Allstate Corp. (ALL, Financial) reported earnings for the third quarter and nine months ended Sept. 30 on Nov. 4. The stock responded by a decline of slightly more than 7% that day.
The shares still remain undervalued according to GF Value Line, but there are some aspects of the underwriting operations of the property-liability segment investors should be aware of. Allstate also offers health and benefits and protection services, both segments are less relevant to this discussion due to their small contribution to revenue and earnings.
Earnings results
Consolidated revenue was up 16.9% year over year and reached $12.5 billion in the third quarter, reflecting the spike in premiums written by National General and growth of net investment income. Claims and claims expenses rose to $8.14 billion, resulting in an underwriting loss of $534 million. The associated combined ratio for the period was 105.3% compared to last year's 91.6% and to (a more appropriate comparison) pre-pandemic levels of 91.6% (third-quarter 2019) and 93.9% (third-quarter 2018).
Operating costs of the property-liability segment were $1.55 billion, up 40% from $1.11 billion in the prior-year quarter.
Net income per share was $1.71 (down from $3.58 a year ago) and remained positive due to net investment income of $764 million.
Operations
The source of concern for investors is the growing combined ratio reported in the third quarter in the auto business.
Source: Allstate's earnings report.
The surge in the combined ratio was mainly driven by the auto loss ratio, which, in turn, is affected by accident frequency and accident severity. The pandemic seems to have changed thehabits of drivers. Less driving due to lockdowns in 2020 resulted in less miles driven, but further limitations in 2021 could have resulted in loss of driving skill, less frequency but higher severity of accidents due to higher speeds as a result of lower congestion. Higher severity drove the loss ratio to rise among Allstate’s rivals as well.
Additionally, a fast-growing competitor of Allstate, Progressive Corp. (PGR, Financial), has reported a higher-than-usual combined ratio several months in a row (the company's investor relations team provides the ratio on a monthly basis, allowing for more accurate tracking of its dynamics).
Inflation
CPI Data from the Federal Reserve Bank of St.Louis suggests that inflation in the motor vehicle parts and equipment segment is also rising at a higher pace than in previous years. While the CPI in the segment was 149.19 in January 2021, it rose to 160.72 in October 2021, reflecting a growth of 7.7% over the 10-month period. This strong increase is illustrated in the chart below.
The company implemented rapid price increases to proactively respond to the sharp rise in loss costs. Other players in the industry previously announced similar measures.
What's next for investors and the company?
Underwriting operations are great drivers of business quality of auto insurers when compared to, for example, life insurers.
When risk is reassessed and an increase in premiums is passed on to all clients, there is additional operational risk of discriminating against “good” drivers. While Allstate is behind its rivals in using telematics equipment to address the issue, it can lead to outflow of clients to its competitors. With the change in driving habits and environment that occured during the pandemic, the competitive factor of using telematics has gained momentum in attracting and retaining quality business more than it used to.
With the current rise in prices of motor vehicle parts and supply chain issues, the margins of Allstate will be affected, influencing the return on equity of auto insurers despite proactive management actions.
There is risk associated with a potential consumer preference shift toward electric vehicles either as a choice of first or second vehicle. This shift could lead to risk premium reassessment as well because there is additional uncertainty with spare part supply for such vehicles and yet unknown influence on accident frequency associated with higher torque and acceleration of EVs.
Last but not least, the aspect of underwriting operations an investor should keep in mind is reinsurance. With rising interest rates, investors in catastrophe bonds will require higher yields, thus pressuring the margins of auto insurers.
