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An Allstate insurance company sign is seen outside one of its stores Jan. 17, 2008, in Miami. (Joe Raedle/Getty Images News/Thinkstock file)

Lawsuit: Allstate knew rise in frequency linked also to underwriting, not just weather, miles

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Business Practices | Insurance | Legal | Market Trends

A lawsuit seeking class-action status alleges Allstate’s CEO and other company officials failed to admit that weaker underwriting standards helped drive up frequency and instead mislead investors by blaming a rise in auto claims solely on external factors.

It also accuses CEO Tom Wilson of insider trading for cashing out $33 million in stock options in November — prior to revealing to Wall Street in February 2015 that auto claim frequency had been up in October and November 2014.

Allstate had not responded to the suit in court as of midday Thursday.

“We have reviewed the complaint and the allegations are without merit,” Allstate senior corporate relations manager Laura Strykowski wrote in an email Thursday.

The complaint filed by the city of Saint Clair Shores Police and Fire Retirement System alleges that Allstate sought market share above margins and then misled investors when the plan went south and contributed to frequency increases. It names the company, Wilson, President Matthew Winter and investor relations Vice President Patrick Macellaro as plaintiffs.

“Defendants claimed Allstate’s plan was to grow auto policies in-force and revenues while maintaining profitability,” the lawsuit states. “In truth, Allstate’s new business was of lower quality and carried increased risk, which caused, in substantial part, Allstate’s largest increase in frequency of auto claims in nearly five years.”

Auto frequency had been, as an analyst put it in August 2013 “‘pretty much nonexistent,'” and Allstate held its underlying combined ratio between 91-93 in the first nine months of 2014, according to the lawsuit.

“However, in October 2014, Allstate experienced a massive spike in auto claim frequency that reversed the long-standing favorable frequency and profitability trends,” the lawsuit states,” The Allstate brand auto underlying combined ratio skyrocketed to 98.2 in 4Q 2014, the highest level since 2011.”

But on an Oct. 30, 2014, earnings call, President Matthew E. Winter said “‘our frequency so far has been extremely favorable to prior year,’ adding, ‘frequency trends have been good,'” the lawsuit states.

In November 2014, Allstate had another “massive, undisclosed spike in claims frequency,” according to the lawsuit, but investors wouldn’t find out until Allstate’s regular fourth-quarter earnings report, typically produced a few weeks into the following year, according to the lawsuit. (In 2015, it was issued Feb. 4, with an earnings call Feb. 5.)

But with Wall Street still unaware of the true claims frequency, particularly bodily injury claims, Wilson cashed out 675,000 shares in stock options for $33 million in Nov. 25-26, 2014 — his first sale in nearly 10 years, according to the lawsuit. However, Wilson kept about 113,000 shares, which would seem to weaken the plaintiff’s argument a little.

On Feb. 5, Allstate stressed that the rise in claims wasn’t a result of their book accepting more claim-prone policyholders, but simply unavoidable market conditions.

“When pressed, Winter was even more direct about the cause of the spike in frequency, falsely and misleadingly stating: ‘Let me start with what is not driving it. Number one, we saw nothing to indicate that it’s a quality of business issue or that it’s being driven by growth, which is a natural question that you would have . . . .’ Winter reaffirmed that the spike in frequency was caused by ‘two factors . . . miles driven and precipitation,'” the lawsuit states.

Analysts accepted the explanation, but “it was not a one-time event because the spike in frequency was being driven
in substantial part by the new business growth in auto policies,” the lawsuit states. “This was well known by Defendants based on decades of Allstate and industry experience in evaluating such trends.”

Winter in the next earnings call reiterated that the frequency growth was fueled by factors like miles driven, and not the quality of their customers. “'(W)e did a very intense deep dive into our business . . . to make sure in effect that these aren’t our problems but are in fact external,'” the lawsuit quotes him as saying in May 2015.

However, on May 26, 2015, Wilson sold another more than 90,000 shares for $6.2 million, and on May 12, Chief Financial Officer Steven Shebik “who directed the team responsible for setting loss reserves, exercised stock options and sold more than $2 million worth of his Allstate stock, almost twice as much as he sold prior to the Class Period in 2014, and almost 300% of his 2015 salary of $750,000,” the suit states. It implies both knew what was coming, though it doesn’t name Shebik as a defendant.

But Allstate finally publicly conceded in August 2015 in the next quarter’s discussion that underwriting needed to be tightened, according to the lawsuit, which ends the class period Aug. 3, 2015. Allstate released earnings at the end of the day Aug. 3, 2015, and held an earnings call the next day.

“At and after the end of the Class Period, Defendants finally admitted that the increased frequency trends were not solely attributable to external factors, but were in fact caused in substantial part by the new business growth, which Defendants described as a ‘new business penalty,'” the lawsuit states. “Defendants acknowledged it would take several quarters to remedy and fix the problem. Defendants also admitted that they needed to tighten underwriting to reduce claim frequency.”

After Allstate’s comments Aug. 3-4, 2015, Allstate stock fell from $69.38 to $62.34, “more than 10% in a single day,” the suit states.

“The stock drop wiped out more than $2 billion of the Company’s market capitalization, revealing the economic loss and damages to the putative class who bought the stock at artificially inflated prices prior to the disclosure,” the lawsuit states.

In Allstate’s defense, businesses sometimes just get things wrong. It’s possible that the actuaries were mistaken on the math on the models predicting that the policyholders the plaintiffs highlighted were a good bet at the premium price quoted. The company might also legitimately have felt the external factors were solely responsible for the frequency increase. We certainly noticed and covered other experts stressing the impact of miles driven on frequency.

Of course, it’s kind of embarrassing for the carrier if it couldn’t properly evaluate its own prospective and existing customers or know what drove losses — that’s kind of the foundation of a successful insurance business — but no model is going to be perfect. (Ask every pollster who predicted a Clinton win.)

For shops, the actual cause of the losses probably matters the most to shops on Allstate’s direct repair program. If a more crash-prone Allstate clientele plays a significant enough role in increasing claims frequency, that subset of crashes is more likely to feed DRP shop volume given the drivers’ direct link to Allstate. If its reported frequency is predominantly driven by external factors, the data still matters in terms of planning shop business — Is it going to be like a lean or busy year? — given Allstate’s No. 3 rank, but the conditions are more likely representative of macro trends that “lift all boats” in the collision repair industry and affect numerous carriers.

Also, for those who are interested, here’s our second-quarter 2016 Allstate coverage, in which Wilson stresses the benefit of raising rates based on market conditions — a useful argument for shops explaining to Allstate adjusters why their labor rates are up. Allstate has since released third-quarter results; look for our coverage of those shortly.

Allstate raised rates again in 2Q, says it’s been responding to external pressures

Featured image: An Allstate insurance company sign is seen outside one of its stores Jan. 17, 2008, in Miami. (Joe Raedle/Getty Images News/Thinkstock file)