Business Context and Reporting Period
The Allstate Corporation filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2010. The company operates primarily through Property-Liability insurance, including Allstate Protection and discontinued lines, and Allstate Financial, which includes life, annuity and related products. The interim financial statements were reviewed by Deloitte & Touche but were not audited.
Key Financial Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total revenues | $7.91 billion, versus $7.58 billion | $23.31 billion, versus $23.96 billion |
| Net income | $367 million, versus $221 million | $632 million, versus $336 million |
| Diluted EPS | $0.68, versus $0.41 | $1.16, versus $0.62 |
| Net margin | Approximately 4.6% | Approximately 2.7% |
| Property-Liability net income | $331 million, versus $314 million | $794 million, versus $836 million |
| Allstate Financial net income/(loss) | $85 million, versus $(38) million | $(18) million, versus $(346) million |
| Property-Liability combined ratio | 95.9, versus 94.7 | 97.2, unchanged |
| Net investment income | $1.01 billion, down 7.3% | $3.10 billion, down 7.8% |
| Realized capital gains/(losses) | $(144) million, versus $(519) million | $(943) million, versus $(550) million |
| Operating cash flow | Not separately presented for the quarter | $3.02 billion, versus $3.52 billion |
- Property-Liability premiums earned declined 0.6% to $6.50 billion in the quarter and 0.8% to $19.52 billion year to date.
- Catastrophe losses were $386 million in the quarter and $1.67 billion year to date, compared with $407 million and $1.74 billion in the comparable 2009 periods.
- Total investments were $102.21 billion at September 30, 2010, up from $99.83 billion at December 31, 2009. After-tax unrealized net capital gains were $1.29 billion, compared with after-tax unrealized net capital losses of $870 million at year-end 2009.
- Shareholders’ equity was $19.27 billion, up from $16.69 billion at December 31, 2009. Book value per diluted share was $35.48.
- Long-term debt was $5.91 billion. Debt represented 23.5% of total capital resources, compared with 26.1% at year-end 2009.
- Cash was $500 million at September 30, 2010, versus $612 million at year-end 2009. Financing activities used $4.81 billion, including $322 million of dividends and substantial contractholder withdrawals.
- Management reported $37.49 billion of cash and liquid investments saleable within 90 days without significant additional realized capital losses, representing 36.5% of the consolidated cash and investment portfolio. Expected investment portfolio cash flows over the next 12 months were $11.08 billion.
Material Changes Versus the Prior Comparable Period
- Net income increased substantially in both periods, primarily because of lower investment impairment losses and improved Allstate Financial results. The nine-month comparison also benefited from a $254 million deferred-tax valuation allowance charge recorded in 2009.
- Allstate Financial improved to quarterly profitability, while its nine-month loss narrowed materially. Higher premiums and contract charges, lower interest credited to contractholders and significantly lower DAC amortization supported the improvement, partly offset by higher contract benefits and investment losses.
- Property-Liability quarterly underwriting income fell to $287 million from $363 million, although nine-month underwriting income was broadly stable at $571 million versus $578 million. The quarterly decline reflected weaker homeowners and standard auto results.
- The homeowners quarterly underwriting result shifted to a $63 million loss from $27 million of income, including a $70 million unfavorable prior-year reserve reestimate related to a litigation settlement. The Allstate brand homeowners loss ratio increased to 80.5 from 75.4.
- Allstate Protection premiums were broadly flat, while Encompass premiums declined sharply. Management continued profitability actions, including rate changes and reduced exposure in selected markets.
- Net investment income declined because of lower yields, lower average asset balances and duration-shortening actions. Derivative losses increased materially as risk-management hedges generated losses that were intended to offset changes in investment values recognized in other comprehensive income.
- Contractholder funds declined to $48.94 billion from $52.58 billion at year-end 2009. Fixed-annuity deposits declined as management reduced distribution through banks and broker-dealers and sought to reduce spread-based product concentration.
Guidance, Outlook, Risks and Unusual Items
- No formal earnings or revenue guidance is provided in the filing. Management expects the annualized cost of catastrophe reinsurance for the year beginning June 1, 2010 to be approximately $560 million, or $140 million per quarter.
- Management stated that expense-reduction actions were expected to exceed targeted annual savings of $90 million beginning in 2011.
- Investment risks remain significant. The portfolio includes substantial RMBS, CMBS, ABS, below-investment-grade securities and assets valued using significant unobservable inputs. Future impairments depend on credit performance, real-estate values, liquidity, interest rates and management’s cash-flow estimates.
- Management recorded $728 million of other-than-temporary impairment losses in earnings during the first nine months, including losses on structured securities, commercial real-estate-related investments and other assets.
- Property-Liability results remain exposed to unpredictable catastrophe frequency and severity, claims inflation, claim frequency, reserve development and regulatory restrictions on rates and underwriting.
- Discontinued lines include asbestos and environmental exposures. Net asbestos reserves were $1.13 billion and net environmental reserves were $205 million at September 30, 2010. Management stated that ultimate losses could vary materially and that a meaningful range of additional reserves could not be developed.
- Legal matters include Hurricane Katrina litigation, homeowners overhead-and-profit class actions, agency-program litigation and other regulatory proceedings. Management believes the aggregate outcome is not likely to materially affect financial position, but an adverse outcome could materially affect a particular period’s results or cash flow. The litigation settlement reflected in the quarter was accrued through prior-year reserve reestimates.
- The company adopted new accounting guidance for variable-interest entities and embedded credit derivatives. The embedded-credit-derivative adoption reduced retained income by $28 million and decreased total assets by $9 million.
- At September 30, 2010, the company had a $1.00 billion commercial-paper facility with no balance outstanding and a $1.00 billion unsecured revolving credit facility. The reported debt-to-capital ratio under the revolving facility covenant was 19.6%, below the 37.5% limit.
Important Facts for Investors to Verify
- Whether homeowners and standard auto underwriting trends, including claim frequency and catastrophe exposure, improve after the third-quarter deterioration.
- The sustainability of Allstate Financial’s improved earnings, particularly given declining contractholder funds, higher surrender rates and continued investment losses.
- Future impairment experience for RMBS, CMBS, ABS, commercial mortgage loans and limited partnerships, including the sensitivity of valuations to management’s projected cash flows and credit-enhancement assumptions.
- The amount and timing of additional reserve development from asbestos, environmental, discontinued-line and litigation exposures.
- Whether expected expense savings beginning in 2011 are achieved without impairing customer retention, new business growth or claims service.
- Liquidity and capital at the regulated insurance subsidiaries, including dividend capacity, collateral requirements and potential funding under intercompany support agreements.