Allstate Insurance Corporation Preferred Stocks: Opportunities and Risks

Allstate Insurance Corporation (ALL -1.72%) has a $25.5 billion market capitalization and offers four traditional preferred stocks and one Exchange-Traded Debt (ETD) security for the consideration of preferred stock investors.

ETDs are very similar to preferred stocks, and are often labeled as such on brokerage statements. But ETDs are recorded on the company's books as debt, rather than equity, and are actually bonds that trade on the stock exchange (rather than the bond market). As debt, ETDs are often considered to represent lower investment risk than the same company's preferred stocks.

Allstate's ETD carries a Baa1 Moody's rating (two notches into investment grade territory) while the company's four traditional preferred stocks are rated Baa3 (bottom of the investment grade scale).

Market strategy and performance
Allstate delineates their market along two customer-focused characteristics, creating four distinct market segments: (1) the preference for full-service versus self-service and (2) those that prefer a specific brand versus those who are less brand-sensitive.

Source: Allstate Q4 2013 Investor Presentation, AllstateInvestors.com

This strategy, while comprehensive, presents challenges as the company continues to adjust their approach to finding the balance between policy growth and profitability. Policy growth is being primarily realized by the self-service (Internet) segments, with esurance reporting an impressive 2013 policy in force (PIF) growth of 26.7 percent over 2012. But this same segment realized a 2013 combined ratio of 117.5 (the combined ratio is the amount paid out in policy expenses divided by the amount collected in premiums, a value exceeding 100 indicating a loss).

Conversely, the full-service Encompass and Allstate brand segments reported solid sub-100 combined ratios (profitable policies) for 2013, but more modest, single-digit policy growth.

Source: Allstate Q4 2013 Investor Presentation, AllstateInvestors.com

In other words, during 2013, Allstate's four-segment business model saw policy growth in the unprofitable self-service segments and stagnant growth in the two profitable full-service segments.

It's hard to tell from company filings and investor information if the self-service segment growth is coming at the expense of branded, full-service products. To the extent that this is the case, the company is effectively converting full-service profitable customers into its self-service unprofitable segment.

Investment performance was a bright spot during 2013 for Allstate as it was for just about every other investor. Surging equity markets and fixed-income yields allowed the company to book about $1.4 billion in investment income, a 3.7 percent increase over 2012.

Despite the challenges of its four-segment business model, however, Allstate still posted a 24 percent increase in operating income over 2012. But this impressive result came almost entirely from a

fortunate reduction in catastrophe claims rather than improvements in its operations or gains in market share. Pure luck delivered a 46.7 percent reduction in losses attributable to catastrophe claims compared to 2012.

By year end, the company's 2013 net income declined by $43 million (1.9 percent) on $34.5 billion in consolidated revenue.

Allstate preferred stock
Allstate issued its ETD and four preferred stocks within a thirteen month period, beginning in January 2013. The return being generated by each of these five securities is roughly triple that being offered by the two percent yield of the company's common shares.

While there are some weaknesses to these securities, they do represent stable, long-term income and a diversification opportunity for preferred stock investors looking to extend their portfolio into the insurance segment.

Source: CDx3 Notification Service database, PreferredStockInvesting.com

All five of Allstate's income securities use the calendar quarter as their dividend cycle. The June dividend for ALL-B, the ETD, has already been declared. Note that the first dividend for the new ALL-E preferred has yet to be declared but is expected to occur in June as well.

With the exception of their coupon rates, Allstate's four preferred stocks (ALL-A, -C, -D and –E) are nearly identical in their prospectus provisions. All offer five-year call protection (from IPO), investment grade ratings, $25 par values and pay quarterly dividends on the same schedule.

But the diversification benefit that these securities offer must be considered in light of their primary weaknesses. Allstate's four preferred stocks have non-cumulative dividends and are offering below-market current yields (the average current yield for high-quality traditional preferred stocks is 6.7 percent) for above-par prices (with the exception of ALL-A).

ALL-A is available for a below-par share price, adding a layer of principal protection and a capital gain in the event of a downstream call. But today's buyers of ALL-A will likely be holding their shares for a very long time since, with a historically low 5.625 percent coupon, Allstate is unlikely to redeem ALL-A shares any time soon.

Even in the face of a changing marketplace, where its primary product is highly commoditized with shrinking brand loyalty and its method of delivery is changing from highly profitable full-service to marginally profitable (or, as yet, unprofitable) self-service, the risk of default is extremely low.

The primary attraction to Allstate's income securities is therefore the stability of the income they can provide over a long period of time and the diversification opportunity they may represent for your income portfolio.