Allstate Corp (ALL) 2003 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second quarter earnings for the Allstate Corporation conference call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question and answer session and instructions will follow at that time.

If anyone should require assistance during the conference, please press star then 0 on your touch-tone telephone.

As a reminder, this conference call is being recorded.

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

Mr. Block, you may begin.

Thank you.

Good morning, everyone and welcome to our 2nd quarter 2003 earnings conference call.

I know this will be a busy day for many of you as several companies are holding calls today.

We'll stick to our timetable and complete this call in no more than an hour.

As in the past, Ed Liddy and Dan Hale will be participating with me on the call as well as other company individuals.

Sam Filch and Mary Mays are here as well and will be able to answer questions.

Following a familiar pattern, we will first hear from Ed providing his perspective on our results, I will provide a little more color on the quarter and then Dan will give his thoughts on several topics including capital management and prior year reserve development then, as always, we will take your questions.

We issued our press release shortly after the market closed last night along with the majority of our investor supplement.

If you need a copy of the release or the supplement, they are available on our website under investor relations.

Now, it is time for our legal disclaimer.

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 effecting Allstate section in Allstate's 10-Q for the first quarter of 2003, in our notice of annual meeting and proxy statement dated March 28, 2003 and in today's press release.

In this call, we will discuss some non-GAAP measures.

You can find the reconciliation of those measures to GAAP measures in the press release on the investor relations portion of our website, allstate.com., on the quarterly investor information link.

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, web cast, broadcast and use of your name, voice and comments by Allstate.

If you don't agree with these terms, please disconnect now.

Now, I will turn the program over to Ed for his thoughts on the quarter.

Ed?

Good morning, thank you all for joining us.

As you saw in our press release, we had another terrific quarter and it was also a very interesting quarter.

It began with a major hail producing storm system in early April affecting Texas, as well as much of the south and midwest, about 28 catastrophic events and $566 million later, tropical storm Bill blew ashore on the late afternoon of June 30th, closing one of the most active CAT quarters we have ever experienced.

Our catastrophe losses were doubled last year's 2nd quarter and were four times the level of the 1st quarter 2003.

It is, however, circumstances such as these that provide Allstate with the opportunity to really distinguish itself in the marketplace.

So, I want to acknowledge all of our agencies and claims folks for fulfilling the promise we've made to our customers, to be there in their time of need.

It was a very difficult quarter from a weather standpoint and I am very proud of the way our folks have handled these challenges.

Now, despite the stormy weather, we managed to generate another outstanding earnings result, posting net income of $588 million, which was a 71% increase over last year's 2nd quarter.

We earned operating income of $599 million or 85 cents on a per diluted share basis which was an increase of 21 cents and we have begun to experience a return to positive unit growth in our core Allstate brand lines a little earlier than we expected.

The results from this quarter, I think, continue to validate the wisdom of our overall strategy and also our ability to execute.

We remain focused on our strategic intent to become better and bigger in our property casualty operations while becoming broader in financial services.

Let me give you a few highlights.

In terms of better, our combined ratio, despite the high level of CAT losses, showed substantial improvement from 100.4 in the 2nd quarter of last year to 97.1 in the 2nd quarter this year.

The combined ratio excluding CAT losses was reduced to 87.9, a 7.5 point drop from the second quarter of 2002 with virtually every line of insurance showing favorable results.

Our home owners' profitability, even with the large catastrophe impact, was very strong, a low 90's combined ratio better than our targeted return levels.

Our Ivantage business, which includes Encompass, the acquired business from CNA and Deerbrook, our auto only IA company, cut its underwriting loss this quarter by more than 60% despite some very small reserve actions on prior years.

Encompass remains on pace to achieve an underwriting profit by the 4th quarter of 2003.

Our expense ratio at 23.4 was four-tenths of a point higher than last year's 2nd quarter and five-tenths of a point less than the first quarter of this year.

We continue to incur higher pension costs on a year over year basis and in this quarter, the second quarter of this year that is, we increased our guarantee fund accrual by $34 million based on some new and recently received information on the Reliance insolvency, at about $34 million alone equates to about half a point on our expense ratio.

Strong cash flow is helping us to offset the impact of lower yields on our investment portfolio.

In terms of bigger, our core Allstate lines of standard auto and homeowners demonstrated sequential increases in premium growth and perhaps more importantly, unit growth.

The unit growth came a little earlier than we expected.

The growth was broad-based with 35 states showing sequential PITH growth in standard auto and 32 states experiencing sequential unit growth in homeowners.

Retention has improved sequentially in both lines of business.

As expected, a new auto rating plan has been approved for California and we begun to write new business under that plan in July, very early results are very positive.

The Texas legislative outcome appears manageable and positive.

We're confident in our ability to remain price adequate.

We are investing in growth opportunities where they present themselves.

We expect to increase marketing and advertising expenditures during the second half of '03, as well as invest in agent productivity opportunities and will continue to implement strategic risk management practices which are proving to work very well.

Our book value share of $27 33 represents a 12.7% increase over the 2nd quarter of 2002 and a 7.5% sequential increase.

In terms of broader, the diversity of our product offerings at Allstate Financial continues to move us towards our goal of becoming a broader financial services entity, although the financial services environment continues to be a challenging one.

Our Allstate financial operating income declined 8% from last year's 2nd quarter largely as a result of lower investment and mortality margins.

We are not passively waiting for better economic conditions, we are pursuing a variety of profit improvement efforts in Allstate Financial.

We've aggressively undertaken a massive rate filing, a massive filing effort to increase the profitability of new business by lowering guaranteed interest rates across the board on annuity products that we sell.

As an example, when the State of New York lowered its minimum interest income guarantee from 3% to 1.5% in May, we were the first company to obtain approval to sell products at this new level.

We're also pursuing a variety of other new business profit improvement efforts including reducing commissions and bonuses and pulling products with higher interest guarantees.

With the first half of the year behind us, based on our results to date and our view of the future, we're increasing our operating earnings per diluted share guidance for '03 by 15 cents to a range of $3.50 to $3.65.

As before, this excludes restructuring charges and assumes the level of average annual catastrophe losses used in our pricing models.

We feel very good about our progress, we're enthusiastic about our future and very confident regarding our prospects for profitable growth.

Things can get even better.

Robert?

Thanks, Ed.

As Ed mentioned last night, we reported 2nd quarter net income of $588 million, an increase of $244 million or 71% over 2nd quarter 2002.

We accomplished this result despite $566 million in catastrophe losses during the quarter, a total more than four times that of the 1st quarter's $133 million.

While the second quarter's catastrophe extremes were exceptionally large, on a year-to-date basis catastrophe losses in total have been within our expect range for the first six months of the year.

Operating earnings per diluted share in the quarter was 85 cents, an increase of 21 cents from the 2nd quarter of 2002.

The major drivers of the increase were the excellent underlying loss ratio results coupled with less prior year reserve reestimates, more than offsetting the substantial increase in catastrophe losses experienced in the quarter.

On a sequential basis, operating earnings per diluted share declined by 10 cents from the 1st quarter of 2003.

The increase in catastrophe losses in the 2nd quarter versus the 1st quarter was worth about 40 cents.

Half of that was offset by an improvement in the underlying combined ratio with additional help from Allstate Financial.

Our strategies and tactics to drive more consistent profitable growth produced another quarter of excellent results, despite one of the most active catastrophe quarters in our history, the overall combined ratio for the 2nd quarter was 97.1, 3.3 points below last year's 2nd quarter.

We're moving the effects of catastrophe losses in prior year reserve reestimates, the underlying loss ratio was reduced by 6.9 points.

The earned effect of rate increases implemented combined with continued favorable frequencies in both auto and homeowners more than offset the modest increases in severity.

The expense ratio increased by four-tenths of a point This increase was the result of a rise in pension expenses, other employee and agent incentives and guaranteed fund expenses.

Going forward, the expected increase in marketing and advertising expenditures will continue to pressure the expense ratio in the second half of 2003.

Sequentially, the combined ratio increased by four points.

Again, the impact from increased catastrophe losses was the primary driver as both the underlying loss and expense ratio improved relative to the 1st quarter.

So not only did we continue to produce solid profitability but we also began to experience a turnaround in unit growth in our core Allstate brand lines.

The tactics we have employed to position ourselves for profitable growth appear to be working well.

Future investments in growth such as increased marketing and advertising expenditures, agent productivity programs, the introduction of the new California auto rating plan and the continued execution of SRM, strategic risk management, should enhance our prospects for continued profitable growth.

Now, we'll discuss some of the details for the quarter, starting with Allstate Protection.

Just as a reminder, many of the detailed operating statistics by line item insurance are provided in our investor supplement.

So, I'm not going to go through a litany of numbers but I'll try to add some color to the trends as we see them.

Beginning with Ivantage, our independent agency channel business comprised of two brands, Encompass and Deerbrook, net written premium growth accelerated to 8.3% over the 2nd quarter of 2002.

Deerbrook, our auto only company, continues to grow fairly rapidly in those markets in which we choose to compete.

The quality of the new business there remains acceptable and the pricing environment is closely monitored with more rate increases implemented during the 2nd quarter averaging 7.1 annual increase.

The Deerbrook auto product with our tiered rating system and new technology is being sold in 17 states.

Net written premiums for Encompass increased 4.6% on the strength of rate increases designed to improve the profitability of this business.

Rate actions include implemented changes in 11 states for auto, averaging 4.9% annually and 12 states for homeowners averaging 9.3% annually during the 2nd quarter.

We have already received approval for several more rate increases to be effective during the second half of 2003.

The combined ratio for Ivantage in the 2nd quarter was 105.5%, a 10.7 point improvement from the prior year, this was the result of about a four-point drop in the expense ratio and a 10 point drop in the underlying loss ratio partially offset by an increase in prior year reserve reestimates.

On an sequential basis, the combined ratio deteriorated from 1st quarter's levels this was entirely due to the increase in catastrophe losses as the expense ratio and underlying loss ratio both showed improvement in the quarter relative to the 1st quarter.

Moving to the Allstate brand, total net written premium growth jumped to 6% over 2nd quarter 2002 as improving growth trends in standard auto and homeowners more than offset the continued slide in nonstandard auto.

This growth rate reflects acceleration from the 3.9% growth rate achieved in the 1st quarter as well.

Please keep in mind that this particular statistic can be affected by seasonality and processing issues causing some level of volatility to occur.

The growth and earned premium is a more stable premium growth indicator and that result increased by 5.7% from the 2nd quarter of 2002, a slightly faster growth rate than the 1st quarter.

The combined ratio for the Allstate brand came in at 95.4%, a 3.5 point improvement from the 2nd quarter of 2002 and well within our range for acceptable returns over time.

Excluding catastrophe losses, the combined ratio dropped to 86.1%, an improvement of 8.1 points over prior year.

Compared to the 1st quarter, the combined ratio deteriorated due entirely to higher catastrophe losses as the underlying loss ratio improved.

Looking at the results by major line, standard auto and net written premium grew by 6.9% over the 2nd quarter of 2002.

This growth reflects not only the impact of implemented rate actions but also an increase in new business production and retention.

Policies in force grew sequentially in the 2nd quarter, the first such occurrence in several quarters.

If we look at unit growth trends outside California, Texas and Florida, we had positive PIF growth over the prior year of three-tenths of a percent and eight-tenths of a percent sequentially.

We are making progress in resolving the issues we face in those three large states, particularly in California where we now have a new auto rate plan in place.

In Texas, where the state legislative session was concluded during the second quarter, we feel more comfortable with our ability to manage through the market issues there.

The issues in Florida still require us to take a cautious approach to growth.

All in all, we are quite pleased with the progress we've made thus far.

Pricing activity in standard auto continues to keep ahead of lost cost trends.

The decline in the level of activity in many markets should be expected given our improved margins and our recognition and implementation of rate indications early in the cycle.

We have attained rate adequacy in many states.

Now, rate adequacy means that based upon projected loss cost trends, our current rate levels are sufficient to produce our targeted rates of return over the next 12 to 18 months.

Further, we remain diligent in our determination of rate need by market and will file indicated rate changes as necessary.

Standard auto loss ratio in the 2nd quarter of 74.1% improved 1.3 points over the 2nd quarter of 2002 despite having three points of additional CAT losses in the quarter.

Sequentially, the loss ratio increased by 2.6 points the difference in catastrophe losses between the two quarters was worth 4.4 points.

So, the underlying loss ratio improved in the 2nd quarter compared to the 1st quarter of 2003.

Overall, loss costs remain manageable with frequencies continuing to decline and severities increasing marginally.

Allstate brand nonstandard auto top line results continued to decline during the 2nd quarter.

Net written premium fell by 17.3% despite improving retention levels.

This still remains profitable as lost cost trends mirror those experienced by standard auto and previously implemented rate actions are being earned keeping the margins adequate.

Allstate brand homeowners net written premiums increased 12.7% from the 2nd quarter of 2002, as new business production increased dramatically, retention kicked up sequentially and rate changes continued to be approved.

With a loss ratio of 68.6% that included very high catastrophe losses, this line produced a very acceptable return.

Property liability net investment income fell by 2.6% compared to 2nd quarter of 2002 to $417 million pretax.

After tax, it was almost flat with the prior year.

The effective tax rate in the quarter was 16.1%, a rate similar to the 1st quarter.

The net investment income for partnerships was $18 million in the quarter.

Compared to the 1st quarter, both pretax and after tax investment income rose by a little more than 2%.

Very strong cash flow is offsetting the fall in new placement yields.

Shifting now to Allstate Financial, premium and deposits for the 2nd quarter 2003 increased 32% sequentially and were comparable with last year.

The increase from 1st to 2nd quarter was due to stronger sales of both fixed and variable annuities as well as institutional products.

New sales of financial products by Allstate agencies topped 780 million for the first six months of 2003, slightly ahead of last year's pace.

Operating income of $131 million represents a decline from prior year of $12 million or 8.4%, as investments in mortality margins declined.

Sequentially, operating income was about level with the 1st quarter once you adjust for the 1st quarter for the negative impact on operating income of the DACON lock of $53 million.

This business will continue to be challenged by the current economic environment.

Now, I am going to turn it over to Dan for his comments.

Thanks, Bob.

From a capital management perspective like many other companies, we're in the process of evaluating our dividend policy in the context of the recent tax law change and also relative to the strong growth prospects we see ahead for Allstate.

And for those of you who may not be aware of our current dividend position, a little history, our current dividend yield of 2.5% is well above the industry average and the S&P 500 average.

We've increased our dividend every year since becoming a public company by an average of 11%.

Also in keeping with our commitment to appropriate capital discipline, since 1995, Allstate has repurchased more than 250 million of our shares at over $8.4 billion, an average cost of $32.43 per share and it represents more than 27% of the shares originally issued.

In February of this year, we announced a new $500 million share repurchase program to be completed by the end of 2005.

During this past quarter, we repurchased 219 thousand shares bringing the year to date total to 1.9 million shares at a cost of $61.7 million.

We are on track to complete our $500 million three-year program during the announced time frame as we've done for all of our previous repurchase programs.

As you may have noticed, our last two repurchase programs for $500 million each were not as large as those in several previous years.

The principal reason for the reduction in size is very simply that we are much more optimistic about growth opportunities now than we were in those prior periods.

We anticipate needing more capital for growth than we did then.

At this point, we're monitoring how the market is reacting to the change in dividend taxation while we evaluate the appropriate mix of dividends versus share repurchases or returning excess capital to shareholders.

We want to balance tax efficiency considerations with operating flexibility and want to be sure that our actions are not misinterpreted with respect to growth alternatives.

Our overriding objective will be to continue to appropriate capital discipline and shareholder value creation, so we will continue to monitor investor reaction in evaluating capital requirements as we determine an appropriate mix of dividends and share repurchases and will make recommendations to our Board of Directors at the appropriate time.

Capital management also involves debt capacity and during the 2nd quarter, we issued $400 million of senior debt with a 30-year maturity and a coupon of 5.35%.

The issue was a replacement for 300 million of 10-year debt that carried a 6.75% coupon.

We ended the quarter with a debt to capital ratio of 17.9%.

We're still evaluating 746 requirements for consolidating special purpose entities which becomes effective with 3rd quarter reports but if we do consolidate SPE's, our debt to capital ratio would increase about 2.7 points.

Had that been required for the 2nd quarter, our leverage then would still have been a very conservative 20.6%.

Turning now to reserve actions and specifically, prior year reserve development, during the quarter, we recorded reserve reestimates, in this case increases in prior year reserves of $48 million compared to $108 million in last year's 2nd quarter.

And 38 million of those provisions this quarter represents asbestos reserves for new and unanticipated claims arising from unexpected years of coverage for one policyholder.

The policy holder informed us this quarter of the decision to open the coverage block to now include years where Allstate provides excess coverage.

This policyholder had exhausted coverage for the previous block of years that had been elected for coverage, years 1954 to 1973.

We did not provide coverage for that block of years.

This policyholder is a signatory to the Wellington agreement which gives signatory producers the right to expand their coverage for asbestos claims through 1985.

Even though Allstate is not a Wellington signatory since we provided excess of loss coverage for some of the expanded block of years, we've established reserves at full limits based on the new claim information received in the second quarter from this policyholder for this new block of years.

In the 3rd quarter of this year, we'll conduct our annual round up analysis of asbestos exposure and we'll communicate the results of this study most likely during our 3rd quarter earnings call.

Looking now at our results through the end of the 2nd quarter from a return perspective.

Our net income return on equity using a rolling 12-month methodology, without adjusting for unrealized capital gains or losses, that GAAP ROE was 10.7% compared with 5.3% last year at this time and the operating income ROE, again, using a rolling 12-month approach after excluding unrealized capital gains and losses from average equity, that operating income ROE was 15.4% versus 10.7 last year.

So both ratios are accelerating as our profitability continues to improve.

Just a few more comments on our total year guidance.

While 2nd quarter CAT losses were definitely on the high side for us as well as the industry, our CAT losses for the first six months were fairly close to what we consider to be our normal CAT load for the first half of the year and we do provide you with enough CAT history in the financial supplement to determine our experience.

So looking at the last half of the year, assuming expected CAT losses and remembering that we're planning on increasing our advertising expenditures over the last half of the year, we now expect operating income EPS within a range of $3.50 to $3.65 per share compared with our previous guidance of $3.35 to $3.50.

We obviously anticipate the strong underwriting performance will continue and we do expect to see personal lines, policies in 4th growth continue to accelerate as we move towards 2004.

With that, Bob, let's open it up for questions.

Okay, Paula, could you start the Q&A session, please?

Thank you, sir.

If you have a question at this time, please press the 1 key on your touch-tone telephone.

If your question has been answered or if you wish to remove yourself from the queue, please press the pound key.

Again, if you would like to ask a question, please press the number 1 key.

Our first question is from Nancy Benacci from McDonald Investments.

Good morning, congratulations on some very good numbers.

I wanted to ask a question that is specifically stated in the release to clarify a comment.

Ed, you indicated that you expect sequential quarter over quarter increases to continue by the end of the year.

Any reason to think there is a hiccup here as we look into the 3rd quarter considering we've already seen a nice improvement here in the 2nd quarter numbers?

No, Nancy, I don't mean to demean your question.

I wouldn't get into the tea leaf reading exercise.

We like what we got in the second quarter certainly in terms of the results but particularly in terms of PITH growth, I would expect that to continue.

Quite frankly, we got more and we got it sooner than we expected, but I wouldn't overthink those words.

Okay, so your comment was more it's in there but more of what we saw in the 2nd quarter should continue as we look out to rest of the year?

Yes.

A follow-up question, Bob, you gave some detail regarding what the PITH numbers were.

Could you clarify again, if you take out the impact of the tougher states, what we were looking at, I didn't catch all that.

If you exclude California, Texas and Florida, we increased over prior year, over 2nd quarter 2002 by, I think I said, three-tenths of a percent, and on a sequential basis it was up eight-tenths of a percent.

Great, thanks very much.

Thank you, and our next question is from Bill Wilt of Morgan Stanley.

Good morning.

I was wondering if you could, revisiting the prepared remarks, you had mentioned a number of states or quantified in some ways the number of states that had reached rate adequacy, I wondered if you could revisit those remarks?

We didn't actually give the number of states.

Oh okay, I thought you quantified it in someway.

We quantified the number of states that have shown sequential PITH growth not the rate adequacy number and those numbers were roughly 35 in standard auto and 32 in homeowners.

Okay, fair enough, thanks.

The broader question on cross selling, what types if any of the macro trends or catalysts do you look to that would signal an improved ability to achieve cross selling?

I think the current rate of cross selling life and investment products to PC holders is currently fairly low.

Are there any macro trends or catalysts that you see in the near future that could spark that?

There are, but I'd like to redefine your question just a little.

Cross selling is more than just life products to property casualty customers, it's more property casualty customers through existing, it's more property casualty products to existing property casualty customers.

What do I mean by that?

We'd like to have not many, if any, mono line homeowners policies.

Where we have a home owners policy and take the risk and get good returns, we'd also like to have the auto policy with it.

Now, in most states you have to be very careful how you do that but there's two things we're concentrating on at Allstate when we talk about cross line sales and they're both equally important.

One is, more policies in the protection business, more customers that have multiple policies with us because we have better profitabilities on those customers that we already have and those customer that we already know.

Now to your question, it still seems to us that there is great opportunity to broaden our horizons in financial services, we are very disciplined in how we define that.

We're not interested in becoming all things to all people, we simply want to sell adjacent or related products in greater quantities than we have right now.

I don't know that there is anything that is going to happen in the macro marketplace that is going to make that easier to do.

It requires great pick and shovel work, you have to keep at it and just keep working the issues.

A couple of things for you to focus on.

The number of EA's of our independent contractor agents who have gone back to classes and gotten registered to sell more sophisticated products is now up to about 7,300.

So you will recall a few years ago, that number was zero.

That is a very good sign about the willingness of our agents to sell more financial service products.

The recognition on their part that the broader and deeper the relationship we have with the customer, the better off we are.

So, I think we're well positioned here.

As Bob mentioned, it is tough selling financial service products right now.

There are a lot of people who kind of have their money in their pockets or their money in their mattress and they want to wait for real clarity on the direction of both interest rates and equity markets, but the Allstate brand name which serves middle America very, very well, leveraging the relationships that we already have through our roughly 11,000 agents that we have and 1,000 financial specialists, we like our potential to be successful in this area a whole lot.

That is great, thanks for the clarification.

Thank you and our next question is from Jeff Thompson of KBW Incorporated.

Mr. Thompson, you may begin. [ no response ]

Our next question is from Paul Newsome of A. G. Edwards.

Good morning.

I was hoping you could go a little bit further into the life business outlook and if you think perhaps the stronger market has helped it at least turn the corner a little bit from the 1st quarter and completely unrelated, I've heard some comments from some of the trade groups that they are optimistic that there's been fairly broad-based tort reform at the state level and then that should help in general, single liability costs across the insurance land, I'd love to know if you have any thoughts whether or not that there will be some benefit there or not?

I'll start with the second part of your question first, tort reform.

Tort reform comes in many shapes and sizes.

One of the ones that's gotten the most publicity is asbestos legislation, as a party of one, I am not optimistic.

There are just too many wounded parties who are a part of that, I just don't think anything gets done and it's a shame, but I don't think anything gets done.

On the issue of class action reform, which would move class action lawsuits out of state friendly state courts and into federal courts, I'm optimistic about that.

There are 57 or 58 Senators who have publicly said they will support that, the magic number is 60 in order to make sure that you can get a closure vote.

I think because med mal was defeated in Congress and my own view is asbestos legislation does not go anywhere, I think there's a really good chance that class action reform passes and it is a big deal.

If you were to couple that with the Supreme Court decision in the Sullivan case that State Farm got in Utah, I think you could see a leveling of the playing field when it comes to liability actions against, not just insurance companies but against anybody in corporate America.

There has been some real progress made on the state basis, the U.S.

Chamber of Commerce which many of the companies in the U.S. support, had great success last year.

They identified 18 state based races where they wanted to be successful, and if fact they were successful in 17 of them.

These are Supreme Court races, they are Attorney General races, in some cases they're Federal Congressional races.

It's a very good track record and it is really all about leveling the playing field so that when somebody brings a major lawsuit you feel like you can get something other than vigilante justice in the court system, so I'm pretty encouraged on the overall issue of tort reform.

A lot of work has to yet get done.

We've gotten close before and not grabbed the brass ring but I like where we are on this issue right now.

The first part of your question on life, I guess the performance of the equity markets in the 2nd quarter may give us all collectively some reason to be encouraged about the prospects but I think on balance, the American consumer, remember we just sell policies one at a time to individuals, I think the American consumers are so burned by their 401(k) performance over the last two or three years that it will take more than one quarter to get out in the marketplace.

I think the American consumer gets mixed signals on interest rates.

On the one hand, you have Alan Greenspan saying I'm going to keep rates low for a long time and on the other hand you have 1, 5, 10 and 30-year rates backing up a little, so there's mixed signals.

And I think there is the issue of very large levels of unemployment in the country depending upon what stats you look at.

The highest we've seen in five, 10 years.

I think people are going to remain relatively cautious in terms of what they buy.

So, I think you have to be an optimist to be in business in general and I am an optimist and I think things will move, I just think they will move and confidence will come back at a little bit slower rate.

I am pleased by the 2nd quarter moving the equity markets but I think it takes a little more than that in order to insight the American consumer to get back into the marketplace.

Thank you.

Thank you and our next question is from David Havens from UBS.

Good morning, underwriting results look fantastic, you know, ex catastrophes.

I am just wondering whether you are beginning, whether results at Allstate and, you know, results are out for Progressive, also yesterday, whether they may almost be getting too good in terms of when you'd begin to approach the regulators looking for help here or there in terms of rates, what are you beginning to hear from the regulators?

Let me respond to your question, David, I would say that results are really good even with catastrophe.

When you exclude the catastrophes, they are more than just good.

You know, we aren't getting much regulatory push back, let me give you a couple of comments.

Homeowners' rate increases, that's a different game with the regulators than is auto.

As you know, in most states auto insurance is a required product so anything that's mandated regulators can tend to look at with a more rigorous eye than they do with things that are not regulated.

Of course, the reality is that every time you go to buy a home you have to have a homeowner's policy so it's regulated or required by the market, if you will, as opposed to required by a regulator.

The key to your question is having gotten to the point where we are rate adequate and we like the margins we have right now, so as we look forward, standard auto rate increases are probably in the 3 to 4% range, nonstandard in the same range and homeowners probably in the same range, so we don't need much in order to continue to expand or maintain the margins that we have.

Companies that acted more slowly, that still have major rate increases to go before the regulators, I think may have a more difficult issue to face.

The regulatory environment feels about the same to me as it has in the past, there's no pickup in regulatory scrutiny.

There are always states where we have difficult times and always states where the marketplace is much more receptive.

I don't see anything different in the regulatory environment right now or in the immediate future which would change the performance that we've been able to achieve.

Okay, thanks for that.

Our next question, Brian Meredith from Banc of America.

Two quick questions for you.

The first one, could you talk a little about the competitive landscape right now out there in the standard auto market and then a follow-on to the last question are we seeing State Farm come back in, any impact from AIG deciding to write business in New Jersey and then one quick follow-up.

Competitive marketplace, Brian, probably about the same as it's been in a while.

There may be one or two, maybe three companies that seem to be leading the parade in terms of a much more sophisticated use of technology, we call it strategic risk management and those companies seem to be doing very very well from an underwriting income or combined ratio standpoint.

The larger companies have the resources, the technology, the brands and the distribution capacity to be able to benefit from that so I do think there is a separating of the industry in those that have and can get more and those that may fall behind.

I don't see an uptick in competitive pressure to grow, I don't see people going out there to buy market share.

I think many companies got badly burned in the '99/2000 time frame with rate reductions and I don't see us going back to that time frame.

I think there's much more discipline in the industry and I'm encouraged to see it.

You know, New Jersey and AIG, I think with State Farm continuing to pull out of New Jersey, there are players who will recognize and maybe there is some opportunity, so AIG, as you know, has been in New Jersey for a while they kind of put a strangle hold on the regulators and threatened to exit if they didn't get some concessions, I don't know the extent of the concessions that they achieved but our profitability and our performance in New Jersey is a thing of beauty.

We have for the last four or five years generated very, very strong combined ratios.

Our agents have done a terrific job.

As you know, we set up a separate company in New Jersey with a dedicated amount of capital.

Our folks all understand that that's their capital to use,and that's it, and boy, they have responded to the challenge, so we like our position in New Jersey.

We have a good ongoing relationship with the regulators there.

Don't expect that either AIG or anybody else who choose to stay or get in the state is going to change that in any major way.

Great.

Next question, with respect to guidance, maybe a little clarification here, understanding, if I look at your guidance right now, it appears that assuming kind of catastrophe loss activity that's pretty consistent in the second half of the year, you're expecting underlying deterioration of almost two to three points.

I understand the advertising expense coming through but is there something else I'm missing?

No, be careful with the annualization game and I know you're doing more than that but at the current guidance that we just gave, $3.50 to $3.65, we're really comfortable right there.

We talk about normal catastrophes, but normal catastrophes has a pretty wide range on it.

It can swing by 15 or20 or 25 cents.

As we sit in the middle of July, still the early part of the hurricane season, we haven't gotten to the really heavy duty part in August and September, that is the right guidance for us to give.

So, I guess what you're saying is you're taking a conservative outlook at catastrophe losses for the second half of the year?

Yes.

Thank you, and our next question is from Ron Frank of Salomon Smith Barney.

Perfect timing because my first question relates directly to Brian's.

Maybe Bob can help with this.

In looking at your claims trends for the Allstate brand domestic, on page 17 of your supplement, it looks like --although obviously you've been experiencing good claims trends for some time, some looked better than good in the quarter.

For example, you saw your first absolute decline in BI severity in recent memory and I was just wondering if you might be viewing those as a little bit better than good and if that might not be part of what's behind the conservatism that Brian alluded to in the guidance and I have a follow-up on Allstate Financial, but maybe we can hit that first?

This is Bob.

You may be over thinking it.

When you look at the -- the trend has been fairly consistent and there's obviously some volatility around the overall long-term trend.

Frequencies continue to behave very nicely in auto and homeowners.

The BI pace severity drop of 1.9% in the quarter follows four quarters or five quarters of increases of 1% or less, so it's been pretty close.

I don't think it's a material change in trend, and I don't think it affected the way we looked at the second half of the year

I wasn't really suggesting that was a C change, but maybe more an implication of the guidances that we might not be extrapolating those specific numbers through the end of the year.

You're over thinking it.

The way I answered Brian's question is correct view.

You're in the middle of a very heavy CAT season, typically you just don't know what is going to happen.

We like our run rates a lot, we like the ability to continue to grow top line, continue to maintain and expand our margins.

I wouldn't read too much into it.

Okay, fair enough.

On Allstate Financial, I was wondering if you could give us a little more color on the mortality and investment margins that you referred to and the pressure there?

Are we specifically talking about spread compression in fixed annuities and in particular, could you give us a feel for what new business is being written in terms of spreads over minimum rates?

Larry?

This is Larry.

Regarding your investment spreads, part of when we talk about investment spreads or investment margin, we also include in there interest earnings on the capital account.

Our investment spreads are holding up.

As we indicated in our press release, our spreads over our guarantees, our spreads are holding up our credit rates over our guarantees are still 100 basis points, so we still have movement there.

Also included in our investment margin is earnings on the capital account.

Unlike in the property casualty area where EMA was up, partnership income for the quarter and Allstate Financial was down 8 million, so -- and, also, investment rollovers on the capital account also decreased investment income, so that had an impact on the investment margin.

As far as mortality margins, clearly, the GMDB on variable annuities and the hedging losses, whenever the market goes up you have hedging losses, so that's an issue there and that's partially offset by how the DAC runs through.

As far as margins on new business that you mentioned, as Ed mentioned, we've made dramatic changes in our new products.

We've dramatically lowered our interest guarantees on new products.

We think we've been at the forefront in the industry.

What we're seeing with the latest uptick in the interest rates is the profitability of our business is getting very close to what we want to see and we're very optimistic on what we're doing.

We're also cutting commissions, we have also withdrawn products that weren't profitable, so we're being extremely proactive in making sure that we can grow operating income in Allstate Financial the future.

Larry, is the profitability on the new fixed business close to the portfolio rate at this point?

Portfolio rate I would say is that the returns on the portfolio were slightly higher than with the returns we have on the new business with all the new changes that we have been making.

Thanks.

Thank you.

Next question is from Robert Glasspiegel of Langen McAlenney.

Good morning.

Ed, I was wondering if you could you give us your initial thoughts on the dividend.

I appreciate Dan's balancing of all the issues which are clear.

My math says to get to a 3% plus yield would be about 22 cent increase in the dividend or $150 million, which is not a large amount of money.

I'm sure you guys have seen how stocks have acted towards dividend increases and clearly you know it's more tax sufficient, as you're saying.

How long is the study going to take and was there any reason you threw out the 11% annual increase rate as a sort of base rate we should be thinking about?

I'm just trying to read the body language of what Dan was saying.

A tea leaf question.

Let me see if I can help you with it.

My view on the situation is exactly the same as Dan's.

We spent a lot of time talking and thinking about it.

Don't over read the 11%.

There are people on the conference call who really do not know our history.

You know us well, you've invested a lot of time getting to know us as a management team.

Not everyone understands where we are from a dividend pay out, so that's all we were trying to do.

It's not that we are slow to pull the trigger.

As Dan mentioned, we like our growth prospects a lot right now, we like them a lot.

Anytime you add substantial top line to rate increases as we've done on homeowners, that requires capital in order to be able to do it.

We're encouraged in terms of PITH growth.

That requires capital, I wouldn't over think it.

We have a fairly disciplined approach on how to do this, we will talk to the Board about it and we'll make the right decision at the right time.

The take away from Dan's comments are we know how to do this, we've returned a lot of money to our shareholders in the form of share repurchases, we have no history of sitting on capital when we can use it, we do understand the value of dividends, something that many other companies are just waking up to and we are amazed by that.

We already are an industry leader in terms of what we do in share repurchases and dividends so, Bob, I wouldn't overthink it.

Take from my comments and Dan's, we like our growth prospects a whole lot.

We're evaluating it.

It is not clear, some companies have had really good success with dividend increases from stock price appreciation and some have had pretty lousy success because the market has totally misinterpreted what their growth prospects were so we're trying to evaluate all that.

Okay, just an unrelated financial services question, the mortality expenses have been rising sort of as the-- in the money death benefit numbers going up.

And this quarter, it rose again because of the cost of the hedge, directionally, I assume maybe it's a lag that is your average in the money death benefit, you know didn't go down in the quarter but if we keep the market going up, that mortality expense should begin to decline, I guess, what scenario would be favorable for mortality going forward?

Clearly the scenario that is favorable is having the markets continue to rise.

Our in the money death benefit right now is 3.3 billion, that is about 26% less than what it was at its peak in the 3rd quarter.

If you want to look for a run rate on our claims, if you take the 3.3 billion times an average death rate on our annual annuity customers of 1.8%, that gives you 60 million per year divided by four or 15 million per quarter so that gives you an idea of the magnitude of the issue there and of course, we're hedging that 100% in all new business beginning at the beginning of the year

Could you give me some help on the cost of the hedge, how much is it with every one percent change in the market is how much per year?

We don't have that detail that we disclose.

But in general, if the market stayed flat, it should go from 26 to 15?

It should continue going down, 3.3 in the money, right

I was talking about the mortality chart should go down from the 26 in the quarter to --

Yes.

Okay, thank you.

Thanks, Bob.

Thank you.

Our final question is from Adam Klauber from Cochran Caronia.

Good morning.

Could you talk about the sequential roll-out in Texas and California now that you're looking to grow, how long does it take to get those states up and running and when will we be able to see an incremental effect within the PITH growth?

You know, we have some wonderful agents around the country, we have got, I don't remember the exact number, 1,700 agents who are very hungry to grow in the auto business in California.

We should begin to see positive effects of that obviously in the second half of this year and we factored that into some of our comments about continued PITH growth that would be even more evident in the 3rd and 4th quarter, so the ramp up time is not that great.

It's not like you have to add agents or you have to add technology.

You simply have to make certain that the agents understand what the new rating plan is and believe me they do.

You know, Texas, just for clarification, the Texas Legislature came out in pretty good shape in terms of insurance but you have to file your current rates, homeowners rates in Texas and get approval and then you can move forward, you can get to more of a use and file kind of methodology.

We expect that process to go quite smoothly, we would like to be one of the first companies to review, not necessarily one of the last.

So, we're very encouraged by the very reasonable solution that came out of Texas.

We're not fans of giving you numbers that exclude California, Texas, and Florida.

It simply is a way to get you to appreciate the underlying run rate in PITH that we already see.

We like where we are in California right now in terms of a new rating plan.

I think Texas is probably in a very stable position and therefore it should begin to grow and be factored into our comments about third and 4th quarter PITH growth and in Florida there is some signs of life there to that leads us to be encouraged, so we like where we are.

Adam.

Thank you very much.

I think we're going to turn it back over to Ed.

Paula, are you there?

Yes, sir.

Let me just conclude.

We do want to finish by 9 a.m. so that you can get onto other places.

Let me summarize by saying it really was another great quarter with a really excellent underwriting performance and clear evidence of a return to unit growth in our core Allstate brand lines and I think that return came a little bit earlier than what we expected.

We continued to focus on a disciplined approach to profitable growth, we're monitoring the quality of our new business and continuously reviewing our rate needs.

We are investing in initiatives designed to generate more profitable growth in both protection and financial services.

We're very confident in our ability to execute on our strategies and I think. as I said earlier. the results for this quarter continue to validate those strategies.

Things really can get better for Allstate, we are on a very good trajectory.

Thank you all for your time.

Ladies and gentlemen, this concludes today's conference, thank you for your participation, you may disconnect at this time and have a great day.