Why did Allstate take a large reserve charge in 1996, and does it signal further problems?

In October 1996, Allstate increased net loss reserves by $318 million after a comprehensive review of environmental, asbestos, and mass tort exposures, using outside databases and actuarial techniques. Management says the uncertainties are such that the ultimate cost could vary materially from amounts recorded and that issues like coverage disputes are unlikely to be resolved soon. The filing does not guarantee that reserves are sufficient, so investors should watch for future adverse development in this long-tail book.

How strong is Allstate's core auto and homeowners business after the 1996 divestitures?

Personal property and casualty (PP&C) underwriting income rose to $416 million from $300 million, and its combined ratio improved to 97.7 from 98.1. Standard auto premiums grew only 2.6%, but non-standard auto premiums grew 27.3%, and homeowners premiums rose 4.4%. Allstate reports that it has about 14,100 full-time agents and that roughly 30% of its agents are exclusive independent contractors. Growth in non-standard auto is expected to slow as that market matures.

How exposed is Allstate to catastrophes, and what has it done about it?

Hurricane Andrew and the Northridge earthquake caused net losses of $2.33 billion and $1.72 billion respectively, and 1996 catastrophe losses were $991 million. Allstate cut Florida exposure by raising rates 24.9%, selling renewal rights on up to 137,000 policies, and transferring wind coverage to a state pool. In California, it shifted earthquake coverage to the state-run CEA, which carries assessments the company estimates at up to $700 million in contingent payments. Allstate had little reinsurance in place for its personal lines at year-end 1996, which leaves it exposed to a severe event before the new Florida treaty takes effect.

What is the capital position and what could constrain the holding company?

Allstate Insurance Company's premium-to-surplus ratio improved to 1.6x from 1.9x, well inside the 3x guideline. All of its insurance subsidiaries exceeded required risk-based capital levels. The holding company depends on dividends from AIC, which can distribute up to $2.2 billion in 1997 without prior approval. The $1.5 billion credit line requires AIC to maintain minimum statutory surplus and limits the debt-to-equity ratio, and that access could be impaired after a large catastrophe loss.

How sensitive is Allstate Life to interest rates and policyholder surrenders?

Allstate Life had $33.6 billion in investments including Separate Account assets, and interest-sensitive products carried liabilities of about $24.8 billion, of which roughly 11% were subject to discretionary withdrawal without adjustment. Surrenders and withdrawals totaled $1.57 billion in 1996. Management says it manages duration to match assets and liabilities, but a sharp rise in rates combined with higher surrenders could force sales of portfolio securities at a loss. Competition from banks and the risk that tax deferral benefits on annuities could be eliminated are also cited.

ALLSTATE CORP 10-K FY1996 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 27, 1997. Cited figures are marked; the original filing is the authoritative source.

The Allstate Corporation's 1996 Form 10-K shows a year of heavy portfolio and footprint restructuring.

Net income rose to $2.075 billion^a, or $4.63 per primary share, up from $1.904 billion ($4.24) in 1995 and $484 million ($1.08) in 1994. Results were helped by higher property-liability premiums, favorable auto injury severity trends, and $784 million of pre-tax realized capital gains, partly offset by a $318 million pre-tax charge to strengthen discontinued lines reserves (environmental, asbestos, and mass tort) and a $150 million California Earthquake Authority assessment. Total revenues were $24.3 billion, and shareholders' equity reached $13.45 billion, or $30.47 per share.

Management sold several operations in 2016's second half, including Northbrook (commercial lines), domestic and London reinsurance (ARCO), and it exited mortgage guaranty by reserving for the run-off of the PMI-related mortgage pool. Property-liability combined ratio was essentially flat at 100.5 versus 100.4, with PP&C's combined ratio improving to 97.7. Non-standard auto premiums grew 27.3%^b, while Allstate Life's operating income rose 12.5%.

The company also issued $750 million^c of trust preferred securities and expanded its stock repurchase authorization by up to $750 million through 1997. Management's risk discussion centers on catastrophe exposure in Florida and California, reserve uncertainty for long-tail environmental and asbestos claims, and the sensitivity of Allstate Life to interest rate movements and surrenders. For investors, the central questions are whether the 1996 reserve strengthening marks the end of adverse development in discontinued lines, whether the company can keep the combined ratio near or below 100 without the cushion of favorable prior-year releases, and how much of 1996's earnings growth came from one-time gains on portfolio repositioning and disposals rather than recurring operations.

02—Key points

Key Highlights

Net income of $2.075 billion ($4.63 per share) in 1996, up 9% from $1.904 billion in 1995, with the earnings gain supported by premium growth, favorable auto severity, and realized capital gains.
Pre-tax charge of $318 million to strengthen net loss reserves for Discontinued Lines and Coverages, including $172 million for environmental and $72 million for asbestos claims, plus $60 million for mass torts.
Property-liability combined ratio of 100.5 (versus 100.4 in 1995). Catastrophe losses were $991 million, and the company had limited reinsurance on its personal lines book, with only a new $400 million Florida excess treaty effective January 1, 1997.
Non-standard auto premiums written grew 27.3% to $2.76 billion, while standard auto grew 2.6%. Allstate Life's net income rose 15.1% to $388 million, and variable annuity sales increased 187.1%.
Portfolio of $58.3 billion in investments at year-end, with 80.7% in fixed income securities and about 94% of fixed income rated investment grade. Equity holdings were cut to $5.56 billion to reduce market risk.
Shareholder capital actions included $750 million in trust preferred securities issued in November 1996 and up to $750 million in additional stock repurchases through year-end 1997. Book value per share rose to $30.47 from $28.34.
Dispositions included Northbrook (sold to St. Paul), domestic reinsurance (sold to SCOR), and London reinsurance (ARCO sold to QBE), which together reduced investments by about $1.59 billion and reserves by about $1.01 billion, while producing a net after-tax loss on dispositions of $60 million.

03—Questions

Frequently Asked Questions

Why did Allstate take a large reserve charge in 1996, and does it signal further problems?
In October 1996, Allstate increased net loss reserves by $318 million after a comprehensive review of environmental, asbestos, and mass tort exposures, using outside databases and actuarial techniques. Management says the uncertainties are such that the ultimate cost could vary materially from amounts recorded and that issues like coverage disputes are unlikely to be resolved soon. The filing does not guarantee that reserves are sufficient, so investors should watch for future adverse development in this long-tail book.
How strong is Allstate's core auto and homeowners business after the 1996 divestitures?
Personal property and casualty (PP&C) underwriting income rose to $416 million from $300 million, and its combined ratio improved to 97.7 from 98.1. Standard auto premiums grew only 2.6%, but non-standard auto premiums grew 27.3%, and homeowners premiums rose 4.4%. Allstate reports that it has about 14,100 full-time agents and that roughly 30% of its agents are exclusive independent contractors. Growth in non-standard auto is expected to slow as that market matures.
How exposed is Allstate to catastrophes, and what has it done about it?
Hurricane Andrew and the Northridge earthquake caused net losses of $2.33 billion and $1.72 billion respectively, and 1996 catastrophe losses were $991 million. Allstate cut Florida exposure by raising rates 24.9%, selling renewal rights on up to 137,000 policies, and transferring wind coverage to a state pool. In California, it shifted earthquake coverage to the state-run CEA, which carries assessments the company estimates at up to $700 million in contingent payments. Allstate had little reinsurance in place for its personal lines at year-end 1996, which leaves it exposed to a severe event before the new Florida treaty takes effect.
What is the capital position and what could constrain the holding company?
Allstate Insurance Company's premium-to-surplus ratio improved to 1.6x from 1.9x, well inside the 3x guideline. All of its insurance subsidiaries exceeded required risk-based capital levels. The holding company depends on dividends from AIC, which can distribute up to $2.2 billion in 1997 without prior approval. The $1.5 billion credit line requires AIC to maintain minimum statutory surplus and limits the debt-to-equity ratio, and that access could be impaired after a large catastrophe loss.
How sensitive is Allstate Life to interest rates and policyholder surrenders?
Allstate Life had $33.6 billion in investments including Separate Account assets, and interest-sensitive products carried liabilities of about $24.8 billion, of which roughly 11% were subject to discretionary withdrawal without adjustment. Surrenders and withdrawals totaled $1.57 billion in 1996. Management says it manages duration to match assets and liabilities, but a sharp rise in rates combined with higher surrenders could force sales of portfolio securities at a loss. Competition from banks and the risk that tax deferral benefits on annuities could be eliminated are also cited.

04—Continue

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