Allstate Corp (ALL) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Allstate Corporation quarter conference call.

During the presentation, all participants will be in a listen only mode.

Afterwards, you will be invited to participate in a question-and-answer session.

At that time, if you have a question, please press the 1 followed by the 4 on your telephone.

As a reminder, this conference is being recorded Thursday, July 18th, 2002.

I would now like to turn the conference over to Mr. Bob Block, Vice President of Investor Relations.

Please go ahead, sir.

Thank you, Tracy.

Good morning, everyone and welcome to our second-quarter earnings conference call.

I know it has been a busy morning for you already.

We expect to take no more than an hour of your time.

Today Edward Liddy joins me telephonically from Stockholm, as he is with a group of our top agencies this week.

Also with me in Northbrook is Casey Sylla, our acting CFO.

Together, we will be discussing our second-quarter trends for 2002.

A question-and-answer period will follow.

As a courtesy to all who have questions, please keep to one question and a follow-up.

This allows us the opportunity to hear from as many of you as possible in time allotted today.

We issued our press release earlier this morning.

If you need copy of this release, it is available on the web site.

We posted most of our investor supplement on the I R web site for your use.

It is important for you to note that the following discussion may contain forward-looking statements regarding Allstate and its operations.

Allstate's actual results may differ materially from those projected in the forward-looking statements.

For information on important factors that could cause such differences, please see the forward-looking statements and risk factors affecting Allstate's section in Allstate's latest report to the SEC on form 10 Q for the first quarter 2002 and in today's press release.

This call is being recorded and the recording is the property of Allstate.

It is not for reproduction or rebroadcast by any other party without the prior consent of Allstate A replay will be available following the conclusion of this call.

Your participation in the call will constitute consent to the recording, publication, webcast, broadcast, and use of your name, voice, and comments by Allstate.

If you do not agree with these terms, please disconnect now.

Now let's begin with comments from Ed live from Stockholm.

Ed?

Thanks, Bob.

And thanks for joining us this morning to discuss the second-quarter results and learn a little bit more about our company.

We had, in short, a very strong quarter, both strategically and operationally, and let me first briefly review our strategic intent.

We want to get much better and bigger in the property casuality business.

At the same time as we broaden our financial services footprint.

This will enable us to generate more consistent earnings growth and consistently earn returns in excess of our cost of capital.

Actions we have taken over the last several years have positioned us well to achieve long-term growth and over the last few quarters, our actions to correct short-term imbalances are bearing fruit and will continue to do so over the next several quarters.

I think the second quarter of this year represents another very positive step in accomplishing our strategic intent.

As I mentioned, the second quarter was a very good result in a tough operating environment.

Let me provide some context on the environment.

First, catastrophes were average for a second quarter at about 280-plus million dollars.

That's much less than the same quarter of last year, but higher, as you would expect, because of weather patterns then the first quarter of this year which had only $110,000,000 in catastrophes.

Second, the largest player in the personal lines market, that's State Farm, announced its intentions to significantly restrict writings in over 25 states.

This clearly creates an opportunity for us for profitable growth, but one that must be approached with discipline and care and that's exactly the way we are doing it.

Third, the issues surrounding the use of credit for pricing and risk selection of both auto and homeowners insurance continue to be raised in a variety of states.

These issues are manageable.

And fourth, as you are all very well aware, the equity markets are in a state of absolute turmoil, making investment decisions difficult for everyone and severely impacting the life and savings marketplace.

Now, in this complicated and somewhat convoluted environment, we performed very well with operating earnings per share before restructuring charges of 67 cents and after restructuring charges of 64 cents.

This was more than double the depressed second-quarter 2001 results and, in fact, better even than second-quarter 2000 results.

It kept them then from going from the first quarter trends, steady progress in the execution of our tactics becomes more evident with each passing quarter.

A couple of highlights with respect to the quarter.

Our rate actions continue to be gained in markets where needed.

That is fueling an increase in our written and earned premiums.

Our Allstate standard auto PIF was down about 4/10th of a point, but our homeowner's PIF, or policies in force, were up 6/10th of a point.

Nonstandard policies in force continue to drop as we manage that business for profitability, and, in fact, the loss ratio in the nonstandard business in the second quarter was down in the mid-75s which gives us a combined ratio of about 93.5 to 94.

We have made enormous progress fixing that business.

Our markets specifics risk management actions to improve profitability are working as evidenced by the improving combined ratios in the quarter.

Our auto frequencies improved again this quarter and that really is the key to improving our overall quality of our risk profile, and I think it is a very solid indication that our strategic risk management programs are working, and working well.

Our auto severities came in well within our pricing expectations, both liability and physical damage.

Our underwriting expense ratio maintained its favorable variance to prior year and the overall dollars of expense, excluding our restructuring charges, were flat with last quarter.

Our property casuality net investment income came in slightly less than last year's second quarter but excluding-partnership income, net investment income rose by 2% over prior year, a very good sign for future earnings trends and a reflection of the improving cash position of our company.

Allstate Financial matched its first quarter operating income despite the difficult market I referred to earlier, and sales of financial service products through the Allstate agents channel continued to grow, exceeding all of last year's production by the end of this June.

A couple of areas of concern.

Ivantage continues to struggle, but, in fact, is gaining traction in rate and risk management actions.

They managed to cut their underwriting loss almost in half from the second quarter of last year and their premiums are beginning to grow.

I expect Ivantage to show a combined ratio of below 100 by the end of next year.

Our homeowners loss trends, specifically in Texas, have not yet turned the corner; however, both the frequency and severity trends in the rest of the country have begun to moderate nicely.

I am confident that we will get this line of business back to acceptable levels of profitability by mid-2000.

So no change in the outlook for that business.

In summary, our earnings are on track.

In fact, they may be a little ahead of expectations.

With $1.37 in the bank, so to speak, through the first half of the year and excluding restructuring, we are increasing our guidance for 2002 to a range of $2.70 to $2.90.

This, of course, assumes normal catastrophe experience for the balance of the year.

I like our position in the market today.

We have the right long-term strategies.

We are focused on generating profitable growth over time, and I would like to leave you with five thoughts for the quarter.

First, the underlying rhythm of our business is improving with each quarter's results.

Our loss ratio, excluding tax, was 72.3 in the second quarter.

That's a half point better than the first quarter, and it includes $105 million of prior year reserve strengthening, primarily for home owners and mold.

It is also 2.4 points better sequentially.

Second, the underwriting expense ratio at 23% all in, was 6/10th of a point better than last year.

The overall dollars of expense were flat, following only a $12 million increase in the first quarter of this year.

So the improvement is not just caused by increasing the premium base, but it is a result of attention to operating the business more efficiently.

Third, we continue to seek and to gain approval for necessary rate actions in most markets.

Both the size and the number of our rate changes filed and approved are about the same as in the first quarter.

Strategic risk management or SRM, puts us in a better position to grow profitably in today's marketplace.

Fourth, we probably don't say enough about this, but our overall process for managing risk for the corporation has served us well over time.

In particular, our asset quality and management of investment risk have kept us from suffering steep losses from any one name or sector.

While we have trading losses and write-downs given today's markets, they are very manageable and very modest in relation to the size of our portfolio.

And finally, our progress in transforming to a broader financial services player has been noteworthy.

Allstate Financial has managed to increase operating earnings despite the tough market.

And as I mentioned earlier our Allstate agencies continue to fulfill more of our customers' needs for retirement and savings products.

They have produced more business in the first half of 2002 than in all of 2001.

That is progress.

Bob, would you like to walk through the details of the quarter and then we will come back for Q & A?

Thanks, Ed.

We reported today operating earnings per share of 64 cents for the second quarter.

That represents an increase of 33 cents from last year's second quarter.

The difference in catastrophe losses in the two periods account for about 22 cents of the improvement, with the balance coming primarily from improved underlying margins in the business.

On a sequential basis, operating earnings per share fell 4 cents.

Again, the major drivers of the change were catastrophe losses that cost an additional 16 cents this quarter with an 11-cent favorable loss set for improved margins.

This margin improvement is the result of our pricing actions burning into earned premium, our risk management actions designed to generate profitable growth, and our disciplined efforts to control underwriting expenses.

As Ed stated earlier, our tactics are starting to be recognized in the P & L providing us with a favorable earnings trend.

During the quarter we realized pre-taxed capital losses of $153 million caused by a combination of investment write-downs, trading activities, and evaluation of derivative instruments.

No one security contributed materially to this result, it was more of a function of market trends as you can well appreciate.

On the flip side, the unrealized gain position of the portfolio increased by over $700 million in the quarter with declines in equity values being more than offset by increased fixed income valuations.

Our decision earlier this year to decrease our position in equities by $1 billion, moving those funds into fixed income securities has proven to be a wise move.

As required by FAS number 142, we seized amortizing goodwill in the first quarter of 2002 and completed the adoption of a fair value appraisal method for goodwill in second quarter.

The fair value appraisal of goodwill resulted in an impairment totaling $331 million after tax, or about 46 cents per share.

This impairment was recorded as the cumulative effect of a change in accounting principle as of January 1, 2002, and, therefore, it impacts our financial statements for the first quarter.

There is no impact to operating income from this impairment.

We have place restated financial statements for the first quarter on our web site for your information and use.

From the capital management perspective, we repurchased approximately 4.1 million shares of our stock at an average cost per share of $38.61 for an overall cost of $156 million.

We are now almost 60% complete with our current $500 million authorization and expect to finish this program by year-end 2002.

Now let's move on to the business units for a closer look at the trends starting with the property casuality segment.

Total net written premium for the quarter increased 5.5%, an acceleration from Q1.

The primary driver of this increase was an increase in average premium as the overall units declined.

Earned premium increased at the same rate, 5.5%.

The growth in earnings continues to accelerate as the impacts of rate actions taken over the last several quarters work their way into the P & L. Overall, the combined ratio for the quarter was 100.4, a 1.2 point increase from Q1 but almost 5.9 points better than second quarter of last year.

The increase sequentially was due to increased catastrophe losses worth 3 points, and greater restructuring charges worth 2/10th of a point, partially offset by a 2.2 point decline in the underlying loss ratio.

Relative to last year, restructuring charges added 6/10th of a point to the combined ratio, but this was overwhelmed by lower catastrophe losses worth 4.8 points and improved underlying loss ratio down 5/10th of a point, and the expense ratio dropped 1.2 points.

Our efforts to control expenses are paying off.

In the quarter, the amount of expense dollars excluding restructuring charges was flat when compared to the second quarter of last year after increasing only $12 million in the first quarter.

An excellent result.

Next, let's go to the results for the Allstate brand.

Total net written premium increased 5.8% in the quarter, a rate slightly higher than the first quarter.

Rate actions were the primary driver of the increase.

Standard auto grew at a 6.3% rate.

Off a little from first quarter as rate actions and market specific profit improvement tactics continue to work their way into the numbers.

Here are some of the specifics behind that growth rate for the quarter.

Average written premium increased 8.6%.

Average earn premium jumped 6.9% as rate actions get reflected in the premium numbers.

We implemented rate changes with second-quarter effective date in 16 states with an annual effect of 7.7%, as well as rate actions in two additional states with effective dates after June 30th.

New business production fell 38% in the quarter, heavily influenced by market-specific actions we have taken in California and Texas.

Retention for the quarter fell 1.5 points and stands at 89.5%, in line with the expected decline based on elasticity models and slightly better than the first-quarter's result.

Policies in force fell 4/10th of a percent compared to last year.

Nonstandard auto net written premium continues to decline falling 11.1% in the quarter.

Units fell 20% as the volume of new business is not enough to replace the naturally high attrition rate of this segment.

Average written premium increased 12.6%, with average earn premium up 9.6%.

We continue to take necessary rate increases averaging an annual impact of 10.5% in 11 states in which we took action with second-quarter effective dates.

We also have approved rate actions with third-quarter effective dates in three other states.

This line has reached acceptable levels of profitability and we will be evaluating our growth and retention strategies, but it will take time for any increase in growth to occur given the retention characteristics of this business.

Allstate brand homeowners net written premium jumped 17.1% in the quarter, fueled by the significant rate actions we have taken over the last year or so.

During the second quarter, we implemented rate changes in 15 states, with an annual average impact of 21.6%.

Average written premium grew 19%.

But average earned premium was up only 9.3%, demonstrating the lag effect for 12-month policies.

Overall, our policies in force still showed a slight increase over prior year of 6/10th of a percent, but it is expected to turn negative in the near term.

Although new business production was down about 10%, and retention has fallen 1.1 points below prior year, these results are much better than we would have predicted given the rate actions take.

It is more evidence of how hard the market is in homeowners.

For Ivantage, which includes Encompass and Deerbrook, overall net written premium increased 3.3% on the strength of Deerbrook's re-entry into the nonstandard market, and accelerated pricing actions targeted to improve the profitability of the encompass business.

Shifting quickly to the loss trends for the Allstate brand for both standard and nonstandard auto, frequency results in the quarter were very good.

In particular, standard auto BI frequency increased slightly by 5/10th of a percent while property damage fell 9/10th of a percent.

Nonstandard auto bodily injury frequency dropped by 5.2 %, and property damage also declined 4.5%.

Unlike the first quarter, weather was not a material influence on these results.

For paid severities, bodily injury increased only 6/10th of a percent, the same as in the first quarter and property damage went up 3%.

So when you put all these trends together, you get a very manageable, consistent trend in auto loss cost in the low single-digit range, coupled with our rate actions over time, you get the potential for margin improvement as these rate increases are earned.

In homeowners, we have some indication in the numbers that, excluding the trends in Texas, lost costs are moderating for a change.

In total, frequencies, excluding catastrophes, fell 8.6% in the quarter, while paid severities grew 14.4%.

The severity trend is still heavily influenced by water -- by water and losses related to mold in Texas.

Excluding Texas, that severity increase was around 5 to 6%, a very good sign.

We continue to evaluate our prior year loss reserves, in part for water losses and have increased them in the quarter by $87 million, less than the adjustment made in the first quarter.

The combination of rates burning into earned premium, and loss trends moderating somewhat, provides ample evidence that this line will return to acceptable levels of profitability by mid 2003.

Wrapping up the property casuality discussion, net investment income declined marginally in the quarter falling about 2%.

However, excluding partnership income, which was 16 million this quarter versus 32 million last year, net investment income increased by 2% over prior year and 4.6% sequentially.

While yields continue to decline as the portfolio rolls over, cash flow trends are improving.

With an effective tax rate of 18% this quarter, the per share contribution increased from the first quarter by 2 cents and was level with last year.

Shifting to Allstate Financial results, operating income was $143 million in the quarter.

The same as in the first quarter.

And $24 million better than last year.

The elimination of goodwill amortization accounted for $7 million of the increase, with the rest being attributable to increased investment margins and better mortality experience.

Statutory premium and deposits increased 13.2% in the quarter.

This includes deposits of the Allstate Bank.

Fixed annuity sales increased by 47% in the quarter with strong results posted throughout our distribution channels.

Variable annuities fell 22%, reflecting the depressed equity market.

Sales through our Allstate agencies system were up 130% in the quarter and have already surpassed all of 2001's production results.

Both life and annuity persistency trends remain quite favorable with both being over 90%.

In this difficult market, the strength of our broad product portfolio and diverse distribution system really paid dividends for us.

We continue to strive to become a much broader personal financial services company serving more of our customers' protection and retirement needs in the future.

And with that, let's open it up for questions.

Tracy, I will turn it back to you.

Thank you.

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One moment please for our first question.

Michael Smith, please go ahead with your question.

Good morning.

On the Ivantage book -- can you hear me?

yeah.

On the Ivantage book, you were within shouting distance of progressive agency loss ratio in a couple of areas but you're miles away on the expense ratio.

How are you going to compete with progressive on that book and how are you going to get the combined ratio down to below 100?

It would seem you will have to do it with expenses.

.

There is no silver bullet there, Michael.

You have to touch all elements of the P & L.

We first have to get the product adequately priced.

We then have to continue to attack the expense base by leveraging much of what we already have in Allstate.

So to the extent, Ivantage can do simple things like leverage glass buying.

Maybe even where it makes sense, combine some of the claims operations.

We'll keep attacking on that end.

That business will get down to a 100 combined ratio by the end of next year.

Well, given that your loss ratio is fairly close to Progressive's already, isn't it kind of tough to price it differently?

You know, it is not.

Again, I think the solution comes by rate increases, which drives the loss ratio down.

Progressive has about two-thirds of its book, I believe, is nonstandard, about a third of its book is standard.

That's close, I believe.

You will have to get the actual numbers from them.

The Ivantage book of business is almost entirely a standard book of business, and it is package policy.

So there is more room for rate increase there in that marketplace to get us a better loss ratio and it's not exactly compable.

We have got to get better pricing, better product, and then continue to attack the expense ratio which is what we have been doing and that's why the result has improved.

Good.

One follow-up if I may.

Your guidance excludes restructuring charges that are 5 cents a share through the first half of the year?

Yes, it does.

Can we assume a dime for the full year?

Yeah, that's probably a good estimate.

Okay, thank you very much.

Ron Frank with Salomon Smith Barney, please go ahead with your question.

Yes, good morning.

I'm a little bit surprised by the fact that the auto -- the Allstate brand standard auto premium growth, although certainly respectable, decelerated for the second quarter in a row in a market that, I guess, most of us seem to view as hardening.

Could you give us a little more color on that?

Are you choosing to be more aggressive on price because you need it or want it than some competitors and therefore being willing to have that deceleration?

Or if you can give us some color on that against the market backdrop?

Yes, Ron, as you know, it is always difficult to talk about averages.

They are in fact, the road to hell.

So you really have to recognize that the business is a local business.

There are states, like California right now, where we are writing almost no new auto business because the economics, the take all comers, the future of a Garamindy in as the regulator, we don't like any of that.

Some of those same issues are true in the state of Texas.

A lot of that lack of policies enforced growth is a fact of us trying to manage the locations that we're doing business in and it's us trying to drive more for profitability and less for top-line growth.

You know, in the 49 states in which we do business, there are always states that are working very, very well and we are going after growth in those states aggressively.

There are other states where it just simply is not smart to do that because two years from now, we won't like what we get.

So we are trying to manage top-line growth with bottom-line profitability.

We much prefer bottom-line profitability.

Ed, if I may follow up.

Not all states or markets are created equal, obviously, and California and Texas are pretty big.

Should we, therefore, expect that growth will be flat -- not flat, I mean, on a year-over-year basis, but on a consecutive quarter basis, perhaps further deceleration as you manage to where you want to be in California and Texas?

Because presumably you are not going to make it up in Idaho and Montana.

We would like to be able to do that but it would take the entire state.

We would need 100% market share.

Ron, part of what you are poking at is absolutely valid.

I would encourage you to think about many of the conversations we've had about strategic risk management.

To the extent we could use credit, financial scores, and we could use our strategic risk management, it enables us to get really good bottom-line performance with less top-line performance.

It is the quality of the book that we are driving for, not just putting numbers of policies in place, some of which we don't like the performance of.

I don't think that our policies in force or that our revenue growth will accelerate through the balance of the year, probably stay where it is.

Maybe decline slightly.

Depends on what happens in California and Texas and a few other states and how quickly some of those large states return to a kind of fertile ground that we would like to see.

Thanks.

And by the way, the road to hell is what the other insurance stocks are doing today. [ LAUGHTER ]

Our next question comes from Alice Schroeder with Morgan Stanley.

Please go ahead.

Hi, good morning.

If I could just echo Ron's comment about the road to hell.

I have a couple of questions about you.

On toxic mold in Texas, you cautioned on the homeowners, that you sort of caveated your improving outlook with, except for Texas and excluding Texas, which you said is not really turned the corner yet in terms of loss cost trends.

Can you give us any indication of when you think Texas might be getting under control or do you think it is simply a situation where you can't really predict yet?

And then I have a follow-up.

First, Alice, toxic and mold are two different things.

Okay.

It's [ INAUDIBLE ] to connect the two of those.

I know the media has done an awesome job of, you know, making it so that it's the only kind of mold there is is toxic, that is not the case.

Second, I would say that we understand the trend in Texas.

We are -- while we don't like it, we are somewhat encouraged by it, in that it is not continuing to accelerate.

As you will recall, we put a new policy which limits our mold exposure and that policy went in in about February or so of this year.

That will round off as for the end of this year, beginning of next year.

The issue is, you know, many people want to rush to, "file a claim", so that they can preserve a bookmark or have a place in line.

Many of those claims turn out to be not valid.

We deny them.

On the other hand, some you really have to pay because of the potential litigation situation.

So, you know, I think this whole thing is unfolding just about exactly the way we thought it would.

We don't see evidence of the mold issue spreading into other locations.

It will take us another six months to get it behind us.

We are able to build our reserves and still show, I think, very, very strong results.

I think we have our arms around this one.

Okay.

My follow-up relates to stock options.

Companies have begun to come out and follow Coca-Cola's example in stock options.

I could argue that your cost of capital is too high because of the current accounting for stock options.

Have you considered expensing them?

Alice, that's a good question.

I guess I have four points on it.

One, we do show our -- the impact of our option grants in our financial statements.

And my recollection is it is about 3 to 4 cents a share after tax.

So for us, it's kind of a tempest in a tea pot.

Second, we have a large, some would call it massive, share repurchase program and sometimes people don't relate that too, share repurchase program dwarfs anything that we do with respect to stock option accounting.

Third, my instincts are that corporate America ought to just go ahead and expense stock options, but we all ought to do it together because what you wouldn't want to have happen is to have companies within the same industry have differential cost structures because some people expense options and some do not.

We are a relatively modest user of stock options.

We think they are valuable to align behavior, but we are a modest user of them.

There are companies in our industry that are more aggressive users and I think substitute stock options for salary increases.

What would be painful and probably not right would be if some folks started to expense options and others didn't.

That's a long-winded answer.

I don't think we will do this voluntarily unless we see many of the companies in our industry moving in that direction because we do want to avoid this differential cost structure, which we then have to explain in a regulated environment to officials who govern our pricing actions.

Personally, I think corporate America and the FASB ought to just get on with it.

If this is one of those things that will help restore confidence in corporate America and in CEO's, we ought to just do, be done with it, and get on with it.

Hmm, well I guess my argument is that you could add to that sine the cost to you is very minimal by going ahead and doing it voluntarily.

The transition charge, if there were one, if there was a methodology change, would be minimal and probably completely insignificant and since the cost is so minimal to you, the impact of that being on a differential basis would be completely trivial and, you know, obviously there would be a highly symbolic importance of going ahead, whereas, as you noted, there are companies whose earnings are overstated as a result of this and they have an artificially low cost of capital relative to you.

Alice, I will expand my statement of a few minutes ago.

Averages are the road to hell.

So are minimal things that you do.

The sum all the minimal things that you do, you wake up and you say, jeez, why is my cost structure so much different than somebody else's.

You are making a valid point, I just think corporate America and industries in general have to move together on this one, and we all ought to decide what we are going to do, and do it.

Okay.

Thanks.

Sure.

Brian Meredith with Banc of America.

Please go ahead.

Good morning, everybody.

Given what's going on with loss cost right now in the standard auto insurance line, it looks like they have gotten a lot better at least over the last couple of quarters on their profitability improving.

I was wondering if you could give us a prognosis of what you would see happening with Allstate's rates going forward for, let's say, the six months, you know -- over the next six months?

You know, Brian, I will.

That's a tough one.

We have a philosophy of taking all rates that are indicated.

You know, every line, every state.

So part of it is a function of general economic conditions and, you know, does medical cost get out of hand or what have you.

We want to maintain or grow our margins and we will do what is necessary to do that.

The reason why comments on expenses and expense ratios are so important is, if we keep getting more and more efficient on that end, we need less rate increases, but at the same time, we can expand our margin.

So you really have to manage the business on a holistic basis.

My instincts tell me over the next 12 months or so, rate increase also continue but at a decelerating rate.

But I think that will be because the margins in the business continue to expand.

Homeowners, I think, I would be less comfortable.

My crystal ball is not nearly as good on that.

I think homeowners rate increases could well continue to be along the same lines of what we have seen over the last 12 months or so.

I believe that the homeowners' product line for the industry is an underpriced product line, and I think more people are following our lead.

We are just not going to give it away.

We are going to earn an acceptable rate of return in the homeowners business every state, every year.

And I think that probably means more rate increases.

I think there are some of our competitors who have rate increases in the wings that are probably going to be twice ours, because they have gotten so far behind the 8-ball.

I know that is a long-winded answer.

I would say on the auto side, rate increases continue but probably at a decelerating rate although I think margins continue to expand.

In homeowners, you will probably see the same kind of rate increases over the next it months as we have seen in the past 12.

Great.

As a follow-up, strategic risk management pricing has, I guess, has been around here for now a couple of years.

Do we have any tangible evidence yet that it is actually working?

Are you getting more PIF growth in areas where -- where you want the policy holders?

Well, absolutely.

We are getting PIF growth where we want the policy holders.

The PIF growth is in the tiers that you want, it's in those top couple of two, maybe top three tiers, those folks that stay with you longer and tend to buy multiple PC products and will also purchase financial service products.

Plenty of evidence.

And I would also suggest if you look at the frequency trends, one reason why the frequency trends are as good as they are is, the new business that we're adding is quality new business, so it's not trashing the existing stuff that we have.

The retention of our -- of our lines where we have good SRM in place is up, and that's important.

So we have plenty of indication that the work that Ron McNeil and the people in pricing and product development have done is really industry-leading work.

We are very confident of it.

And it really goes back to the question that Ron Franks asked earlier, if I could get everyone on the call to understand what we want to do is to manage to grow the bottom line.

If that means we get a little less top-line growth because it is the right kind of customers that we have coming in the door, we are all for that.

Great, thank you.

Okay, Brian.

Our next question comes from Bob [ INAUDIBLE ] Please go ahead.

Good morning.

I wonder if you could characterize what were the two or three most important factors in raising the earnings guidance by 20 cents?

I am guessing it is the auto infrequency trends and the cash flow investment income.

Those seem to be the two things you are highlighting the most.

Is that a fair characterization?

Yeah, it is a fair characterization.

I would also point out a couple of other things.

As I mentioned, our nonstandard business is really performing well.

A year ago, we were struggling with it, six quarters ago, we were struggling with it, but we have got that business down to a 75 loss ratio.

It is not bleeding.

That's another thing I would mention to what you added.

And I would say our performance on expenses is really strong.

It is one thing to have your expense ratio improve because you are getting good rate increases on the top line.

That's the ratio gain.

Our expense ratio is improving because of that, but also because our expenses are flat.

And as we see all of the things that we put in motion to bear fruit starting to pay off for us, we get a lot more comfortable about what the back half of the year looks like.

I like the way you caveated your question, Bob, and that is, that assumes you have a normal level of catastrophes.

To the intent you have more or less than what's normal it could wreak havoc or could make that forecast not achievable, but given normal catastrophes and that's what we would predict, although our crystal ball is not very good here, we are comfortable in the 270 and 290 range.

What is the status of your CFO search, outside, inside, how would you handicap it at this point?

Probably outside.

I have a very good acting CFO in Casey Sylla, who has done an extraordinary job of running our investment portfolio for a good, long period of time.

I want the right person in that job.

We have a number of folks inside.

Talking to a number of folks outside.

I really had hoped to have that done by the end of July.

We will see if I am able to deliver on my own internal time table.

Thank you.

Michael Lewis with UBS Warburg.

Please go ahead.

Good morning.

I guess my follow-up question goes back to maybe Ron Frank's question, a little bit different way though.

You mentioned the State Farm changes right now.

You obviously mentioned your profitability.

Progressive went specifically into the advantages that State Farm's actions are going to have on its PIFs and everything else, anyway they measure it, they will take advantage of this.

You are competing against Progressive for that business.

I guess my question is, taking out California and Texas, when do we see Allstate's ability to gain advantages here and show the top-line growth that's created by unusual situation of the leader moving to the side?

And when can we start seeing this in the PIF numbers, and can you give us some PIF numbers without Texas and California to show if you were making any progress in taking advantage of the market and all the rate increases and adding to your new growth in policies in force?

All right, Michael, there were about five 'ands' in there, let me see if I can break them down.

I think clearly, the issue that State Farm is facing provide an opportunity for us.

And I will tell you that the State Farm customer looks and feels a lot like the Allstate customer.

Doesn't necessarily look and feel like the Progressive customer.

I think the first stopping point for all of those folks would first be Allstate and second, third and fourth would be somebody else.

Second thing I would mention to you is, as you know, Progressive does not offer homeowners insurance.

Many of those people when they move away from State Farm want a one-stop shop, someone that can provide both homeowners and auto.

We can do that.

Third, we are anxious to take much of State Farm's business.

But you know what?

We only want the good stuff.

We only want the stuff that's not going to have disproportionately large losses and we want the stuff that we can sell multiple products too.

And we are going to be very cautious on that.

Mike, I would hold out as an example, our ability to do this in New Jersey.

About three or four years ago, we started down a very long, painful road in New Jersey because we were losing $150 million in underwriting income a year.

That business over the last two to three years has been profitable.

It's got a combined ratio well below 100, and it is because we made some very, very difficult decisions and implemented them.

So today in the state of New Jersey, we are growing.

We are taking market share--from State Farm, but we have pulled all underwriting authority from our agents in New Jersey and we're basically double underwriting everything we get.

Because what we want is -- is continually increasing earnings.

Not earnings that spike up because we get an increase in PIF and then two years from now we have to provide large reserve because the business we took was not good.

The combination of State Farm as the market leader at 20% market share, the combination of some of the difficulties they are having, our strategic risk management which gives us the ability to underwrite new business in a much more finite and much more accurate way than we ever have in the past, our very aggressive expense management initiatives right now, which means we don't have to keep taking the same size rate increases that some of our competitor will have to do.

I think it positions us very well.

You know the PIF will grow, but concentrate on the bottom-line growth, because what we want is quality customers, not just more customers.

Thanks very much.

One other question.

What does the nonstandard market look like in Sweden? [ LAUGHTER ]

I don't have any idea, Mike.

All I do is spend my time on the phone.

I should have just stayed home.

I will tell you, Michael Lewis, we are here with 400 or so -- 450 of our top agents.

The attitude of our agents, it's been a long time since I have seen it as positive as it is right now.

The really aggressive things we have done over the last couple of years, which was hard for some of our agents have swallowed, they now see that it is now paying off.

We are profitable in almost all of the states.

In a lot of states, people are beginning to see our rates are more competitive than they have ever been, and I am really encouraged by the attitudes of our agents.

It's a good chance for me to get face to face with 450 to 500 of our people all at once.

Thanks a lot, guys.

Adam [ INAUDIBLE ] with Cochoran Corona, please go ahead

Good morning.

How sustainable do you think this 72 to 73% loss ratio ex-cad is over the next couple of quarters?

Well, I think -- I think it is sustainable.

As I said, our goal is to improve margins, and that means both attacking the loss ratio side and continuing to -- to attack the expense ratio side.

You know, we want to drive the homeowners' loss ratio down substantially from where it is right now.

So I think there is good potential for the overall loss ratio of the company to continue to go down as we are able to do that.

And as the effect of rates that we have already taken begin to continue to flow through the P & L and manage our lost costs and our expenses appropriately we should see the margin expand.

Thank you.

Ira Zuckerman with [ INAUDIBLE ], please go ahead.

A couple of questions.

First of all on Allstate Financial, you mentioned that improved mortality is one the contributors to the earnings.

Could you give us an idea of the amount of the mortality swing and whether it represents change from above to below, above to normal, normal to better?

You know, I don't have that number with me here in Stockholm.

Bob Block may have it.

I would say, Ira, mortality is one of those things -- I am embarrassed to tell you this, it's one of those things that bounces around periodically and whenever it does, we drive ourselves crazy trying to explain it.

Sometimes, you know what, the number just is different than what you expected or it's different than a previous period.

I think right now what you have is a mortality number that's based -- that's bounced back into the normal kind of range as opposed to normal, up to exceptional.

I think it has probably bounced back to normal, whereas the first quarter it was worse than normal.

Bob, I don't know if you have any numbers that would support that or put some meat on those bones.

Yeah, that's right, Ed.

Of the increase in net income, or in operating income in the second quarter, about half of the 14 million increase was due, was attributed to mortality, than in increased investment margin takes up the rest.

And that's after the increase due to the lack of good will.

Okay.

The other question I've got.

Can you give us an update on how the Internet strategy is progressing?

I can.

You know our Internet strategy is working well for us.

We are not driving the kinds of business, solo business, through the Internet and the call center that we anticipated.

What we are finding is that upwards of about 6% of the business that our agents write, in fact, comes from calls through the call center or initially going on the Internet.

We are also finding a lot of service applications.

We are finding people paying more and more of their premiums on the Internet.

We are finding more and more people finding claims and doing status checks of their claims on the Internet.

So it's helping to drive our expenses down or to keep them from going up.

I'm convinced that over time, the ability of opening ourselves up to the customer.

Let the customer decide how, when and where they want to reach us, is going to serve us very, very well and I think we are seeing the early signs of that.

Could you give us an idea, then, of how much is being spent on the project and when you expect to see any return on that expenditure?

Oh, I certainly expect to see a return in expenditure.

We are not in business for the fun of it.

We want to generate good returns for our shareholders and returns in excess of our cost of capital.

We have scaled back the money we are spending on it.

We are up and running in 30 states, represent 90% of the U.S. population.

I don't see it extending to the other 19 states in which we do business, simply because there aren't enough people there to justify it.

Each state costs us between $750,000 and a million to bring up and if there aren't enough people in any given location to justify, we don't think that makes much sense.

We have rationalized our call centers and integrated them with a lot of our other call centers and service centers.

So over time, this initiative kind of morphs into everything else that we are doing.

Remember, ne the really correct calls we made, or correct decisions we made, was to integrate the Internet and call center strategy with our base business.

So it is seamless to a customer.

Others have tried to kind of keep it as a totally separate and distinct business.

That wasn't our strategy and it is not where we are going.

We want the customer to have the flexibility to reach us any time, anywhere, anyplace they choose and we want to be able to do that efficiently, at the right cost per call, right acquisition cost and that's all pretty much, pretty much playing out the way we thought it would, Ira.

Thank you very much.

Jeff Thompson with KBW.

Please go ahead.

Good morning.

Very good quarter.

I have first a numbers question.

Are your paid losses in the press release or do you give that in the call?

They are not in the press release.

Why don't you go to the next one and I will look up the paid losses.

I was going crazy looking for it.

Second question, and I think it is related, do you have your property casuality cash flow in the quarter?

And can you sort of quantify, I guess, this sequential improvement in investment income.

How much is related to cash flow and how much was due to variation in LP gains or losses.

Yeah, you know, it is not in the quarter.

Let me see if I can get at it conceptually as opposed to numerically.

Any time you operate at a PC business, at 100 or below combined ratio, you know, in general it translates to positive cash flow.

But to the extent we are there now.

You will see our cash flow continue to improve.

Second, for a while, over the years 2000, 2001, we were paying off old claims from the days of which we implemented claim core process redesign.

We were paying them off at or below the amount we had reserved them at, so it was neutral or slightly positive from an income statement standpoint, but it was -- it was using cash.

That's all flattened out now.

So we're rapidly getting back to the -- to the part where the -- the loss payments are relatively consistent, and to the extent we operate the business at a sub-100 combined ratio that will add more cash flow into Casey's investment portfolio.

Bob, I don't know if you have loss cost ,that you want to share.

Yeah, the paid losses in the quarter were 4,514 million,

Sorry, what was that again?

4514.

Okay.

They seemed a little high.

Relative to what?

Bob, why don't we clear that up after the call.

Okay.

Let's talk afterwards.

I actually had one more question.

Sure.

You said 4414?

Not 5414?

4515.

Okay, they're actually down again.

Okay, very good.

The last question I had, considering the auto loss cost trends you talked about in the rate increases, are you at reserve adequacy today for personal auto?

We are always at, or better than reserve adequacy.

I am sorry not at reserve adequacy, pricing adequacy.

That's a big difference.

No we will continue to take rate increases.

Some states around the country where we absolutely need to take rate increases, and we will do that.

Bob, are you there.

I'm here.

Operator, next question.

Our next question comes from Jay Cullen from Merrill Lynch.

Please go ahead.

Hi, Jay, how are you?

I am good, I am good.

A couple of questions.

The first is, the homeowners' claims trends outside of Texas, which you suggested are moderating, if you go back a couple of years, do you have any sense that maybe the inflation that you saw and the increases that you saw in 2001 may have been an anomaly?

No, Jay I don't have that sense.

Others may, but I don't have that sense.

We chatted about this from time to time.

I think what we saw was a result of a couple of things.

I think there was enormous pressure on remodeling, and on construction and reconstruction.

You know, America, in general, went through a house-purchasing and upgrading process that was somewhat unprecedented.

Material costs escalated and labor costs escalated.

When you couple that with frequency improvements, and increased CAT, that's a tough combination.

As I said earlier, my instincts are, and our numbers tell us, that the homeowners' line has been underpriced for quite a while and we wanted to get it fixed.

You know, you always have to, when you get the homeowners, you all start looking at the particulars.

There was some ice damming at the end of 2000 that was much more severe than we thought.

That was a very difficult winter weather at the end of 2000 and into the first couple of quarters of 2001.

Much more difficult than we thought.

So to the extent that those things are an anomaly, maybe there is some validity in your question.

But I think the basic pressure on home repair, home remodeling, construction and labor costs, I think it grows those severities up and we are just now getting to the point where we are pricing for them.

Follow-up question.

Any sense of what kind of losses you will see from the Texas floods, and related to that, should we expect to see a spike of then mold claims following these floods?

You know, I am going to assume that the Texas weather -- Texas winter rain, whatever, is relatively modest from a claim standpoint.

Much of that is rising water.

Rising water is covered by federal insurance, not by our insurance.

You know, not clear to me that you will see an increase in the number of mold claims.

It could be, Jay, I just don't think so.

Remember, a lot of those areas now are covered by policies that limit the mold coverage because we are 5 to 6 to 7 months into that whole process.

I am thinking that's just going to be part of being big business in the property casuality area.

Seems like -- we are talking a year from now, seems like the mold issue won't -- given the policy changes you made in Texas, mold issue won't be a real big issue in a year from now.

We aren't adding to it.

We still have the issue of the policies that have been in place for a while continuing, but we won't be adding to it from where we are right now.

Okay.

I think as I said earlier, maybe it was in response to Alice's question.

I think we have got our -- our arms around this, and I think our business is running sufficiently well right now that, to the extent we need to beef up some of the reserves, we have the capacity to do that and we will stay right on top of it from a rate increase standpoint.

Whenever we pass through -- whenever we incur mold costs, we are going to pass that through the consumer and that's going to mean higher prices.

Great.

Thanks a lot.

Okay, Jay.

Our last question comes from Everett Miles from Goldman, Sachs.

Hi, can you hear me?

Yes, I can.

It is actually Joan Zeis.

Hi, Joan, how are you?

Just fine.

Actually I just have two quick questions.

One is, could you talk about what assumptions changed to cause -- to cause under FAS 142, the write-off of the goodwill?

How much of it related to American Heritage, how much to Penbrook, and just interested in knowing what is left and if there is anything else at risk?

The second question is about the variable annuity business and if you feel that there is any risk to your DAQ [Phonetic] amortization and your DAQ assets and what you're thinking in those terms, and what plans you have in that particular product?

Yeah, the goodwill amortization, in terms of where it applies as shown in the press release, I am thinking it is about -- Bob help me, maybe 300 million on AHL and about 40 million in Penbridge, or so.

Yeah, it's 283 on American Heritage and 48 on Penbridge.

You know, Joan, really what changed there, was the methodology of how you write things off.

I tell you, we like the AHL acquisition a lot.

We are getting everything that we anticipated we would get out of it.

Some of the cancer-related policies that we discontinued, we wrote off stuff for that.

Really what you need to do with 142 is give it your best shot, because anything you have to write off from here on out, goes directly to the P & L. We follow all the rules and regulation but we like that AHL acquisition a lot.

We expanded it to more locations around the country, opened up more regional offices.

Our Allstate agencies have taken to that product very aggressively.

You should distinguish what the new SFAB requires us to do versus maybe, what your change in outlook for that business is.

We feel very, very comfortable with that business.

Penbridge Penbrook is all part of Canada.

The Canadian situation is very problematic.

We are doing okay up here.

The only business we have left in our international fold.

We continue to work hard on fixing it.

That business is probably operating at a 106 or so combined ratio.

There are certain territories of Canada which are just awful, and we have to make some decisions of staying in those places, continuing to write there, or exiting some places.

Your question of VAs.

I need to start with a different place.

We think that there is clearly a place in the portfolio for variable annuities.

Right now nobody wants them because there's real issues on seeing which way is the market, the equity market going to go.

We look at the DAQ [Phonetic] associated with our VAs on a quarterly basis, and right now I think we are okay with.

But if the markets would continue to go down using the Dow as a surrogate by 60 or 70 points, that's clearly going to cause anybody that has any DAQ [Phonetic] associated with any VA some sort of difficulty.

We've probably got some offsets to that that maybe others don't have.

To the extent that you believe history is a precursor of the future and you look at what the equity appreciation rates have tended to be, once you get through some very difficult down periods and get comfortable with the DAQ on the VAs, we look at it on a quarterly basis to make sure we aren't polluting ourselves.

As I said, there are some offsets to it, but if the market continues to go down at very substantial rates, everyone that has VAs is going to have some DAQ write-off issues.

Do you have a large exposure to these guaranteed minimum death benefits?

How much did you actually have to pay out this quarter?

I don't have that.

I would say such a small number that I don't know what it is, otherwise I would have it.

Joan, I would tell you, we have been big in the VA business for about two years.

Two and a half to three years maybe.

Others who have been there for a much longer period of time, the issues you are poking at are going to be much more severe with us.

I am going to guess that our guaranteed death benefit payments were -- they were probably less than $10 million.

Okay.

Great.

Thank you very much.

Okay.

I would now like to turn the call back to you.

Please continue with your presentation or any closing remarks.

Robert, it's yours.

Thank you for joining us today.

Phil and Larry and I will be happy to take your calls for follow-up questions or what have you, throughout the next day or so.

So look forward to talking to you and look forward to speaking with you in about a quarter.

Thank you.

Thank you, all.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation and ask that you please disconnect your line.