What's It Worth? (ALL)

Famous investor Warren Buffett said in his 1996 Annual Report, "An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds." In a prior post (10/27/2008), I posted a chart showing that Allstate (ALL) had consistently generated underwriting profits, meaning that the cost of the float (money held not owned) has been less than zero.

So what is ALL worth? ALL's float is $18.5 billion. This float is lower than the premiums (about $27 billion) - demonstrating that ALL has a "short-tail" product. The growth of the float is about the growth rate of the economy - 2.5%. So, in 10 years, the value of the float may be about $24 billion. (During the past six years, float has grown even more slowly because of increased use of reinsurance - of course that helps the "cost of float.")

The cost of this float is variable. ALL has experienced a range from 89% to 103%, including catastrophe costs. For the cost of float, I assume -3%. I arrive at this because Progressive uses a target of -4%, setting a competitive challenge for others.

This negative cost of float is added to the investment return. The return on investment (excluding capital gains and losses) has averaged 5% over the past ten years. After adjusting the total for a 30% tax, the combined cost of float and investment yield is 5.6%, providing about $1.4 billion.

Valuing this $1.4 billion income properly is essential. It is likely to grow slowly, at 2.5%, but, without high risk - while insurance contracts are fairly commoditized, they are sticky. By adding a risk rate of 1.5% added to a 5% government rate, I arrive at a discount rate of 6.5%. (Inflation is not a focus because roughly offsetting effects run through the entire calculation.)

With a discount rate of 6.5%, but a growth rate of 2.5%, I have a denominator for the $1.4 billion, estimating the value of the float 10 years hence at $35 billion or $17 billion today. (It is merely coincidental how close this estimate is to the present float value.) By adding this to the current net worth of ALL, I should have an estimate for the likely worth.

The most significant recent issue facing ALL (and other insurers recently) has been the change in value of ALL's investments. Whereas the 2008 investment write-offs related to AIG, Fannie, Freddie and Lehman were small - 2% - as a function of the balance sheet, but they were large 10% - as a function of net worth. In addition, there are significant unrealized losses in the valuation of mortgage-related securities. For the purposes of this calculation, I am assuming the conservative GAAP measure (which is not used for statutory insurance underwriting purposes) of $17 billion.

Combining the two numbers provides a value of $34 billion. ALL has 536 million shares outstanding with the per share value figuring around $63 per share. This computation includes no value for the life insurance component. I have chosen to exclude life insurance value because of the increased complexity and excessively competitive pricing (another post, another day).