Insurance giant Allstate (ALL) reported earnings last week - operating income per share came in at $1.24, while average analyst expectation was for $1.29. By my count, this is the 5th straight quarter that ALL has missed analysts' expectations! Yet I can find no outcry among shareholders, analysts, and the media. Shouldn't there be some pressure/accountability on the CEO, CFO, and/or whoever is guiding expectations? Net income was also down 98% year-over-year. The one positive I've seen is that ALL maintained their fairly healthy dividend payout.

I don't see the near-term future outlook getting any brighter for ALL and the Insurance Sector in general. Most obviously, the large number of foreclosures and lack of home buying means a direct drop of home insurance premiums to them. Renters don't pay home insurance -- direct revenue decrease here. ALL is certainly not immune to the mortgage/credit crisis. They announced exposure to residential and commercial real estate of $28.1 billion. And they have another $11 billion of investments in the debt and equity of companies in the financial sector.

ALL Daily Chart


Then there is the effect of storms and the weather. The recent Midwest flooding has cost Insurance companies billions. We are entering Hurricane season currently, and who knows what Mother Nature may bring, but this is always a risk. According to my research, the company's "combined ratio" -- a measure of premiums earned against payouts and expenses -- was 94.4 percent for the quarter, up from 87.6 percent in the second quarter of 2007. This number rising is not good for profits.

In the Auto Insurance arena, there have been some recent issues for ALL -- government regulators in California recently forced them to drop Auto Insurance rates by 28% in that state - obviously not a positive for profit margins. They have also been involved in high-stakes showdown political fights with regulators in states like Florida. And is the general trend towards people owning less cars, smaller cars, motorcycles, bicycles, scooters, etc due to high gas prices going to cause the growth of auto insurance premium revenues to slow?

In the bigger picture, in my view it is underappreciated that most of the large insurance companies are involved in complex financial engineering that compares in many ways to investment houses and banks. They make and have made a lot of profits through complex hedging and other financial maneuvering - the same kinds of risky trading that has come back to bite so many Banks and Investment Houses in the rear recently.

There is a tricky accounting game going on with many of these companies that are holding fairly illiquid securities and paper. They are basically "marking them to market" themselves, and some companies are using more conservative pricing methods than others. There is a temptation within companies to give as positive a pricing mark as they can, in the hope that the price will come back soon. This can sometimes backfire, which contributed to the recent collapses of Bear Stearns and Indy Mac.

I have no direct knowledge of ALL's complex holdings and how they are being priced, I'm just pointing out the dilemma that financial companies who hold bad paper are in right now. I do note that ALL announced $857 million of realized losses in the recent quarterly report.

In the most recent earnings report, ALL also announced they are entering into some advanced derivates and hedging to reduce further risk. These involve hedging against stock market and interest rate risk. What you have to realize with these structured products is that someone is on the other side of the trade - likely a big investment house created and sold these to the company, and they expect to make a profit as well. It sounds like ALL is basically giving up some future profit potential to limit risk - and some of this is occurring after the barn door is already open.

I've kind of singled out ALL here because I've done more research on them, but there are many other insurance companies that are in the same sour boat, in my view. And the choppy waves don't look to be dying down any time soon. I'm sure some will say, all of this is priced into the stock already -- but in my view, the bad news has not finished coming for these companies, and from a technical chart basis they look terrible. The next selling wave of the financial sector may well be in the insurance group.

I haven't yet advised my subscribers to go bearish on ALL, but I have been actively looking at possible bearish options trades on ALL and several other insurance companies, especially on any short-term rebound.

Price Headley is the founder and chief analyst of BigTrends.com.