Allstate Crashes

By Brian Graney (TMF Panic)
September 24, 1999

Property and casualty (P&C) insurer Allstate Corp. (NYSE: ALL) was laid to waste this morning after warning that its third quarter earnings are going to miss estimates. The company is guiding investors to expect operating EPS between $0.50 and $0.55 for the period, down from last year's $0.76 and short of the prior First Call mean estimate of $0.78. The fourth quarter looks a little better but will still be down, with operating EPS between $0.65 and $0.73 compared to $0.78 a year ago.

Allstate said higher catastrophe losses stemming in part from Hurricane Floyd, additional reserves for asbestos-related losses, and increased expenses for marketing and technology upgrades will crimp earnings. Also, an increase in loss costs and a decrease in average premiums will cause margins to erode, according to the company.

That loss costs are rising is interesting to hear, since it has been the gradual decline in loss costs over the past few years that has triggered a much lower overall personal lines pricing environment. This shift to lower pricing has often been categorized as "intense pricing competition," and indeed, Allstate chairman and CEO Edward Liddy cited the dreaded but now almost clichéd "intense competition" situation in today's press release. But unlike in past quarters, the falling price environment is going to sideswipe Allstate's underwriting results this time around, thanks largely to the reversal of the loss costs trend.

This is bad news for investors who were hoping that Allstate could weather the current P&C storm by keeping its personal lines pricing slightly above the cut-it-to-the-bone insurers, a plan of action that has allowed the firm to maintain its combined ratio in an enviable neighborhood lately. In Q2, the company's combined ratio was 95%, or an even more impressive 89.4% once catastrophe losses were backed out. That ratio will surely be rising in Q3 and Q4, although it won't hit the 100% area that auto insurer Progressive (NYSE: PGR) warned of a few weeks ago, alluding to higher acquisition costs.

Investors trying to make heads or tails of all this are left with an interesting situation. The P&C insurers are definitely out of favor right now. The Standard & Poor's SuperCap Property/Casualty Insurance Index is off 26% so far this year following a less-than-stellar performance in 1998. For its own part, Allstate's shares are now down 31% year-to-date after slipping 14% last year. The industry is in a state of flux, which could signal an opportunity for value-seeking insurance investors to start poking around for assets that are mispriced. Certainly, Allstate's multiple is low right now at roughly 8.5 times trailing 12-month earnings of $3.10 per share. But does that make it a good investment?

To answer that question in the affirmative, an investor has to believe in Liddy's plan for the future. Instead of focusing on underwriting niches like the direct-response marketing angle preferred by Berkshire Hathaway (NYSE: BRK.A) unit GEICO or specialty insurance areas like Chubb (NYSE: CB), Allstate's strategy is to go in the opposite direction. The idea is to leverage the company's national brand name and beat its rivals on scale by creating a "multi-monster" -- multi-channel, multi-product, multi-brand, and multi-national -- while still focusing on its core competency of proving coverage to middle-class households in the U.S.

The plan could lead to greater growth through more diversified earnings streams, or it could backfire as competition in the personal lines business becomes even more intense. With such changes going on amid such tumult, this is the time for value-inclined insurance investors to take a closer look and determine if they'll be in good hands holding Allstate in their portfolio.

Related link:

• Fool on the Hill, "A Tough Year for P&C Insurers," 11/10/98

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