Edward Liddy of Allstate Corp.: Risky business

Edward Liddy has been a senior executive at Allstate Corp. for nearly its entire 13-year life as a public company, but he never saw a year like 2005.

The property/casualty insurer, based in Northbrook, Illinois, suffered more than $5 billion in losses from claims by homeowners' policyholders in the regions affected by Hurricane Katrina -- the most expensive natural disaster in U.S. history -- and a string of other catastrophic storms that hit the southeastern part of the country last year. Following a $1.5 billion net loss in the quarter ended September 30, Allstate posted net income of $1.8 billion for 2005, a decline of 45 percent from 2004.

Liddy, a native of New Brunswick, New Jersey, joined Allstate as president and COO in 1994, shortly after the insurer was spun off in an IPO from Sears, Roebuck and Co., where he had been CFO. In 1999 he succeeded Jerry Choate as chairman and CEO.

Now that Allstate has absorbed the financial shocks associated with Katrina, Rita, Wilma and other big storms last year, Liddy, 60, aims to lower the insurer's risk profile in hurricane-prone areas. One tactic might be to cease writing new policies in the western Gulf Coast. Allstate took a similar step in Florida following a series of damaging hurricanes there in 2004.

But the CEO is also pressing government to help bear part of the risk. He is lobbying state insurance regulators to form a "windstorm pool" similar to the one established by Florida to cover homeowners who couldn't get private insurance after Hurricane Andrew devastated parts of that state in 1992. And he wants the federal government to form a similar entity to supplement private insurance for future Katrina-like catastrophes.

Allstate went public at $27 a share in 1993 in what was then the biggest IPO in U.S. history, at $2.12 billion. Today, after a 2-for-1 split in 1998, its shares change hands for about $53 apiece, for a return of 293 percent. The Standard & Poor's 500 index returned 184 percent during the same period.

To sustain that kind of performance, Liddy will have to rely more on Allstate's other businesses, such as its auto insurance division. He also wants Allstate agents around the country to sell more annuities and other investment products to existing property/casualty customers. During a recent trip to New York, Liddy -- a Catholic University of America graduate who earned an MBA at George Washington University and serves on the boards of Goldman Sachs Group, 3M Co. and food and drugstore chain Kroger Co. -- visited with Institutional Investor Senior Editor Justin Schack.

Institutional Investor: How long will Allstate be feeling the financial impact of Katrina and the other hurricanes that hit the U.S. last year?

Liddy: We've absorbed the financial impact. The fact that we still turned a profit in 2005, despite all the losses we incurred, really tells you about the staying power of our business. Rating agencies have come out and reaffirmed our ratings. From a financial and capital adequacy standpoint, we're in very good shape. Our business is built to withstand these kinds of shocks.

You had less reinsurance coverage backing your homeowners' business in the Mississippi Delta than you did in Florida. Why?

Simple probability. Think of the way Florida just sticks out there. It gets hit from all sides. There's just a much higher probability of hurricanes hitting there than in the Delta region.

Have you visited any of the areas that were hit by Katrina and Rita?

Oh, yeah. I've been down to Gulfport and Biloxi, Mississippi. Seeing it on television or in a photograph doesn't do it justice because it limits your peripheral vision. As far as you can see in every direction, there's nothing. It's stunning. The only sound you hear is bulldozers working. It's just overwhelming.

There has been some debate about how much of New Orleans and other areas hit by Katrina should be rebuilt. What's your view?

The issue with New Orleans is, does it really make sense to rebuild it the way it was when there were sections that were somewhere between seven and 17 feet underwater? It just doesn't make sense. It will get rebuilt, but whether it's rebuilt in the same way and whether that is accompanied by a clear strengthening of the levee system, I don't know. The rest of those areas, you'll be surprised how quickly they will come back. I think that as a result of all of this exposure, people will discover that Gulfport and Biloxi are pretty nice areas. It may cause more development rather than less development.

Have you seen that in other areas that were devastated by hurricanes?

We saw it in Homestead, Florida, which was leveled by Hurricane Andrew. Also Punta Gorda and Sanibel Island on Florida's west coast, which were hit by Charley. Hurricanes are perverse, in a way, in that they do a lot of damage, but then they give rise to a lot of rebuilding at some point in the future.

What have you learned from dealing with these storms that might affect the way you do business in the future?

We are taking a look at these coastal areas that are exposed to storms. We want to reduce our risk. There are more people moving into these areas, which in many cases are where home values have increased most dramatically in the country. That's just not going to work going forward.

How do you reduce your risk?

We have a number of options. We could purchase more reinsurance where it's available and affordable. We could stop writing new business. We could invite new companies to come in and transfer some portion of our book of business to them. It will probably be all of the above, and it will depend on the reaction of the various state regulators. The price of the product in those areas has got to go up. It's underpriced right now.

And there are limits on what Allstate can charge . . .

Yes, regulators have to approve it. If you are a state insurance commissioner and someday you want to be a governor or something, you aren't necessarily interested in the rate increases that certain companies think that they need to keep themselves whole. There's a dynamic tension in the process. It all works out in the long run. It's the short run that you worry about.

You have also been urging the federal and state governments to backstop the insurance industry. Tell me about that.

We and other insurers are mitigating our exposure in disaster-prone areas just as more people are moving into those areas. I think that state governments have to play a more active role. And the federal government probably has to play some sort of a role.

Have you discussed this with government officials?

We started that discussion in 2004, and it felt then like we were a voice in the wilderness. Now there's a whole lot more interest. People are all beginning to agitate now for some sort of a federal backstop reinsurance group.

Some people are likely to see this as a bailout for the insurance industry.

This is not just an insurance issue. It's an economic vitality issue. if you listen to [Florida Governor] Jeb Bush now, he understands that when people start moving out of Florida because they can't get insurance, that has implications for the health of the state's economy. When more people draw that conclusion, then there's a greater chance that something can happen legislatively. There should be a state windstorm pool that stands behind these really huge events that companies can't afford. And to the extent that it's a really, really huge event, let the federal government be a reinsurer of last resort.

How will scaling back your homeowners' business affect your overall growth prospects?

We have a great auto business, which is three to four times the size of our homeowners' business. So we'll continue to emphasize growth in that area. There will still be a number of places throughout the country where homeowners' is a great product from which you can generate reasonable rates of return on a consistent basis. Trading slower growth in some of the exposed states for greater earnings and greater consistency, we think, is a good trade for us to make.

How do you measure your own performance as CEO?

When you run a public company, you have to deliver value for your owners. Measuring a stock price at any one point in time is necessary and interesting, but it's not the only measure. If you aren't concerned about customer loyalty and retention, the long-term implications on your stock price are very negative. Our business is just a promise to take care of you. If our people aren't motivated to do that, then our customer is going to have a lousy experience and leave us. You can't turn a blind eye to how you treat policyholders and employees. Ultimately, doing the right thing for those constituencies is doing the right thing for your stockholders.