Last year the gulf coast got buffeted by a near-biblical onslaught of evil weather. And although 2006 has proved thus far to be calm, meteorology savants say we're just in a hiatus during a possible decades-long bout of Atlantic hurricanes. Bad news for vendors of homeowner's insurance.

The problem with claims is that you need premium income to cover them--but policyholders do not like a rate increase and neither do the politicians they send to the state legislature. Property/casualty insurers like Allstate (motto: "You're in good hands") are doing the best they can in this charged atmosphere. Nevertheless, Allstate is cutting back home coverage in Florida and up the eastern seaboard and raising premiums for the remaining policyholders there. This retreat is only the latest cost-cutting move by Allstate, the nation's second-largest shareholder-owned property/casualty carrier--after American International Group; mutually owned State Farm is the biggest. Previously the company axed higher-risk auto insurance, ditched most non-North American insurance business and converted employee-agents into independent contractors responsible for their own benefits.

Under Chief Executive Edward Liddy, 60, and his number two, Thomas J. Wilson, 49, the refocusing has worked and the company has prospered. Since Liddy took over in January 1999 Allstate shares are up 55%, versus 11% for the S&P 500. Still, Wall Street remains worried that many Hurricane Katrinas lie ahead. Allstate trades at 1.9 times book value, compared with 3 times book for Progressive Corp., its closest publicly traded competitor. Allstate stock is a mere 8 times trailing earnings, versus 12 for Progressive, which covers only autos and hence is far less threatened by storm losses.

Allstate's net income slipped 44% last year because of heavy hurricane-related outlays; 2005's third quarter was the company's second red-ink period in its history. The company paid out $5.7 billion in claims for Katrina and other storms, and now is paying much more for reinsurance, a sort of insurance for insurers. But the financial situation has rebounded nicely in 2006: Earnings are up fivefold to $3.8 billion through Sept. 30 on a premium volume (net of reinsurance) of $21 billion, up 1%.

Covering 35 million policyholders and 17 million households, the Northbrook, Ill.-headquartered insurance titan is a huge presence. Liddy and Wilson talk about how promptly and deftly the massive Allstate responded to catastrophe claims in the wake of Katrina and the other storms. But they are quick to point out that they run a business that seeks a profit. Indeed, no one should confuse Allstate with the Sisters of Mercy. In Florida Allstate decided not to renew 95,000 home and condominium insurance policies. At the same time, Allstate stopped selling commercial insurance policies to small businesses in Florida and didn't renew another 16,000 Sunshine State policies it had in force. "We just didn't make any money there," Liddy says, shrugging his shoulders.

As harsh as this sounds, he has a point. The decision to drastically cut back in Florida came after the hurricane season of 2004, when four hurricanes hit Florida, wiping out all the profits earned by Allstate in the state since Hurricane Andrew in 1992. Likewise, Hurricane Andrew losses destroyed the profits the company garnered there prior to 1992. In other words, the company has not earned a dime in Florida since it started selling insurance there in the mid-1930s. "In states like Florida, you can't charge enough to make money or [get] an acceptable return on capital," says Brian Meredith, senior property/casualty insurance analyst at ubs Securities.

Earlier this year Allstate announced it will not sell new homeowner policies in the coastal counties of Mississippi and Louisiana. The company also said it wanted to drop wind and hail coverage for 30,000 homeowner policyholders in 18 Louisiana parishes. In January Allstate stopped issuing new homeowner policies in parts of New York including Long Island, New York City and southern Westchester County. The decision doesn't affect existing homeowner policies and Allstate will continue to issue new coverage for apartment owners and renters.

After Katrina, Allstate and other insurers refused to pay for flood damages. Why should they? The policies excluded floods. Many homeowners didn't buy coverage available from the federal government.

Unsurprisingly, the exit from unprofitable markets prompted a lot of anger. People must now scramble for coverage from smaller carriers at much higher rates, if they can get coverage at all. The Mississippi attorney general and irate flood victims have sued Allstate and its peers in a bid to force payments for the water damage. "The flood exclusion was heavily advertised," Watson insists. Early signs show the insurers have the edge: A Mississippi judge ruled in August in favor of Nationwide Mutual's refusal to pay a flood claim.

James Donelon, Louisiana's commissioner of insurance, calls Allstate's cutback plan illegal and vows to fight it in court if necessary. In July Allstate lashed back by threatening to exit the Louisiana homeowner's insurance market altogether if regulators block its plan to drop wind and hail coverage.

More problematic is Allstate's retreat in New York, where hurricanes seldom strike. U.S. Senator Charles Schumer (D-N.Y.) called Allstate's reasoning "bogus hurricane risk." He demanded the company reverse itself and begin writing new coverage without a premium hike. "Allstate is the poster child for terrible corporate citizenship," says Schumer on his Web site. "The odds of a severe hurricane hitting in New York City is one every 500 years. They should be ashamed of themselves."

Should they? Allstate's Liddy has some justification to be nervous about New York. If we are indeed in the midst of a hurricane-heavy time, there's ample cause for concern that a severe storm would venture that far north. According to Nicholas K. Coch, a professor of coastal geology at Queens College in New York City, significant hurricanes have slammed into the region before. One in 1821 sank most of the ships in New York Harbor. An 1893 hurricane submerged a populated island, Atlantis-style, that lay south of the present Rockaway shore. In 1938 a hurricane flattened many homes on New York's Long Island, and waves as high as 50 feet pounded the shoreline all the way to Massachusetts. That storm killed 700 people. If it occurred today, the Insurance Information Institute estimates that insured losses would total $60 billion.

In 2005 the Atlantic hurricane season contained 28 storms, including 15 hurricanes. Seven of these hurricanes were considered severe; a record four of them hit the U.S. In Katrina's aftermath, devastated New Orleans remains a fixture in the news media.

Meanwhile, Liddy is leading an industry push for federal aid after insurers pay out a certain amount, reported to be $4.5 billion. Katrina caused insured losses of $40.6 billion for the industry overall. "We have all seen on our television screens that the current system is inadequate," says Liddy. Whether a catastrophe fund will be created is anyone's guess. A powerful counterargument is that such a government security program will only encourage more building in flood-threatened areas, thus increasing potential loss of life and property.

What's interesting about Allstate is that homeowner's insurance is not its biggest business. It's auto coverage, which rakes in three times the premiums that home policies do. In addition, auto claims are on the way down: The population is aging and so less accident-prone; cars are safer; and drivers are more reluctant to file small claims--a leeriness they acquired during a rate spike in 2002 and 2003, out of fear that an accident report would boost insurance bills.

Given that, you might wonder why Allstate bothers writing homeowner's insurance. One reason is that the homeowner business tends to be more profitable, provided that no acts of God intervene. Accidents occur more often with autos than with homes; fender benders outnumber house fires.

The contrast is seen by comparing the combined ratios of the two lines. That's how much of a premium dollar goes to claims, reserves for payouts, underwriting expenses and policyholder dividends. If the number is below 100%, the company is making an underwriting profit (investment income isn't counted here). For Allstate in the most recent quarter, the ratio was 84% for autos and 74% for homeowner's.

Even more important is that Liddy figures offering both types of insurance gives Allstate the ability to cross-sell. The company also peddles financial products such as annuities and life insurance, although these are much smaller parts of the operation. In industry argot, the "stickiness" of the relationship between Allstate and its customers is enhanced by a multiline product roster.

Before Liddy came along, Allstate was a slow-acting, highly bureaucratic organization, says Steven Kauderer, managing director of the North American insurance practice at consultant Mercer Oliver Wyman. "Allstate was a sleepy giant," he says. "It is more entrepreneurial now."

Perhaps that's because Liddy's background is outside insurance. He had worked at security firm ADT, drugmaker G.D. Searle and Sears, Roebuck. As Sears' chief financial officer, Liddy spun off the retailer's subsidiary, Allstate, in 1993. Liddy is stepping down in January (he will remain as chairman), to be succeeded as chief executive by kindred spirit Wilson, meaning any large strategic shift is unlikely.

In his seven years as the head man, Liddy has never shied away from difficult decisions. His first big move was to broaden the company's distribution methods and sell through stand-alone agents, call centers and the Internet. The company had to remove 6,500 agents from its payroll and turn them into independent contractors. That move sparked a wave of lawsuits (a few are still pending) from agents upset over losing their health insurance and other benefits.

Liddy's next goal was to restrict Allstate mostly to North America, where he believes growth prospects are stronger. Waiting for robust insurance markets to develop in other countries, where governments have long taken care of financial security, will take too long, he reasons. By the end of 2002 the company had sold off all its international divisions, retaining only the homeowner's and auto insurance operations in Canada.

Liddy has also fled the sinkhole called nonstandard auto insurance--policies for bad drivers. An insurer can charge very high risk drivers extra, but not enough extra to cover the higher claims. A harsh decision for the fellow whose policy got canceled. But Allstate is a business, not a philanthropy.

Back to Insurance Reform - National