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Last week, home and auto insurer Allstate Corp. (ALL - Analyst Report) announced its pre-tax catastrophe (CAT) and net of reinsurance loss estimate to jump to $198 million for Mar 2013. This takes the total CAT loss estimate for the first quarter to $391 million, occurring from 9 events.

However, the total estimate for the quarter was partly negated by favorable reserve re-estimates of CAT losses in the prior years, bringing the net pre-tax CAT loss to $359 million. This is higher than $259 million incurred in the year-ago quarter.  

After tax, Allstate is expected to incur CAT losses worth $129 million in Mar 2013 and $233 million in the first quarter of 2013. The company is slated to release its first quarter results after the closing bell on May 1, 2013.

Help from the Bond Market

As CAT losses have become a regular phenomenon with uncertain extent of damages, Allstate now seeks to manage its exposure to such losses by investing collateral into bonds primarily created for natural disasters. While these funds carry high interest rates, they also have the risk of losing capital if a natural catastrophe occurs.

However, Allstate is investing into CAT bond collateral securities, which are rated “AAA” by Standard & Poor’s Investor Ratings Service (S&P). The last bond, Willow Re 2008, that the company had invested in 2007 had matured in 2011. Post that, Allstate has now put in its collateral into money market funds through a special purpose reinsurer – Sanders Re Ltd.

Subsequently, Allstate intends to buy $100 million of Class A bonds (rated “BB+” by S&P) and $150 million of Class B (rated “BB”) securities from Sanders. These securities are due to mature in 4 years and will cover losses related to hurricanes from Alabama to New York along with the earthquake in California.

Such CAT bonds were very popular in 2007 but the collapse of Lehman Brothers led to significant losses for the bond investors. While many insurers are now indulging into such CAT bonds, these securities have been trading at an all-time low. Nevertheless, the returns are higher than any alternative mode of protection. Moreover, market estimates CAT bond sales of about $7 billion by the end of 2013, at par with 2007-level.

Overall, as the CAT bonds provide insurance coverage to Allstate, we remain at the edge to analyse the future developments and traction in this market. Allstate carries a Zacks Rank #2 (Buy), other outperformers in the insurance sector include PartnerRe Ltd. (PRE - Analyst Report), Hilltop Holdings Inc. (HTH - Analyst Report) and Montpelier Re Ltd. (MRH - Analyst Report). All these stocks carry a Zacks Rank #1 (Strong Buy).

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