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No Shelter From Storm Losses

By ANDREW BARY
This year's catastrophic tornadoes spell darkened earnings forecasts for the major property-casualty insurers.


Major property and casualty insurers like Allstate, Travelers and State Farm are having a gloomy quarter. A series of storms in the Midwest and Southeast during April and May—including those causing heavy damage in Tuscaloosa, Ala., and Joplin, Mo.—could produce record second-quarter catastrophe losses for the industry.

"I can't imagine a worse scenario for the quarter," says Joshua Shanker, the P&C analyst at Deutsche Bank Securities. The industry's domestic catastrophe losses for the quarter could total $15 billion to $20 billion—the kind of losses typical of a tough third-quarter hurricane season, not the usually benign second quarter.

Allstate last week said its catastrophe losses in April and May were $2 billion, compared with an average of about $300 million in the past nine second quarters. That likely will mean a loss for Allstate of a $1 a share in the period. Travelers said recently that its storm-related losses would be $1 billion after taxes, or an estimated $1.5 billion pretax. Travelers projected its adjusted book value on June 30 will be about equal to where it stood at year end, when it was $54 per share.

State Farm, a mutual insurer owned by policyholders, said Thursday that claims from April and May storms will "soon exceed $2 billion." State Farm is the No. 1 homeowners insurer, with a 21.8% share. The bulk of storm losses will come from homeowners insurance, with some losses from autos as well as commercial policies covering damaged buildings. Reinsurance losses aren't expected to be high, because the individual tornadoes and other storms didn't produce the kind of multibillion-dollar losses that typically trigger reinsurance policies held by primary insurers like Allstate and Travelers.

Major P&C insurance stocks have fallen in the past month, but they're still besting nearly every other major part of the financial sector. Shares of Chubb, Ace and Travelers are up about 5% this year, while Allstate is down 7% at $30. The group has benefited from its safe-haven status, as investors flee big banks and investment banks like Citigroup (ticker: C) and Goldman Sachs (GS), many of whose shares are down 20% this year.

"My hunch," says Shanker, "is that investors have been buying P&C insurers to get away from the banks and then formulating a thesis to own them." The bullish industry argument, as made by investor Steve Eisman at the recent Ira Sohn conference ("Where Top Hedge Funds Are Putting Their Money," May 30) is that industry pricing on a wide range of commercial policies is finally rising after several weak years. That should boost profits and the stocks in coming years.

The stocks, however, seem to anticipate some pricing improvement already and industry capital levels still are ample.

Chubb, Travelers and Ace trade around 1.2 times tangible book value and for about 11 times estimated 2011 profits. Their profits in recent years have benefited from reserve releases from conservative underwriting policies in the past. Some 43% of industry earnings last year came from releases, according to a report earlier this year from Bank of America Merrill Lynch analyst Jay Cohen. This means recent profits have overstated earnings power from current business.

Chubb, at 63, trades for 11 times projected 2011 profit of $5.60 a share, while Ace, at 65, fetches 10 times projected 2011 net of $6.26 a share. Travelers, at 58, trades for 12 times estimated 2011 earnings of $4.74. Those consensus estimates, however, could prove high due to the second-quarter storms and the looming Atlantic hurricane season.

Shanker is neutral on the sector and one of the few analysts with a Sell rating on Travelers, which is cutting back on its aggressive share-buyback program because of the second-quarter storm losses. Allstate, at 30, looks inexpensive trading below its $35 tangible book value. It, however, faces company-specific challenges in boosting its return on equity to more than 10%, amid market-share gains by direct writers of auto insurance like Geico, USAA and Progressive (PGR); those companies are taking share from companies like Allstate that rely mainly on agents. Allstate is the No. 2 auto insurer, behind State Farm.

P&C stocks look fairly valued and have benefited from their defensive characteristics this year. With the ever-dangerous third quarter on the horizon, investors may be wise to hunker down until it passes.

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