Online Insurers Enter Cost-Cutting Competition in Evolving Chinese Market

Waterdrop and ZhongAn boast stronger valuations than rival Fanhua after more successful cost-reduction efforts last year

Key Takeways:

•      Waterdrop reported a significantly narrower net loss in last year’s fourth quarter thanks to aggressive cost cutting

•      ZhongAn made its first-ever annual profit from insurance underwriting last year and more than doubled its profit after reducing operating expenses as a proportion of revenue

•      Fanhua lagged the other two in cost reductions and reported a modest gain in fourth-quarter operating profit

By Warren Yang

For companies operating in China’s ever-evolving insurance market, the ability to trim fat can be just as critical as policy sales. Nothing shows that more clearly than the latest results from three of the country’s top online insurers, Waterdrop Inc. (WDH.US), ZhongAn Online P&C Insurance Co. Ltd. (6060.HK) and Fanhua Inc. (FANH.US). Among that trio, the purely digital pair of Waterdrop and ZhongAn are having greater success in taming costs than the older-school Fanhua.

At the end of the day, all of these companies are coming to realize that investors may like growing premiums, customer numbers and revenues. But they like big profits even more – especially growing profits from the group’s core insurance business. That can be hard to do while spending aggressively to find new customers, especially in a fickle Chinese environment where frequent new rules can sometimes send short-term chills through the market.

Last Wednesday, Waterdrop, an online-only insurance brokerage, reported its net loss for the fourth quarter of last year narrowed more than 80% to 71 million yuan ($11.2 million) from a year earlier, as its net operating revenue also decreased 27%. The company achieved that progress by substantially slashing its operating expenses.

Waterdrop’s cost-cutting steps during the quarter included some layoffs and reduced use of third-party channels to lure traffic, company management said on a conference call to discuss the latest earnings. As a result, it was able to pare operating expenses during the three months by nearly 40%.  It slashed marketing costs by an even bigger 60% from a year earlier.

Waterdrop could pull off such massive reductions so quickly in large part because it is a technology-oriented online business. Expenditure for online marketing is relatively easy to cut, while new technologies like artificial intelligence allow fewer staff to be more productive.

Yet Waterdrop’s net loss still widened for all of last year as growth in costs far outpaced a humble 6% increase in revenue. So, we’ll have to wait and see if the cost cuts will continue in the new year, or whether the fourth quarter represented a short-term trend.

In addition to all the other challenges they face in the competitive and fast-evolving industry, China’s insurers – both online and offline – must contend with regulatory changes that are often unpredictable, swift and can have big effects on business.

In one of the most recent examples, China adopted new rules in November 2020 related to insurance coverage for critical illnesses, giving insurers less than three months to come up with new products that comply with the new requirements. Among other changes, insurance payouts for mild illnesses were capped, while types of diseases that can be covered by insurance were expanded.

The changes sparked a spike in insurance sales during the short period before the new rules took effect, followed by a quick drop-off across the life insurance industry. 

Left reeling

Like many of its peers, Fanhua, China’s first listed insurance broker founded in 1998, was left reeling throughout last year as it struggled to reduce costs fast enough to make up for the sharp sales slowdown.

Its latest earnings report released Monday showed the company’s total net revenue slipped about 6% to 802.6 million yuan in the fourth quarter year-on-year, a much milder decline than Waterdrop’s. But Fanhua, which distributes via both online and offline channels, could only reduce its operating expenses by 7.7%, with general and administrative expenses actually increasing.

As result, its operating profit grew only modestly, by less than 15%. Making matters worse, a loss it booked from an affiliate during the period caused its net profit to drop during the quarter. Fanhua’s revenue and total operating costs were both largely unchanged for all 2021 from the previous 12 months, while net profit declined due to the loss from the affiliate.

Despite all the industrywide challenges, 2021 was a banner year for ZhongAn, China’s first online-only insurer created in 2013 by Alibaba-affiliated Ant Group, Tencent (0700.HK) and Ping An Insurance (2318.HK; 601318.SS). After years of toiling in relative anonymity, ZhongAn last year showcased how a company can both cut costs while still generating new revenue despite the sometimes-challenging environment.

Like Waterdrop, ZhongAn is a digital-only company. But it creates and sells its own insurance products instead of acting a middleman like Waterdrop and Fanhua. ZhongAn made its first-ever annual profit from insurance underwriting last year, the company said in its latest earnings report released the same day as Waterdrop.

ZhongAn achieved the milestone even as it paid out a larger chunk of revenue in claims, because operating expenses as a proportion of sales decreased thanks to advances in technology for selling products and handling claims.

In terms of products, ZhongAn is also more diversified that Waterdrop and Fanhua, which are focused on life and health insurance. ZhongAn gained popularity in its early days with a product that covers costs for returning goods sold on Taobao, Alibaba’s online shopping service. But it now offers a wide variety of insurance schemes – something it can do more easily than its two online peers since it directly offers its own products.

Among those, insurance products related to health and “digital lifestyle,” including e-commerce and air travel, saw decent double-digit percentage growth last year in gross written premiums, the equivalent of top-line revenue for insurance underwriters. But impressively, sales of insurance for consumer finance companies also more than doubled.

With a handsome 60%-plus gain in investment income added in, ZhongAn’s net profit for 2021 soared 110% from the prior year. ZhongAn was the lone insurer among the three to see its stock rise initially after its latest earnings release, although it later gave back most of the gains.

ZhongAn also has a higher price-to-earnings ratio (P/E) exceeding 27, compared to about 9.7 for Fanhua. The metric isn’t applicable to Waterdrop as it isn’t profitable yet. On a price-to-sales (P/S) basis, ZhongAn trades at a multiple of about 1.6 based on 2021 revenue, also higher than about 1.2 for Waterdrop and 0.7 for Fanhua.

In addition to its stronger earnings, ZhongAn may also enjoy a valuation premium over the other two partly because it’s listed in Hong Kong, where investors are friendlier these days toward Chinese companies than the U.S., where the other two are traded.

U.S.-listed Chinese stocks have been heavily sold off lately, amid investor fears that they may be kicked off U.S. exchanges because of a law that requires Chinese companies to make their audit information available to U.S. authorities. China currently bans such information sharing, but regulators from the two countries are now negotiating a deal that would allow such exchanges.

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