GEH still has no licence to operate in Hong Kong, missing out on all the growth experienced by AIA and Prudential.
“When we say we don’t have a licence for GEH to sell into Hong Kong, it is true ... But it doesn’t stop us from selling insurance in this market to Hong Kong and Chinese customers who come here to open an account with the bank. I cannot comment on the future,” Wong says.
What about the other banks? HSBC owns HSBC Life and Maybank owns Etiqa although AmBank recently divested its life business AmMetLife to GEH. Elsewhere, Ping An owns a bank and life insurance business. Save for a handful of banks in emerging markets, most banks have either divested their life insurance business in the manner of Citi because of banking regulations or — in the case of DBS Group Holdings and United Overseas Bank U11 (UOB) — regulatory constraints such as additional capital requirements.
In a recent briefing, when asked why DBS divested its insurance business in 1999–2000 (see Table 2), group CEO Piyush Gupta says: “Manufacturing insurance requires a very different skill set. If you are doing both manufacturing and distribution, you still have to run two separate businesses with no obvious synergy between the two. Focusing on the banking business has proven beneficial for us; being just a distributor of insurance has proven very good for us.”
Wee Ee Cheong, group CEO of UOB, says: “Different players have different strategies. We have our own strategy; we focus on our customer base and we focus on distribution. There will be people who also manufacture. That in itself is exciting for the market by providing investors choices.”
Gupta adds: “You can make a good ROE on the insurance business but then you could also go into the jam-making business and say it is a great business. We have to pick and choose the businesses we want to be in based on our core competencies and where we can bring the greatest value to the shareholder. Focusing on banking, including distributing wealth management and insurance products, has been a better use of our capital and management capabilities.”
Lee Wai Fai, group CFO of UOB, adds that UOB has to focus on what it is good at. “We decided to focus on distribution and tied up with the best in class for manufacturing and production.” He adds that in the past 15 years, life insurance has become a lot more capital-intensive.
This was highlighted in a recent Citi report, which says that GEH may be subject to higher capital requirements. “The market is likely excited about the potential to upstream unrestricted cash of $3 billion as dividends. We are sceptical as GEH is designated as a D-SII by the MAS and has been subjected to higher capital requirements of 25%,” the Citi report says.
At a recent GEH AGM, minority shareholder Ong, who had asked whether OCBC could provide more liquidity for GEH so that its valuations better reflect its fundamentals, says GEH’s excess liquidity that could be upstreamed is likely to be around $1.5 billion, which is much less than what analysts estimate.
When asked about excess capital and whether OCBC would be able to raise its dividends further, group CEO Wong says: “There will be some impact in the early part of the transition to Basel IV of accretion to CET-1 but it will be erased over time. We cannot rely on that to plan your use of capital because the benefit will be erased.”
As for the use of capital, given that OCBC has the highest CET-1 ratio among the local banks, more than 16% as at the end of March, Wong says: “We will continue to grow organically as we plan, and we will continue to invest. Fundamentally, we also want to protect our credit ratings.” She adds that a fair CET-1 ratio is around 14%.
Will the minorities accept the offer?
Minorities were always concerned about an offer to privatise GEH. During GEH’s AGM in April, a long-term shareholder expressed concern over a third offer from OCBC for GEH as he feared it would be a disappointing one. Based on comments online and in chat groups, GEH’s minority shareholders are disappointed with the offer and hoping for a better one.
Much depends on the shareholders of Sungei Bagan Rubber and Kuchai Developments, led by Lee Thor Seng, whose family is related to the Great Eastern Wongs, and the Wongs themselves. An OCBC observer points out that the Sungei Bagan Lees may be under a fiduciary duty to accept the offer given that the offer prices Sungei Bagan’s GEH stake higher than the company’s own market cap on Bursa Malaysia.
On the other hand, OCBC has its own shareholders to look after, and they may not be happy for OCBC to raise the offer too high. The accretion to ROE is believed to be just 0.2%. If the offer price rises too much, the acquisition is no longer accretive to OCBC’s shareholders. Since Wong changed OCBC’s dividend payout ratio, its share price has risen, leading it to do better from a total shareholder return perspective than DBS, UOB and GEH.
Melissa Kuang, an analyst at Goldman Sachs, calculates that GEH has $2.4 billion in capital, which could be returned to shareholders once GEH is privatised. Minority shareholder Ong sees this as somewhat high. He cautions that the denominator of insurance capital adequacy ratios is total risk requirements or TRRs. TRRs appear more complicated than risk-weighted assets in banks’ CET-1 ratio calculations.
In the meantime, OCBC’s and GEH’s shareholders await the IFA’s recommendations with a combination of anticipation and resignation.
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