An Empirical Analysis of investment portfolio of China insurance company1

Hao Jia* Hao Yansu*

Abstract:
As the crucial mainstay for insurance industry to survive and develop, the insurance
investment enables insurance companies to offset their possible underwriting losses
and make a considerable profit. Since a period ago, there have been many issues in
the investment of Chinese insurance companies, such as lack of investment vehicles,
low rate of return on investment, and irrational investment portfolio. These factors
restricted the development of China insurance industry. But this situation has greatly
changed since the year 2005 and 2006, when the channels of insurance investment
were expanded by China Insurance Regulatory Commission along with the prosperity
of the capital market. Therefore China insurance industry is embracing with greater
opportunities. Based on the analysis of insurance investment vehicles and the modern
portfolio theory, this paper proposes an optimal scheme of insurance investment
portfolio by formulating a series of models. Powered by those models, the optimal
portfolios of China Life Insurance Company Limited, Ping An Insurance (Group)
Company of China and PICC Property and Casualty Company Limited are evaluated.
Furthermore, an explicit estimate on the portfolio can be made through comparative
analysis of theoretical results and real data. In the conclusion part of this paper, we
present recommendations to improve the investment portfolio management of China
insurance companies.
1 Introduction
By an average of 38% high-speed growth per year, the total assets of China insurance
industry reached 1973.1 billion by the end of 2006. However, the rate of return on
investment of insurance companies maintained at a low level: 2.97%, 3.6% and 5.8%
in 2004, 2005 and 2006, respectively. Apparently, compared with the rapid growth of
China insurance industry’s assets, improvement in the yield of insurance investment is
in high demand.

Fortunately China Insurance Regulatory Commission (CIRC) published a set of

regulations to expand the insurance investment tools in 2006. These give insurance
companies a great opportunity to get high returns on investment. The CIRC
promulgated and put into effect the "Indirect Investment of Insurance Capital
management on Infrastructure Projects" on March 23, 2006. On October 16, 2006, the
CIRC approved that insurance companies could invest in shares of commercial banks.
Subsequently, the "Overseas Investment of Insurance Capital management (draft)"
was published on December 21, 2006 for public comment.

On one hand, the promulgation of these regulations and policies provides the insurers
with more investment tools and more opportunities to maximize the investment

1
Thanks Professor Hao Yansu for his great support.
*
Postgraduate Student of Insurance School, Central University of Finance and Economics E-mail:
giolla@163.com
*
Professor of Insurance School, Central University of Finance and Economics, Director of China
Insurance Market Research Center
returns. Meanwhile, it is a challenge for the young domestic insurers because it calls
for an adjustment of investment strategy under the new policies—they must analyze
the returns and risks of both newly added investment vehicles and former vehicles
comprehensively, and then evaluate the optimal investment portfolios.

The purpose of this research is to provide theoretical and technical supports with
insurance investment in China, the largest emerging insurance market. Meanwhile,
other emerging insurance markets like India and Brazil also face the same situation
that they are all experiencing rapid development, which highly requires the
improvement of investment efficiency. This paper may also be used as a reference for
other emerging insurance markets.

2 Background of China insurance investment

2.1 Investment vehicles
The economic system reform of China is still in its early stage, and this has limited
investment capability of the insurance industry -- investment vehicles are restricted by
the immature capital market and stringent insurance regulation, which have
significant impact on the insurance investment, to ensure the insurance companies
complying with the basic principles for insurance investment, such as diversification
and dispersion, maturity matching (including the liquidity principle) and currency
matching. Therefore it is necessary to make analysis to the insurance investment tools.

2.1.1 Deposit

When China domestic insurance industry resumed operation in 1980, little attention
was paid to investment management, so insurance funds could only be deposit in
banks. Since then, deposit has been the primary insurance investment tool, as at the
end of 2006, deposits of insurance funds reached 562.8 billion Yuan, accounting for
33.2% of the total funds. Deposit is highly security and liquid, but it is sensitive to
macroeconomic policies and its interest rate is lower than securities. Since 1996, there
has been a huge loss arising from difference of interest rate in Chinese life insurance
companies as China central bank has lowered the interest rate eight times. Till now
the interest loss is still a heavy burden for these companies.

2.1.2 Bonds

The CIRC promulgated and put into effect the “Enterprise Bonds Investment
management of Insurance Capital “on March 30, 2003. Then insurance companies
began to invest in enterprise bonds, but the bonds scope is strictly limited in central
enterprise bonds such as railway construction, construction of power et al, as well as
bonds whose credit rating are at least AA. The investment amount of enterprise bonds
is subject to not exceed 20% of the total assets of the company.

On August 21, 2005 CIRC launched “Interim Measures for bond investment
management of insurance capital”. The official document approved that insurance
companies could determine the proportion of investment in Treasury bond
independently whilst the maximum proportion of investment in enterprise bonds
increases from 20% to 30%. Therefore insurance industry increased the bonds ceiling
substantially.

Due to its security and liquidity, which comply with the principles of insurance
companies’ investment strategies very well, bonds become the most important
investment tool for insurance industry. The bond accounts of China insurance industry
have grown rapidly. The amount of bond investment in 1999 was 80.5 billion Yuan;
however the amount rose to 944.6 billion by the end of 2006. And insurance
companies become the second largest institutional investor in bond market.

With the continuous growth of total proportion of bond investment, the investment in
Treasury bond has reduced in spite of its advantages in stability, liquidity and tax
benefits. Compared with other high-yield bonds, Treasury bond becomes less
attractive so that insurance companies hold Treasury bond with purpose of security
rather than profits.

2.1.3 Security investment funds

In October 1999 CIRC and China Securities Regulatory Commission (CSRC) jointly
issued an announcement which officially approved insurance companies to invest in
security funds to indirectly enter the capital market.

By the end of 2001, attracted by the bull market, the security investment funds of
insurance industry increased from 1.5 billion Yuan to 200 billion Yuan, and the
average increasing rate reached 20%. But from the end of 2001, China's capital
market had started a long and painful period of adjustment.

In 2002, the rate of return on security investment funds invested by insurance

companies was -21.3%. Within following three years, the bear market made the low
return on insurance security funds get even lower. In 2005, the stock market met a
better situation: return on security investment funds gradually improved, and the
security funds amount increased to 8% of the total investment funds of insurance
companies. In the first eight months of 2006, 80.059 billion Yuan was invested in
securities investment funds by insurance industry. Compared with the growing
amount of the total investment funds, the amount of investment funds in the first eight
months was smaller than that of 2005, and the reduction was nearly 30 billion Yuan.
The reduction is mainly because of the increase of direct investment in stock. In the
first eight months, the amount of stock investment reached 49.903 billion. It seems
that insurance companies don’t need security investment funds to help them invest in
stock any more.
2.1.4 Stocks

On February 7, 2005, the CIRC approved that insurance companies could invest in
stock, and the amount that has deducted the premium income of variable life and
universal life products shouldn’t exceed 5% of the total assets of last year.

The main characteristic of stock is its high risk: on one hand, the principal can not be
returned; on the other hand, the prices in secondary market fluctuate all the time, and
the influence factors of the prices are unpredictable and speculative.

In 2006, most companies in China have successfully completed the non-tradable

shares reform. And lots of blue chips issued in this year. So the market value of A-
Share2 was pushed to nine trillion Yuan. Shanghai Stock Exchange Index rose 130%
over the year, 300 stock index of Shanghai and Shenzhen Stock Exchange rose 121%.
So insurance companies received real benefit from the stock market and the yield of
stock investment reached 8.92 billion Yuan with a 27.1% rate of return. With the good
performance in stock market, the return of insurance funds ran up to 95.53 billion
Yuan at the end of 2006, with an average yield of 5.8%. Insurance investment has
created a new record.

2.1.5 Infrastructural Construction

On March 6, 2006, CIRC announced that insurance companies can invest in

infrastructure construction project indirectly. Compared with the original channels for
investing, infrastructure projects are low-risk and high-yield.

The infrastructure projects mainly cover transport, communications, energy,

municipal and other state infrastructure projects. These state-backed projects are
lower risk and relatively high yields. For example, the internal rate of return of Tian
jin railway project reaches 5.02% and the return of Shanghai underground railway
project is about 6.21%, whereas the total insurance investment return is only 3.12% in
the same period.

Entering into long-term infrastructure construction has a long history for insurance
funds around the world. In Japan's post-war recovery period, the insurance companies
found by some large financial groups had more interests in infrastructure projects. By
the end of 1986, insurance funds that invested in real estate and city construction
reached 20.1845 trillion yen, so the insurance companies had made great
contributions to Japan in the post-war economic recovery.

China encourages foreign capital to participate into infrastructure projects especially

2
A-Shares are common stock issued by mainland PRC companies, subscribed and traded in
RMB, listed on mainland stock exchanges, and reserved for trading by PRC citizens. The A
Share market was launched in 1990.
in various forms of municipal public facilities construction. Many foreign insurance
companies like New York Life, Yasuda Fire & Marine Insurance and Allianz Group
have invested in China public facilities construction already. And after the permission,
China domestic insurance companies are preparing to invest in infrastructure projects
—the Beijing-Shanghai high-speed railway has attracted nearly 40 billion Yuan
insurance funds, which accounts for 30% of the total investment amount.

2.1.6 Overseas investment

On August 18, 2004, CIRC and Central Bank of China jointly issued the "Foreign
exchange insurance funds management(draft)", and allowed the foreign exchange
funds of domestic insurance companies to invest in overseas bond markets, with the
purpose of opening a new channel for the 10 billion U.S. dollars foreign exchange
funds of China insurance industry. International experience shows that the global asset
allocation capability is the core competencies of the insurance industry. Currently,
there are no substantive overseas investments of China insurance industry, overseas
investment portfolio and risk control strategies have to be explored.

2.2 Analysis of China insurance investment portfolio

Capital utilization rate of insurance companies in developed markets usually can

reach 90%, and the investment involves stocks, bonds, funds, futures, foreign
exchange trading, real estate, and mortgage loan. Among these vehicles, some are
positively correlated to the market interest rates, like deposits, loans, treasury bonds,
and some are negatively correlated to the market interest such as real estate and
stocks. Transfer of insurance funds can help companies control the risk effectively. In
contrast, China insurance investment channels still need to be expanded, and the
financial environment needs to be improved.

Specifically, compared with developed countries, the securities investment proportion

of China insurance funds is smaller. The insurance funds are mainly used in low-
income bank deposits and treasury bonds. As of the end of 2005, China insurance
funds totaled 1.410011 trillion Yuan, with an annual increase rate of 30.82%. Within
this fund, bank deposits are 516.8 billion Yuan, accounting for 36.66% of the funds;
treasury bonds are 359.176 billion Yuan, contributing 25.47%; enterprise bonds are
120.605 billion Yuan, accounting for 8.55%.
 9.57%
1.12%
5.82%
36.66%
8.55%

12.81%

25.47%

Bank deposit Treasury bond Financial bond Enterprise bond

Subordinate bond Stock The others

Figure 1: Structure of China Insurance Funds in 2005

With the reform of economic system and development of capital market, the portfolio
of insurance investment is changing. Let us have a look at China Ping An Insurance
Company investment portfolio for the last three years. We can also find the same
trend of the whole insurance industry that bank deposits kept decreasing, while the
proportion of bonds, Security investment funds and stocks increased year by year.

100%

80%

60%

40%

20%

0%
2004 2005 2006

Fixed deposit enterprise bond and financial bond

treasury bond security investment fund
stock

Figure 2: Investment Portfolio of China Ping An Insurance Group 2004 -2006

Efficient and diversified insurance investments in developed countries have brought
their insurance companies huge profits. According to Swiss Re's statistics, during a
range of 20 years, the average rate of return on insurance funds in developed countries
is more than 8%. That high investment return helped the insurance companies to
consolidate their profit, although they may have an underwriting loss.

China insurance company's investment yield is below this level. From 2001 to 2004,
the insurance industry overall investment rate of return continues to decline and
reached the minimum rate 2.40% in 2004, far less than the Supervision Index 3%.In
2005 and 2006, the recovery of return is mainly dependent on the prosperity of capital
market.

7.00%
5.80%
6.00%

5.00%
4.30%
3.89%
4.00% 3.60%
3.14%
3.00% 2.68%
2.40%
2.00%

1.00%

0.00%
2000 2001 2002 2003 2004 2005 2006

Figure 3：Rate of Return of China Insurance Industry 2000-2006

3 Literature Review
Harry Markowitz initiated the work on portfolio management problems. He
developed a portfolio theory according to which the mean and the variance of the
portfolio return are sufficient measures of the uncertainty for the portfolio selection
purposes.

Since its introduction in the 1950s the theory has been utilized in several applications.
Most of these applications are static allowing only one time period, and then dynamic
models are developed. However, dynamic models have faced resistance due to the
computational difficulties and vast data requirements as well as the sensitivity of the
errors in input parameters.

Many researchers have used the portfolio theory to analyze investments of insurance
funds. Lambert and Hofflander (1966) used Markowitz's portfolio theory in research
of the investments of the property insurers. Forst (1983) considered the structure of
the insurance funds, and analyzed the feasibility of using modern portfolio model in
the research of life insurers. Dominique (1989) used diffusion analysis to look into
underwriting profit and investment income. Cariño and T. Kent(1994) present an
asset/liability model for a Japanese Insurance Company. They use multistage
stochastic optimization to determine an optimal investment strategy that incorporates
the uncertainty in future assets and liabilities as well as complex regulations imposed
by Japanese insurance laws and practices.

In China, the study of insurance investment remained at the very early stage where
model assessment is much more done than empirical studies. Shan Mingli (2000)
proposed the main problems of the application of Maikowitz Portfolio Theory in
China , as well as presented their ideas of improvements for the optimal investment
portfolio model. Yang Guiyuan and Tang Xiaowo (2001) studied how to choose the
securities investment portfolio and established a correlation model. Guo Cunzhi(2001)
discussed the application of modern portfolio in securities choosing and studied the
prospects of this theory in the present stage in China, and put forward relevant
proposals. Rong (2001), analyzed the gross income and risks of insurance companies,
and improved the theory of the insurance investment model with an optimal
investment ratio formula. Cui (2004), according to CAPM theory, constructed a
minimum risk investment portfolio under a given profit.

Shen Shuguang (2002)studied insurance investment systematically, contained

research of insurance investment tools, and the current insurance investment
environment and gave some strategies to regulate such situation, that the investment
should according to permission of the market and environmental conditions.

4 Research Methodology and Data

4.1 Model
4.1.1 Assumption

Portfolio Theory (Markowitz, 1952) holds that all the investors are risk-averse. And
investors expect to gain the maximum return under certain risk or suffer minimum
risk under certain expected return. It means the investor’s portfolio must seek the
balance between targeted risks and expected return in order to minimize the risk while
pursuing the maximization of return.

Markowitz’s mean-variance assumption is that the investors must be rational-- they

are pursuing the maximum return and are risk-averse. Pursuing the maximum return
means the rational investors tend to prefer maximum-return security under the same
risk. Risk-averse means the rational investors tend to prefer the minimum-risk
security under the same expected return. Portfolio theory assumes risk-return tradeoff,
so extra return must be paid if investors stand extra risk.

4.1.2 CML
CML is a line used in the Capital Asset Pricing Model to illustrate the rates of return
for efficient portfolios depending on the risk-free rate of return and the level of risk
for a particular portfolio.

The CML is derived by drawing a tangent line on the intercept point on the efficient
frontier where the expected return equals the risk-free rate of return. And CML is
considered to be superior to the efficient frontier since it takes into account the
inclusion of a risk free asset in the portfolio. The capital asset pricing model (CAPM)
demonstrates that the market portfolio is essentially the efficient frontier. The formula
and figure of CML are as below.

Capital Market Line

R0 Efficient Frontier
σ
0
Figure 4: Capital market line

R=R0+ [(Ri-R0)] × σ

Ri denotes the expected return of risk assets, R0 denotes return of the risk-free asset, R
denotes expected return of portfolio and σ denotes the portfolio’s risk.

According to Markowitz’s theory, the ultimate goal of investing is to minimize the

risk under certain profit or maximize the profit under certain risk. An effective
insurance investment portfolio can increase investment income of insurance funds and
improve the solvency of insurance companies. It can reduce the operation risks of
insurance companies and enhance the competence of enterprises too.

4.1.3 Portfolio models

Currently, China insurance funds are used in bank deposits, bonds, stocks, securities
investment funds, insurance policy loans, indirect investments in infrastructure
construction and overseas investments. We set bank deposits be the risk-free
investment for insurance company, and take treasury bonds, enterprise bonds, stocks
and securities investment funds as risk assets.

As the insurance funds have not yet been used in the infrastructure investments and
overseas investments, this study does not include these two investment channels.
Bonds investments include financial bonds, subordinated bonds, convertible bonds
etc. To simplify the study, we only study more representative treasury bonds and
enterprise bonds. Hence some errors may exist because of the ignorance of some bond
varieties.

We suppose there are N+1 investment assets, including N risk assets and one risk-free
asset. Then the return of the portfolio is
N N
R=r+ g α 0 r0+g ∑αiri α 0 + ∑αiri =1
i =1 i =1

r denotes underwriting profit margin;

r0 denotes rate of return of risk-free asset;
ri denotes the rate of return on the ith risk assets;
g denotes the proportion of the investment asset to total asset;
α 0 denotes the relative amount invested in risk-free asset;
αi denotes the relative amount invested in risk asset i (0≤ αi ≤1). αi can be seen as
the measurement of insurance investment portfolios. And r, ri are stochastic variable
denoting the yield of the ith risk asset. Hence, the expected rate of return and total risk
of portfolio are as follows:

N
E（R）= E(r)+ g α 0 r0+g ∑αE(r
i =1
i )
i

N N
Var(R) = Var(r)+2g ∑α Cov(r,
i =1
i ri) + ∑g 2αiαjCov(r i, rj)
i, j=1

Insurers generally expect to get maximum total return and minimum total risk.
However, the amount of risk they will take on is positively correlated to expected
return. So Insurers will balance the total return and total risk by their risk preference
to choose a portfolio with risk assets and risk-free assets, in order to maximize the
satisfaction of the proceeds, and meet the demand for insurance payments, while
minimizing its total risk. Therefore we are going to establish an insurance portfolio
model with minimum risks under certain rate of return to calculate the optimal
portfolio of China insurance companies. That is:

N N
min[Var(r)+2g ∑αiCov(r, ri) + ∑g 2αiαjCov(r i, rj) ]
i =1 i, j=1
 N
s.t. E(r)+ g α 0 r0+g ∑αE(r
i =1
i i) =E(R)

N
α 0 + ∑αiri =1
i =1

α 0 , αi ≥0,(i=1,2,…,N)

To calculate the optimal portfolio, we need to solve the optimal values of α 0 and αi
(i=1,2,…,N). The insurance portfolio model above is a kind of nonlinear programming
problem, so we can use Kuhn-Tucker conditions to solve it. We will take the nonlinear
programming problem below as an example.

Min f(x)
gi(x)≤0 (i=1,2,…,m)
s.t.
hj(x)=0 (j=1,2,…,l) Function f(x), gi(x) and hj(x) all have first continuous partial
derivatives.

According to Kuhn-Tucker conditions, if x* is the minimal point, and the constrained

gradients ▽hj(x*)(j=1,2,…,l) and ▽gi(x*)(i∈I(x*)) are linear independence, there are
vectors λ = ( λ1 , λ2 ,…, λm )T and µ = ( µ1 , µ2 ,…, µl )T making the following
conditions come into being.
m l
▽f(x*)+ ∑λ ∇g
i =1
i i ( x*) + ∑µj ∇h j ( x*) =0
j=1

λi g i ( x*) =0, λi ≥0 (i=1,2,…,m)

λ1 , λ2 ,…, λm and µ1 , µ2 ,…, µl are called Generalized Lagrange

multipliers.
4.2 Data
The data adopted in this paper are extracted from Annual Report of Insurance
Companies, Yearbook of China’s Insurance, China Securities and Futures Statistical
Yearbook, Almanac of China’s Finance and Banking, website of Shanghai Stock
Exchange, website of Hong Kong Stock Exchange and Cleaning Limited, website of
the CIRC and website of the China Banking Regulatory Commission. Then we will
determine the value of the independent variables. Firstly we take Ping An insurance
Group as an example.
4.2.1 Underwriting profit margin

Because insurance company's profits are mainly derived from investment profit and
underwriting profit, so this study set underwriting profit be insurance company profits
minus investment profits. So we set underwriting profit margin=underwriting profit/
(underwriting income-change in unearned premium reserves-change in long-term
unearned premium reserves).

Table 1： Underwriting Profit Margin of Ping An Insurance Group 2000-2006

Unit: RMB 1 million

2006 2005 2004 2003 2002 2001 2000 average

underwriting -4936 -4843 -2741 -3527 -1503 -1613 -1634 —

profit
underwriting 81712 54780 55911 59334 62027 46527 27375 —
income
unearned 2600 1372 1191 152 881 496 0 —
premium reserves
long-term -5.75 519 0 301 390 780 0 —
unearned
premium reserves
Underwriting -0.2 -0.09 -0.05 -0.06 -0.03 -0.04 -0.06 -0.07
profit margin

4.2.2 Return of risk assets

Table2：Rate of Return of Risk Assets 2000-2006

2006 2005 2004 2003 2002 2001 2000 average

treasury 3.51 2.41 4.4 3.21 2.66 3.03 3.40 3.231

bond（%）
Enterprise 4.13 3.73 5.34 4.17 3.43 3.79 4.11 4.100
bond（%）
Security 53.63 -3.08 -13.86 8.89 -19.38 4.42 31.9 9.36
Investment
Funds（%
）
stock（% 129.88 -7.86 -15.15 11.02 -17.48 -21.67 52.34 18.73
）

4.2.3 Restriction of asset’s investment proportion by CIRC

Table3： Restriction of Asset’s Investment Proportion

investment tools restrictions

 Deposit no limit

Treasury bond、Financial bond no limit

Enterprise bond, Subordinated Bond, Convertible Bonds 30%

Security Investment Funds 15%

Stock 5%

4.2.4 Return of risk-free asset

Table 4: Interest Rate of Bank

2006 2005 2004 2003 2002 2001 2000 average

fixed 2.329 2.25 2.115 1.98 1.98 2.25 2.25 2.165

deposit
agreement 3.787 3.89 4.00 3.75 3.75 4.2 4.2 3.939
deposit
average 3.058 3.07 3.06 2.865 2.865 3.225 3.225 3.052

4.2.5 Proportion of investment insurance assets

Table5: Proportion of Investment Asset to Total Asset of Ping An insurance Group

2000-2006
Unit: RMB 1 million
2006 2005 2004 2003 2002 2001 2000 average

investment 269596 246748 201444 155920 126530 34241 23249 -

asset
gross asset 441791 319706 264496 206044 162596 94831 64290 -

investment 0.752 0.772 0.762 0.757 0.778 0.361 0.362 0.65

proportion

4.3 Calculation steps

We expect to calculate the optimal investment portfolios of China insurance
companies, and compare them with the actual portfolios of the three representative
China insurance companies, and then we can get conclusions and proposals on how to
improve the investment gains.
According to the value of the independent variables, we can educe:
r0=3.052% where r0 denotes rate of return of risk-free asset;
g=65% where g denotes the proportion of the investment asset to total asset;
E(r)= -7.0% where r denotes underwriting profit margin;
E(r1)=3.23% where r1 denotes rate of return of treasury bond;
E(r2)=4.1% where r2 denotes rate of return of enterprise bond;
E(r3)=9.36% where r3 denotes rate of return of investment funds bond;
E(r4)=18.73% where r4 denotes rate of return of stock;
Then we can calculate the variances and covariances of these rates of return.

Table 6: Variance-Covariance Matrix of Return of Risk Assets and Underwriting

Profit Margin

treasury bond enterprise investment stock underwriting

bond funds profit margin
treasury bond 0.418980 0.240391 -0.068184 0.262049 0.380583

enterprise 0.240391 0.370900 0.933010 0.165752 0.222950

bond
investment -0.068184 0.933010 668.5224 -0.019922 0.038324
funds
stock 0.262049 0.165752 -0.019922 3056.934 0.937298

underwriting 0.380583 0.222950 0.038324 0.937298 0.003210

profit margin

We bring the values of the independent variables to the insurance investment portfolio
we established:
4 4
Min [0.003210+2×0.65 ∑αi Cov (r, ri) + ∑0.65 2 αiαj Cov (ri , r j ) ]
i =1 i , j=1

4
s.t. -7.0%+0.65×3.052% α0 +0.65 ∑αi E (ri ) =E(R)
i =1

N
α0 + ∑α i =1
i =1

Furthermore, the “Interim Measures for bond investment management of insurance

capital” issued by CIRC stated that the proportion of enterprise bonds to total
investment assets of insurance companies should not exceed 30% of the total assets of
the company. So the result of enterprise bond investment proportion multiplying
proportion of investment asset should be less than 30%, that is α2 ×g≤30%.So α2

≤30%/ g =30%/g=30%/0.762=39.37%. In the same way, we can deduce α3 ×g≤15%， α4

×g≤5%, and α3 ≤15%/g=15%/0.762=19.69%， α4 ≤5%/g=5%/0.762=6.56%.

So we have a new model with the added constraint conditions, and the solution of this
model is the efficient portfolio of Ping An insurance Group.

4 4
Min [0.003210+2×0.65 ∑αi Cov (r, ri) + ∑0.65 2 αiαj Cov (ri , r j ) ]
i =1 i , j=1

4
s.t. -7.0%+0.65×3.052% α0 +0.65 ∑α E(r ) =E(R)
i =1
i i

N
α0 + ∑α i =1
i =1

α2 ≤39.37%

α3 ≤19.69%

α4 ≤6.56%

α0 , αi ≥0，(i=1,2,3,4)

This model is a kind of nonlinear programming problem with constraint conditions, so we can
use Kuhn-Tucker conditions to solve it. We input the data into Excel’s programming function,
and get the efficient portfolio as follow:
Table 7: Efficient Portfolio of Insurance Funds

rate of 1 2 2.5 3 3.5 4 4.5 5

return
variance 2.537 9.794 15.195 21.776 29.541 38.493 44.208 72.064
deposit 0.768 0.659 0.550 0.420 0.311 0.273 0.165 0.027
treasury 0 0.077 0.157 0.271 0.364 0.344 0.437 0.501
bond
enterpri 0.198 0.198 0.210 0.210 0.210 0.230 0.230 0.220
se bond
funds 0.017 0.033 0.041 0.049 0.057 0.087 0.102 0.186
stock 0.017 0.033 0.042 0.050 0.058 0.066 0.066 0.066

Table 7 shows the total risk increased with the total return. Bank deposit proportion
reduced significantly when the total investment return increased, however Treasury
bond proportion increased with the total return significantly. Enterprise Bond and
Security Investment Fund changed a little, for example the proportion of enterprise
bond is about 21% in various efficient portfolios. The restraint condition of stock is
less than 6.56%, whereas the proportion of stock has reached the ceiling when the rate
of return increases to 4, so the proportion of stock is unable to rise.

Optimal portfolio can peak the slope of CAL, which means the reward-to-variability
ratio reach the maximum too. And the function of CAL’s slope is:
Si=[E(ri)-r0]/ σi

Si denotes slope of CAL

σi denotes standard deviation of the portfolio

E(r)

E(r)=4.5 σ =6.6

3.052%

σ
0

Figure 5: CAL and Effective Frontier

By calculating the slope of these CALs, we know that when rate of return is 4.5%,
variance is 44.408, and the slope of CAL reaches the maximum 0.23. So we can
conclude that when total return is 4.5%, the portfolio meet the two requirement of
high return and low risk. Let’s compare this optimal portfolio to Ping An group’s
actual portfolio.

Table 8: Actual Portfolio of Ping An Insurance Group 2004-2006

 Actual portfolio (%) Optimal portfolio
(%)
2006 2005 2004

deposit 25.21 27.95 39.87 16.5

bond 63.19 64.74 56.03 66.7

meanwhile
treasury bond 34.44 37.70 34.96 43.7
enterprise bond 12.51 9.81 7.47 23
fund 4.4 4.08 2.85 10.2

stock 5.64 2.1 0 6．6

In the same way, we can deduce the optimal portfolios and actual portfolios of China
Life Insurance Company and PICC Property (Casualty) Company.
Table 9: Actual Portfolio of China Life Insurance Company 2004-2006

Actual portfolio (%) Optimal portfolio

(%)
2006 2005 2004

deposit 33.35 37.93 46.81 15.3

bond 58.05 29.59 21.23 63.6

meanwhile
treasury bond 26.41 18.2 14.01 42.6
enterprise bond 5.14 0.66 0.72 21
fund 4.46 5.00 3.53 13

stock 2.64 0.20 0 8．1

Table 10: Actual Portfolio of PICC Property (Casualty) Company 2004-2006

Actual portfolio (%) Optimal portfolio

(%)
2006 2005 2004

deposit 17.78 32.22 33.50 15.1

bond 60.13 51.27 41.87 66.5

meanwhile
treasury bond 36.00 37.87 22.65 43
enterprise bond 14.32 8.17 12.36 23．5
fund 10.74 7.34 15.9 9.6

stock 10.12 0.05 0 8.9

5 conclusions
From the comparison of practical portfolio and theoretical investment portfolio of
these three companies we can see that:

5.1 Analysis of deposits and treasury bonds investment of China insurance companies

The investment funds of insurance companies are mostly liabilities to the insured,
because the funds must be paid to them after the insurance accidents. Therefore, to
maintain an adequate solvency, insurance investment must strictly follow the principle
of security. So the majority of domestic insurance company's funds mainly invested to
the bank deposits and treasury bonds. But the rates of return of them are lower than
other securities correspondingly. If domestic insurance companies decide to raise the
yield of investment, it is necessary to increase the investment of enterprise bonds and
other high return securities.

5.2 Actual investment proportion of enterprise bonds is lower than the theoretical one

In 2006, enterprise bond investments proportion of Ping An reached 12.51%, with a

30% increase for the last three years. Enterprise Bonds become favored mainly
because their returns were significantly higher than that of treasury bonds and
financial bonds. Currently the rate of return of the top three enterprise bonds in China
are 5.64%,5.61% and 5.19%.In addition, the scale of China enterprise bonds issuing
expanded rapidly. In 2006 China issued a total of 101.5 billion Yuan enterprise bonds.
In 2007, China National Development and Reform Commission will continue to
expand the enterprise bonds issuance, with an increase of no less than 55%.

5.3 The actual proportion of securities investment funds is a little lower

An important reason for the low proportion of securities investment funds is that
China securities investment funds market is still in its early stage of development,
which makes the insurance companies puzzled by high market risk and fluctuations of
rates of return—the performance of market from 2000 to 2006 is the best proof.

In China, policy influenced the stock market apparently, so systematic risk in stock
market is significantly higher than that in other mature stock markets. That is even the
nonsystematic risks can be transferred, the investors will have to take on plentiful
systematic risk.

Furthermore the insurance funds can directly invest in stock market, so insurance
companies do not need security investment funds to help them invest in stocks. This is
another reason for the low percentage of security investment funds.

5.4 Stock investment grows rapidly and approaches the policy ceiling
After the exploration in 2005, China insurance funds started to increase the scale of
direct investment in stock in 2006. By the end of August 2006, the investment
proportions of stocks get to 49.903 billion Yuan, and accounted for 3.14% of the total
investment funds. In 2006, stock investment of PICC was 7.9 billion Yuan, accounting
for 10.12% of its total assets. The proportion of stock investment of New China Life
insurance Company and Tai kang Life insurance Company has nearly reached the
ceiling.

China insurance companies have to increase investment return to meet rapid growth
of the total assets. And in the last two years, lots of banks, telecommunications and
other large capitalization stocks have listed, therefore the insurance industry will
continue to invest in the stock market substantially.

Although the good news from the stock market is really exciting, the insurance
industry should be conscious of the risks of the stock market. In the past four years,
the bear market has brought many losses to institutional investors, so the insurers
should control the amount of stock investment. It is reported that “regulation of
insurance venture capital investment management” has been draw up already.

5.5 The overall use of insurance capital from the analysis

It can be seen from table 8, 9 and 10, the sum of deposit and Treasury bond accounted
for majority of the investment funds, and the sum match the theoretical results very
well. That means, China insurance companies think much of investment security. And
we can learn from table 7 that with the return of portfolio increase, the proportion of
enterprise bonds maintained, and the proportions of Treasury bond and stock
increased, whereas the proportion of deposit decreased. Therefore, if China insurance
companies want to obtain a higher investment return, they need to reduce the
investment of bank deposit and enhance the investment of security funds and stocks
under effective risk control.

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Appendix

Table 1： Underwriting Profit Margin of China life Insurance Group 2000-2006

2006 2005 2004 2003 2002 2001 2000 average

underwriting -13821 -4665 -516 -4168 -574 -1101 -266 -

profit

underwriting 182680 80253 65075 51354 128781 81313 65164 -

income
 unearned 483 67 623 547 409 276 264
premium
reserves

Underwriting -0.0759 -0.0581 -0.008 -0.0820 -0.0045 -0.0140 -0.0041 -0.0352

profit margin

Table2: Proportion of Investment Asset to Total Asset of China Life Insurance Group
2000-2006
2006 2005 2004 2003 2002 2001 2000 average

investment 594879 494356 374890 15651 12864 94351 72038 -

asset 6 9
total asset 684515 559219 433671 45578 29989 22096 15976 -
1 8 6 9
investment 0.870 0.884 0.864 0.343 0.429 0.427 0.451 0.61
proportion

Table 3: Variance-Covariance Matrix of return of risk assets and underwriting profit

margin—China Life Insurance Group

treasury bond enterprise investment stock underwriting

bond funds profit margin
treasury bond 0.418980 0.933010 0.165752 0.222950 0.172876

enterprise 0.933010 0.370900 -0.019922 0.038324 0.084338

bond
investment 0.165752 -0.019922 668.5224 0.937298 -0.440753
funds
stock 0.222950 0.038324 0.937298 3056.934 -0.461198

underwriting 0.172876 0.084338 -0.440753 -0.461198 0.001245

profit margin

Table 4: Efficient Portfolio of China Life Insurance Group

rate of 1 2 2.5 3 3.5 4 4.5 5

return
variance 3.742 9.907 18.050 26.660 30.049 40.281 49.036 53.142

deposit 0.846 0.697 0.558 0.463 0.302 0.234 0.181 0.153

treasury 0.011 0.069 0.167 0.233 0.375 0.402 0.411 0.426

bond
 enterpri 0.113 0.168 0.190 0.207 0.209 0.210 0.210 0.210
se bond
funds 0.015 0.033 0.042 0.048 0.059 0.087 0.120 0.130

stock 0.015 0.033 0.043 0.049 0.055 0.067 0.078 0.081

Table 5： Underwriting Profit Margin of PICC insurance Group 2000-2006

2006 2005 2004 2003 2002 2001 2000 average

underwriting profit 535 1766 465 1486 1045 1502 833 -

underwriting income 24792 49802 50628 58111 41478 39297 36803 -

unearned premium 3512 -227 1500 2613 1340 1480 660

reserves
long-term unearned 0 337 600 915 0 0 0
premium reserves
Underwriting profit -0.025 -0.034 -0.009 -0.027 -0.026 -0.039 -0.023 -0.0264
margin

Table 6: the Proportion of Investment Asset to Total Asset of PICC Insurance Group
2000-2006
2006 2005 2004 2003 2002 2001 2000 average

investment 38068 36128 34989 10933 14771 7560 4200 -

asset
gross asset 106124 95112 90757 75956 59443 52593 48954 -

investment 0.359 0.380 0.386 0.144 0.248 0.144 0.086 0.250

proportion

Table 7: Variance-Covariance Matrix of return of risk assets and underwriting profit

margin—PICC

treasury bond enterprise investment stock underwriting

bond funds profit margin
treasury bond 0.418980 0.933010 0.165752 0.222950 0.172876

enterprise 0.933010 0.370900 -0.019922 0.038324 0.084338

bond
investment 0.165752 -0.019922 668.5224 0.937298 -0.440753
funds
 stock 0.222950 0.038324 0.937298 3056.934 -0.461198

underwriting 0.802480 0.800420 -0.072187 0.135461 0.029420

profit margin

Table 8: Efficient Portfolio of PICC

rate of 1 2 2.5 3 3.5 4 4.5 5

return
variance 2.176 10.811 16.007 23.240 31.998 40.802 45.769 89.261

deposit 0.733 0.621 0.538 0.462 0.301 0.255 0.151 0.026

treasury 0.057 0.113 0.172 0.217 0.353 0.362 0.430 0.460

bond
enterpri 0.182 0.196 0.201 0.220 0.231 0.235 0.235 0.235
se bond
funds 0.014 0.035 0.044 0.050 0.057 0.077 0.103 0.186

stock 0.014 0.035 0.045 0.051 0.058 0.071 0.081 0.093