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3 Favorite Post-Sandy Insurance Plays: Merrill Lynch

NEW YORK (TheStreet) -- Hurricane Sandy and the interest rate environment have combined to set up some nice insurance stock recovery plays for long-term investors.

Bank of America Merrill Lynch analyst Jay Cohen on Monday that "given the hit to book values we expect from Sandy in the fourth quarter of 2012 and the minimal impact we currently expect from investment marks this quarter, our price objectives are little changed."

The analyst focused on three names that he believes have the most upside over the next year in the property and casualty (P&C) space.

Before Sandy's onslaught, 2012 was shaping up to be a recovery year for P&C carriers, with many of the best-known names showing underwriting profits, following a difficult 2011. Before Sandy, Insurance Information Institute president and economist Robert Hartwig said that insured catastrophe losses were "down somewhere in the order of 50% from last year."

It is, of course, too early to gauge the total damage that Sandy will cause the economy or the insurers, but industry loss estimates range as high as $25 billion.

"We're getting ranges anywhere from $5 billion to $25 billion, from the modeling firms," says Loretta Worters, a spokesperson for the Insurance Information Institute," who says that the average P&C industry loss estimate from Sandy "is probably $18 billion."

"There have been so far about 360,000 homeowners insurance claims in New Jersey and about 330,000 claims for homeowners in New York, with probably about 180,000 in other parts of the country," Worters says, adding that "there are a lot of business claims that haven't been processed yet, and we think the claims will be much higher on the business side than they will be on the personal side."

Allstate (ALL) on Nov. 28 estimated that its losses for October, net of reinsurance, totaled $1.1 billion. The company said that "autos represent approximately 40% of the total gross losses, with 78% in New York, 19% in New Jersey and 3% in other states."

Allstate's stock closed at $40.49 Monday, down 5% from their year-to-date closing high of $42.62 on Oct. 16, but returning 51% year-to-date. Following Sandy's arrival, the shares dipped as low as $37.92, in intraday trading on Nov. 2.

Allstate's shares trade just below their reported Sept. 30 book value of $42.64, and for nine times the consensus 2013 earnings estimate of $4.50 a share, among analysts polled by Thomson Reuters.

Bank of America Merrill Lynch analyst Alison Jacobowitz rates Allstate a "Buy," with a price objective of $46, and estimates that the company's adjusted book value will still increase to $42.86 at the end of 2012, despite the losses from Sandy, and rise to $46.35, as the end of 2013.

Following Allstate's announcement of its October loss estimate, Jacobowitz said "we don't expect to see serious downward revisions to earnings as a result of the October losses, nor do we expect spreads to be moved by this number." The analyst estimates that Allstate will report a fourth-quarter profit of nine cents a share, and EPS of $3.62 for all of 2012, increasing to $4.25 in 2013 and $4.65 in 2014.

In a very competitive market, P&C insurers typically rely on investment income for profits, as they often take underwriting losses. Cohen said that the companies his firm covers "still face two notable headwinds in their efforts to improve their ROEs: low interest rates which will continue to put downward pressure on investment income and the real likelihood of less favorable prior year reserve development," and that "companies are trying to offset these headwinds by both raising prices and buying back stock."

Cohen expects P&C returns on equity "to bottom in 2013," as the buybacks and price increases "will not be enough to offset the pressure on investment income and the probable slowdown in favorable prior year loss reserve development," which could lead to "underlying margin improvement as premiums are earned into 2014."

Here are Cohen's three favorite P&C stock picks for the next 12 months, ranked by upside potential implied by the analyst's price objectives:

Stock quotes in this article: ALL, XL, ACE, AXS 

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