Description

Allmerica Financial (NYSE:AFC) is a diversified insurer. Two thirds of Allmerica’s revenues are property & casualty related. As with most of their P&C brethren, the company is focusing its attention on “re-underwriting” - cutting back policies written during the previous poor pricing environment and writing higher margin businesses.

The remaining third of their revenues come from their life insurance division. This division’s revenues come principally from selling variable annuities. Variable annuities are like mutual funds with a life insurance wrapper. An investor who puts $100,000 into a variable annuity gets all of the upside of the investment minus fees paid for a life insurance wrapper. The money accrues without taxation, can be accessed after a pre determined time and as a final benefit, if the investor dies while his investments are under water the insurance company pays out 100% of the initial $100,000 investment as a Guaranteed Minimum Death Benefit. Here is where the company’s problem lies. Many policies were written in the 1998 – 2000 period and many of these investments are down 50% or more. For statutory book purposes, the company has had to reserve against the $50,000 loss as contingent liability. The rather conservative assumption being that every investor will die in a timely fashion with their investments underwater. Moody’s, seeing this strain on the company’s statutory capital, downgraded Allmerica’s bonds making it impossible for the company to grow this portion of their business.

Now how do you value this company? On the P&C side they have $1 billion in statutory capital, which we value at 1.3x book as it is a growing and profitable business earning 9 – 10% ROE’s. Take out $250 mm in debt and you are left with a $20 per share valuation. The stock is selling at $10, so as of this writing the market is pricing their life business at minus $10 p.s. (-$500mm).

The life insurance division has statutory (read conservative as noted above) book of $375mm ($7 p.s.) and their clients will continue to pay their premiums or lose their death benefits. Even if independent brokers churn their business to competitors, there is at least some positive present value to their life business. In fact, the more business they lose the more their statutory capital rises as contingent death benefits lapse. Also if the stock market were to go up their capital rises. At worst we think the life company is worth 50% of book or $3. With the stock selling at $10, our target price is $23 ($20 for the P&C operations plus $3 for the life co liquidating value.) Our target is a double from present prices.

Catalyst

The company is having a "Strategic Alternatives Conference Call on Monday October 7th at 10:00am (913) 981-5543. We expect that managment will either announce plans to sell the life division or to "stack" the book which would give them access to the P&C capital.