Allstate Corp (ALL) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2005 earnings conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Robert Block.

Mr. Block, you may begin.

Thank you and good morning, everyone.

Thanks for joining us for our second-quarter 2005 earnings conference call.

This morning Ed Liddy, Dan Hale, and by telephone, Tom Wilson, will add some color on our results, and then we'll go to a question-and-answer session.

As always, we would appreciate it if you could keep to one question and one follow-up when your turn comes up.

That allows us to get as much participation as possible.

We expect to complete this call within an hour.

As has become our practice, we issued our earnings release and the majority of our investor supplement last night.

If you need a copy, is available on our website under investor relations.

The following discussions 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" section in our most recent 10-K, as well as yesterday's press release.

In this call we will discuss some non-GAAP measures for which you'll find reconciliations in our press releases, earnings press releases and in our quarterly investor supplement, which again is available on our website under investor relations.

This call is being recorded and 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.

A replay will be available following the conclusion of this call.

All of our remarks are current only as of this date and time of the call.

Now we will begin our discussion of the quarter's results with Ed Liddy.

Ed?

Good morning, everyone.

As always, thanks for joining us.

I'm going to keep my remarks to a minimum this morning for a couple of reasons.

First, we worked very hard at providing the investment community, all of our constituents, with a transparent look at our financial results through increased disclosure.

There's a lot in our press release and the supplements.

We encourage you all to read it.

And the second, this quarter's results once again reflect the excellent execution of our long-term strategy and are very comparable to trends we've experienced in the first quarter and also over the last couple of years.

Now before I go any further, as Bob mentioned, Tom Wilson is joining us today by phone and will be a regular on all future calls.

As I think you all know, Tom was recently promoted to President and Chief Operating Officer of the Company.

He now has assumed responsibility for both Allstate Protection and Allstate Financial.

And he will do the same fine job in his new role that he's done in his previous roles over the past 10 plus years at Allstate.

Let's briefly get into some details.

The marketplace remains competitive, but in a disciplined way.

Pricing for auto insurance remains somewhat soft, but shows no signs of major price cutting by competitors to gain share.

I thinking most of you probably saw that during the quarter the overall market leader has begun to adopt a tiered pricing approach to the market.

We believe this is a natural competitive response and one that should help maintain the level of rational behavior in the marketplace.

Lost cost trends for both auto and property insurance remain very manageable.

And obviously, as you saw, this was a great quarter weather-wise.

I would characterize our results as more of the same very high-quality performance.

We continue to post excellent results as we aim to grow profitably while maintaining capital discipline.

Just a few highlights to make sure that we are all looking at the same numbers.

Our revenues increased 5.9%.

Our net income, at 1,149,000,000, grew just over 11%.

Our operating EPS at $1.66 was up 12.9%.

Our book value per diluted share jumped to $33.48.

That's an increase of 6.4% from quarter one 2005 and 13.3 versus the second quarter of last year.

Our operating income, return on equity improved from the first quarter of this year and now sits at 17.3.

And I would remind you all that this result still includes the hurricane losses from the third quarter of last year.

We calculate our ROEs on a trailing basis.

Looking at Allstate Protection where our efforts to proactively manage exposure to catastrophic events became evident in the results, a few highlights.

The overall top line remained stable from the first quarter with an increase of around 4% and stronger in Allstate brand standard auto and homeowners.

While our new business net premiums written declined for auto and homeowners on the country-wide basis, we experienced an increase in new business net written premiums written for both lines in the majority of states in which we compete.

Our unit growth remains on pace to take market share.

Our retention ratio trends remain essentially unchanged at historically very high levels.

We continue to appoint new Allstate exclusive agencies, now reaching almost 12,000 in the US at the end of June, and those agencies are creating new capacity by expanding the number of licensed support staff within their agencies.

With respect to the bottom line, the results reflect exceptional profitability led by consistent underlying profit margins and favorable catastrophe experience.

Like industry trends, but I think at levels better than the industry, our loss cost trends for Allstate remain relatively benign, continuing below our increase in average earned premium.

Our expenses remained slightly ahead of prior year, including increased marketing costs.

And relative to investment income, cash flows again are strong, helping to offset the negative effects of a decline in yield, while also supporting our very aggressive share repurchase activity.

With respect to Allstate Financial, the second quarter demonstrated some progress in our strategy to improve returns over time.

The operating income grew just under 9% to 137 million versus the same quarter last year.

And new sales of financial products to our Allstate exclusive agencies increased by 14% over the second quarter of 2004.

Our total premiums and deposits declined slightly in the quarter as short-term interest rate trends have clearly impacted the consumer desirability of fixed annuities relative to certificates of deposit and other savings vehicles.

You know, I'm very pleased with our overall performance thus far in 2005.

We're on track for another great year as we continue to execute on our strategy.

And I will have Dan fill in a little bit more details, and then we will come back for Q&A.

Thanks Ed.

Results for the second quarter and the first half of 2005 clearly reflected our continuing emphasis on profitable growth as a result of our pricing and underwriting discipline, our enterprise risk management processes, and our capital management actions.

At the top line we grew net written premium at a rate of 3.7%, up to about $7 billion for the Property-Liability business.

The growth rate was affected by declines in new business in certain states due to competitive pressures, and importantly due to catastrophe management actions.

However, after adjusting for reinsurance costs including the reinsurance for the 95,000 Allstate Floridian policies transferred to Universal Insurance Company of North America, after that our adjusted net written premium growth rate was 4.5%, which represents a slight improvement over the comparably adjusted first-quarter growth rate.

And we continue to generate solid growth in our core lines.

Allstate brand standard auto net written premium grew at a 5.3% rate with PIF growth -- policies in force growth -- of 4.2% at a 90.8% retention ratio, while Allstate brand homeowners premium increased 8.1% on 5.4% PIF growth at an 88.3% retention ratio.

We completed the reinsurance arrangements described during our first-quarter conference call for the states of Florida, Texas, New York, New Jersey, Connecticut and North and South Carolina at an aggregate annualized cost of $190 million.

And as mentioned in our press release, we're continuing to consider other risk management actions, including the expanded use of alternative markets and the acquisition of additional reinsurance where costs are justified by the related P&L reductions.

The overall objective is to first ensure that we get properly rewarded for the capital required to support the risks that we assume in every product line and state and then to cost effectively manage risk in order to moderate earnings volatility and continue to generate high-quality, sustainable returns.

For those of you who have been following the legislative activities in Florida, you're aware that we did not get all of the changes we were requesting in the structure and terms of the Florida Hurricane Catastrophe Fund.

However, there were modifications that will benefit insurers and our customers going forward.

As an example, with the changes to the fund, coupled with our actions to reduce our exposure to hurricanes in Florida, our 2004 losses would have been about one-third less than what we actually incurred assuming those changes and actions had been in place.

This year our expected retention for qualifying personal property losses for the two largest hurricanes will be 233 million each, and then it will drop to 78 million for other storms. last year our retention was 312 million per storm.

As you know, Hurricane Dennis was a-third quarter event which based on early industry Cat model projections is expected to result in insured losses somewhere between 1 to $3 billion.

By comparison, hurricane Ivan, which hit just about the same area, generated insured losses of about $7 billion last year.

We will know more about the specific impact of Dennis in the coming weeks and we will disclose those results as and when appropriate.

Our combined ratio was 85.2% for the quarter, and that includes a $120 million accrual for an anticipated litigation settlement and 43 million for an expected assessment from Florida's Citizens Property Insurance Corporation, the entity, as you know, created by Florida to provide insurance to property owners unable to obtain coverage in the private market.

This assessment will be billed and partially recouped from policyholders in the future.

However, for GAAP accounting purposes the receivable cannot be recorded until premiums are billed.

But back to our combined ratio, the 85.2% is our lowest quarterly combined ratio since becoming a public company 11 years ago.

Obviously we had unusually light CATs for a second quarter.

However, after excluding CATs, along with our litigation accrual and after adjusting for favorable reserve reestimates, that ratio drops to 82.6%, which represents all 1.4 point improvement over our first-quarter run rate.

That combined ratio run rate is also the lowest, the best combined ratio run rate in at least the last 11 years.

While favorable frequency trends have moderated somewhat, both auto and homeowners frequencies are still below prior-year levels, and severity trends continue to be consistent with the modest increases of the past few years.

These facts are certainly clear evidence that our strategies are working well.

Overall loss costs are well contained, while our policies in force continue to grow at historically high levels, reaching a record high PIF count at the end of June.

Our top priority is still profitable growth as we continue to focus on maintaining margins and improving returns.

At the same time, we're continuing to aggressively pursue a disciplined approach to capital management.

During the quarter we repurchased 14 million of our stock, 14 million shares of our stock at a cost of $796 million or $57 per share.

We have now completed about 38% of our current $4 billion program over the past six months.

Turning now from capital management to a couple of balance sheet ratios, our net income ROE including unrealized gains was 16.1%, up from the 15% last year end.

And that 16.1% is calculated on a trailing 12-month basis, including the impact of the four hurricanes in last year's third quarter.

Our operating income ROE excluding unrealized gains and again on a trailing 12-month basis was 17.3%.

And our debt to total capitalization ratio was 18.9%.

Our book value per diluted share at the end of June was $33.48, up 13.3% compared with June of '04.

Excluding unrealized gains and fixed income securities, our book value increased 6.2% over the past six months and 9.6% over the past year.

Finally, with respect earnings guidance, we're now expecting operating income per diluted share for the year assuming the level of average expected CATs used in pricing for the remainder of the year we're expecting it to be in the range of $6 to $6.40 compared with the previously announced range of 5.40 to 5.80.

Now, Bob, I think we're ready for questions.

Operator, if you could start the Q&A session, please?

(OPERATOR INSTRUCTIONS) Tom Cholnoky, Goldman Sachs.

Ed, time to go to the gym and work on the vertical leap.

I won't bother you on that one.

But I guess two unrelated questions, if I can.

Number one, what are you currently building into your pricing assumptions with respect to loss costs?

Are you still kind of -- are you building in an upward trend in loss costs?

Are you building flat?

What are you doing there?

It's not the easiest question to respond to, because as you know different states require that you do it different ways.

But, whenever we look forward to loss costs we clearly include some of our recent history, and then a little bit of what we're projecting.

We do not bake in all of the good news that we're currently enjoying.

Okay, so in other words, net-net would you -- are you still assuming, though, that you're going to get some uptick in loss costs trends?

No we're not.

You mean in our pricing?

Yes, as you look forward.

Yes, we would probably be -- we are assuming that you would have some modest uptick in it.

Okay.

And then I guess second, could you just respond to what is going on with investment income?

You're moving, it looks like, more into taxables, because your tax rate on investment income seemed to jump up from the first quarter.

And what kind of tax rate should we be thinking about in terms of investment income on a go-forward basis?

The most important dynamic to focus on with investment income is our using much of the cash that we generate to repurchase shares.

So we have less available to us to put to work and offset the lower yields.

I think if you look at the year-to-date tax rate, I don't have any reason to believe that the year-to-date tax rate wouldn't be reflective of what we expect to occur over the balance of the year.

I have to tell you, I haven't concentrated on that in the second quarter, but I'm not aware of any reason why it would be -- the first-half result would be any different.

As you may recall, we said that we were reducing the duration in our AIC portfolio, which is mainly tax-exempt securities.

And that is down from a duration in the 5 plus range, down to about 4.5.

So from a total portfolio perspective you're seeing a little different weighting that what we had before.

Okay, but we should probably think about the year-to-date tax rate as a reasonable kind of run rate?

Right.

Yes.

I'll come back them.

Thanks.

Bill Wilt, Morgan Stanley.

Good morning.

The reserve release from Allstate Protection this quarter was quite a bit less than it had been last year.

Is there -- does not offer any insights into the operating trends, frequency or severity trends, that you could share?

There's no real insight from that.

Quarter-to-quarter we look at where we are from a frequency-severity point of view versus what was assumed in prior periods in the reserves.

Last year was a larger release than the first or second quarter this year, but again it depends quarter-to-quarter what the trends are telling us and how comfortable we feel that we really understand what the trends are saying about the future.

So again, last year there was a more significant change.

This year they have been a little bit more moderate.

Thanks for that.

Part two, are there any major investments on the horizon that you could talk about, investments in technology, in claims?

Recognizing there are probably many things going on at any given time, are there any particularly notable projects on the horizon?

I'll comment, and then I'll ask Tom if he's got a better or broader perspective.

We're investing heavily in our Company right now.

We're generating really great returns.

We can see the ability to grow at rates faster than the market.

And we think it's a great time to invest in the Company.

And you see that in our expense ratio, and to a lesser extent in our claims ratio.

So the investments in Your Choice Auto, which we think is going to work very, very well for us in the back half of the year and on into 2006, that requires some people to launch a product like that, develop a product like that.

We have talked from time to time about the Next Claims activity, Next Claims System (ph), next generation as we refer to it.

That's an important initiative in terms of driving up our customer loyalty and our retention rates.

Those are already in the our numbers, and we would expect to continue to spend on those.

Developing the next version of SRM, be it SRM for auto or SRM for homeowners.

We're working on those kinds of initiatives on a very regular basis.

They are in our expense ratio and will continue to be in our expense ratio because they pay off big time the balance of this year into '06 and '07.

Tom, I don't know if there's other things you want to throw in there.

I think I would just mention that Next Gen (ph), which is our new claims system, what we're trying to do there is reengineer the entire process of settling claims, particularly focused on property and physical damage claims, whereas about ten years ago we went through core claim process redesign which was focused on bodily injury.

We're focused on doing the same thing this time in physical damage claims and in property claims.

The only other system investment that is large and will have large impact on the Company is our sales system, so the actual system that the 30,000 Allstate branded exclusive salespeople use.

We're making it much more simple.

We're moving off green screens into Windows-based so it's really point and click.

And that should improve the efficiency of the people in those sales offices, which should enable them to do a better job selling, building relationships, and hopefully quoting more business.

That's helpful.

Thank you very much.

Al Copersino, Columbia Management.

I don't want to overstate this point.

You cited the market share leader will begin tiering, and obviously it would take them several years to catch up where Allstate is even today.

My question is this, though -- I guess several analysts, several commentators, have stated this as a positive effect, that State Farm will be doing this.

But I guess I'm confused by that.

I would think that the success in of tiering depends on large part on the mispricing by other players.

Sort of like stock picking, you need some of your competitors to under or over value certain customers.

So excluding the fact that it will take other companies years to catch up with where Allstate and a couple of others are, isn't in a negative that this could actually make it more difficult to find mispriced customers?

A couple of points.

First, remember the structure of the marketplace here -- 1200 companies selling products in the automobile and homeowners rate.

The top 5 companies have 45 or 46% market share.

They're the ones that have moved to tiered pricing, maybe the top 5 or top 10.

There's a lot of market share out there in the hands of smaller players, regional players, that do not have the capacity to move into tiered pricing the way we have.

So concentrating just on one I think probably is not appropriate.

Second thing I would say is when State Farm goes to tiered pricing, I believe the largest impact would be that they won't do things with such a wide swath as they have done in the past.

So when you have only three buckets -- good, better and best -- and you want to be more competitive, you rates down and it can result in some irrational and illogical reactions.

When you do it on a tiered pricing basis, I think what it does is it has the potential to maintain the rationality in the marketplace, and in fact to increase the returns in the industry.

The third thing I would say is you really have to get behind their definition and their strategy with tiered pricing and compare it to ours.

I believe that we and Progressive clearly have the best strategy and the best tactics with respect to, as we call it, strategic risk management or tiered pricing.

And it will take a very long time for anybody to catch up with us.

I'm not sure that they ever will.

I would remind you we started on tiered pricing in 1999, 2000.

We're into our SRM IV on auto and SRM III on homeowners.

It's a constant learning process.

It is more than just a black box.

It's getting your whole selling activity, pricing, underwriting, risk assessment activities all pointing in the same direction.

I just don't see how someone starting this late in the game is going to have a negative impact on us.

I think, and I think those analysts that you referenced, I think they have it right.

I think to the extent it makes the largest player a more rational player, that is good news for the industry and good news for us.

That's helpful, Ed.

Thanks a lot.

Greg Peters, Raymond James.

Good morning, everyone.

I suppose I would like to take my first question and have you he talk a little bit about the results of Encompass and Deerbrook.

I was a little bit surprised, first, by the lack of growth.

Actually, I think it looks like premiums shrunk a little bit on the auto line.

And secondly, it looks like the nonstandard Deerbrook, the combined ratio popped above 100.

I thought maybe you could -- that would be my first area of questioning.

Our focus, Greg, as you know, is on profitable growth.

And if you look at the improvement in combined ratios in Encompass including Dearborn, it's really been phenomenal over the last couple of years.

And that will continue to the our focus.

Doug Went (ph) and the people managing that, we are focused on growing that business, but we're going to do it the right way at the right pace.

I would not read much, if anything, into the Deerbrook numbers.

They're very small numbers.

I would concentrate more on the bigger enchilada, which in this case is the Encompass numbers.

We like the prospect for profitable growth in the independent agency channel.

We're not going to abandon that as a focus.

And I think as the back end of this year unfolds and into 2006 you will begin to see some good top line growth, top line unit growth, which is what we want.

We've laid the foundation.

Encompass is now using the same claims system, the same underwriting system, the same tiered pricing.

So we think we're poised for growth.

Okay.

Fair enough.

The other item I was hoping to get some color on, in your statistical supplement you talk about the new issued applications, and I think you referenced it in your press relates.

And after last year where you had some substantial growth in new issued applications, it's been down or trending negative the last couple of quarters.

And I was hoping just for clarification on exactly what that number represents, how it's calculated, and what it means when it's like in the standard auto brand down 8.2% in the second quarter.

Bob, you want to --?

That statistic, they are new applications issued by Allstate.

So it's new business coming to Allstate.

It will represent the quarter-over-quarter change.

That's what the down 8.2%.

The reason, as we stated earlier, is a couple of things in auto.

It's increased competition, new entrants into Jersey.

In New Jersey we had enjoyed a very nice competitive run there.

A few companies have come in and have priced the market at the rates that we don't think are necessarily the right ones.

So we've really cut back on our new business there.

And also the new business in Florida auto has been down relative to where it was last year, primarily because of the cut back in homeowners.

Is, Bob, the new issued applications, that's a different number then what actually is closed on in any given quarter, correct?

No, that's actually closed.

That's actually closed?

Closed new business written, yes.

Thank you very much for the clarification.

Ron Frank, Smith Barney.

A few things, if I could.

First of all, given your comments about the relative disadvantage of the fragmented part of the market, do you think that's going to accelerate consolidation at some point?

Because if I were running a small company in this business, and I listen to your remarks and believed you, I would lean toward probably selling out to capture the value of my franchise before you came and sort of ate my lunch for me.

And so I'm wondering if you expected -- if a logical extension of your theory is an increase in outright acquisitions of some of these companies by you or other large players.

I think to the answer to that is probably not.

Remember the corollary statistic is at about something like 65% of the revenue in this industry is in the hands of mutual companies who are not subject to or amenable to any kind of acquisition.

So I think what happens is business moves one policyholder at a time as opposed to what happened in the banking industry where the little companies got gobbled up by the larger companies and then the larger companies got gobbled up by still even larger companies.

I don't think that dynamic is or will be in play in our industry.

Second question is for Tom, if I could.

Tom, we spoke a while ago about the market research that led you to introduce the Choice product.

And I was wondering now that it is getting rolled out in more states if you can give us any early feel for whether the reception you are actually encountering is matching the expectations that your market research said.

And then I have a brief data question.

The answer is yes, it is matching our research.

We think the product is well-designed and is getting good reception in the marketplace.

That research said a couple of things.

It said some people only want to buy on price.

It said some people really want to buy features and want to have a conversation about it.

As we go into the marketplace we're finding that true.

We're also finding that the number of people who buy up and want features is more than the number of people who buy down.

So on the new business our average premium in our Your Choice Auto space is up.

We have also found that the relationship and the sales conversation is much stronger, which helps us from being subject to what I would call small fluctuations in the 5 to 7% range in terms of people making competitive moves.

If people feel like they had choice in the conversation, they are not likely to switch for 25 or $50.

And then what we have not been able to determine yet, Ron, is what it does to retention.

Our belief is that it should also drive retention higher, which of course is worth huge amounts of money.

Tom, you may have just partially answered my data question, which is I was curious to see that the average written premium for standard auto written actually expanded in terms of the year-over-year gain in that from March to June quarter.

And it wouldn't seem attributable to price as nearly as I can tell and based on your market comments.

I'm referring specifically to the move in gross written from 1.3 year-over-year in March to 1.6 in June quarter for standard auto.

I was wondering if beyond the comments you just made on Choice -- my guess is it is a little early for that to be having that big an effect -- if there were other mix or other factors that maybe driving that.

It would be too early for Your Choice Auto, because remember most of it is new business.

We're doing some endorsements, but that's a relatively small portion of the overall revenue stream.

So the one -- it's probably just a mix thing.

I can't give you a specific answer on the 3/10 of a point difference from quarter-to-quarter.

But I suspect it's just a mix item.

I agree with that.

I'm not aware of anything that's rattling around those numbers that we could reference that would have an impact.

I just threw it in because I figured you were missing the frequency and severity question.

Ron, is that going to be 0.4?

No, I'm done.

Thanks.

Jay Gelb, Lehman Brothers.

Thanks and good morning.

I had a question on the tiered pricing.

Is there any way to quantify so far how much of a lift you've gotten in PIF growth or improvement in the underwriting results based on the implementation of tiered pricing?

We spent some time attempting to do that.

I would encourage you to look at it holistically because it is both PIF growth and perhaps even more importantly the impact on loss costs that tiered pricing is so important to us.

So we're deeply into it.

We think it is a real competitive advantage.

It helps us on the top line, but it helps us even more in the combined ratio and the loss costs.

So we don't have a good, simple way to quantify what its impact is.

But the improvement you think is coming on both sides?

It clearly is coming on both sides.

And it has been coming on both sides for the better part of three or four years.

Okay, great.

And then separately, on the life piece, can you talk a little bit more about the implications of the announcement to get out of the manufacturing role of long-term care insurance and what the implications may be for the rest of the business in terms of how you manage the capital base in Allstate Financial?

I would not read too much into it in terms of further implications.

We didn't sell much long-term care insurance and we didn't make much money.

And as we looked at it, we just would prefer to focus our resources on things that have greater potential, both top line and bottom line, but also greater management, better improvement in our rate of return in that Company.

So I would look at it as kind of a one-off decision, more of our desire to concentrate our resources on where we can be more effective.

We want to get the returns on that business.

It is above our cost of capital now.

As you know, we report it on an unlevered basis, but we want to get that return up into that 11, 12, 13% range.

And if we have small products that are diluting our focus and not adding much to our returns or our probability, then they make no sense to continue to sell them.

Great.

Thanks for the answers.

Adam Klauber, Cochran Caronia.

Good morning.

Thank you.

What type of minimum growth rate range would you be comfortable with for 2006?

That's earnings per share growth rate.

(multiple speakers) looking for guidance? (multiple speakers) I'm just not going to go there.

We like where we are.

I would encourage you to continue to focus on profitable growth as our mantra.

We like what we're able to do with our returns right now.

The ROE is driving up.

You have any kind of an average third quarter this year as opposed to the very difficult third quarter we had last year, and you can begin to see ROEs on the 20-plus% range.

We're going to concentrate on growing our business comfortably.

We like the guidance we have for 2005 in the $6 to $6.40 range, and that's as far as we're going to go on that.

Second question -- homeowners continues to be very profitable.

Are there any factors that should change that profitability in the near or longer term?

A couple of thoughts on that.

As Dan mentioned, we have a fair amount of -- a number of activities that we've engaged in to protect, preserve and in fact improve our homeowners profitability.

That's what actions like buying reinsurance in Florida and the Southeast is all about.

It's why we continue to look at reinsurance programs in other parts of the country to perhaps cover other kinds of exposure.

It's why we brought a new company into the state of Florida to take on about 95,000 or so of our more exposed policy risks.

Those things can have a negative impact on the top line, but they really do marvelous things to try to preserve and in fact enhance the homeowners profitability.

Homeowners is not as intensely regulated as auto is.

It is regulated.

But as long as availability and affordability don't become an issue, I don't see the regulatory environment causing us difficulties with respect to homeowners.

And I am reading into your question some aspect of is the regulation okay in homeowners.

We like where we are in homeowners.

We're so much better than the rest of the industry.

That is a lead that we worked hard to get, and we're going to continue to improve it.

Thank you very much.

Alain Karaoglan, Deutsche Bank.

A question on reinsurance program in terms of obviously there's a cost to it in terms of premium, and you have talked a little bit about what you'd like to achieve in terms of the benefits.

But is it quantifiable?

If we're to assume that your average CAT load is 5 points, do you expect that to reduce your CAT load to 4 or 4.5, or to just maintain it at that level given the business mix that you have?

Basically, the reinsurance kind of coverage we're talking about is protection on the tail and tail risk.

So I wouldn't expect the normal kind of CAT activity, if you will -- again, what we saw last year I wouldn't classify as normal -- but the normal kind of CAT activity to be impacted that much.

But as you saw in Florida, not only the coverage by the Florida hurricane Catastrophe Fund, but the reinsurance we're buying on top, we would expect that if you would have sizable hurricanes this year and in the future to have an impact on our loss costs.

So we should still think about a 5 point CAT load, but in case of very big events that's where it is going to (multiple speakers)

Yes, that's a good way to think about it.

In terms of the expense ratio, Ed and Tom, it's around 24%.

It's better than a lot of companies in the industry, but it's not as good as a company like Progressive.

Where do you think that should be five years from now in order to be able to generate the returns and be competitive?

Probably a two-part answer.

I'll give you some insights, and then Tom may have even better ones than I have.

As I mentioned earlier, now is the right time and a good time for us to be investing in our business so that three years, five years, ten years down the road we very much like the way the Company is positioned.

And that's exactly what we're attempting to do.

By beefing up our marketing and our advertising spend, we're able to send different messages, better, enhanced, more integrated messages into the marketplace.

That's going to help us.

It doesn't help you tomorrow, but it clearly begins to seed the idea in the marketplace the Allstate is the place to go.

We are always focused on expenses, but we're more focused right now on making the right set of investments.

Over time that expense ratio will go down.

The expense ratio will go down, the business will get bigger.

We won't have as many new projects that we want to invest in so that we can grow the Company.

But I don't think you should look for the expense ratio to go down by any perceptible amount, certainly not in '05, probably not in '06.

Maybe it is more towards the '07, '08 timeframe.

Now is the time for us to be investing well and widely in a business that's generating 20 or 21% returns on capital or return on equity.

Tom, any color or comments?

Obviously we're in the same place, which is lower is better, because in part you're always trying to generate better value for your customers.

But it is impacted by a couple of different things.

One is the competitive environment in which we operate, and secondly is all the things Ed talked about in terms of what we're trying to do to invest in the business.

If you look at the competitive environment, in '01 we had cut back on marketing due to our profitability issues.

As a result of that Progressive and Geico moved in and began to aggressively market.

We moved back in '03 and we really raised the bar so that the marketing spend required to play in this industry now with a major brand like ours is different than it was four or five years ago.

So if you look Progressive spending on marketing and Geico's, you'll see that that has gone up too. so I think some of it is competitively driven.

In terms of what we're trying to invest in, it's all the stuff you've heard about -- it's great marketing, it's pricing, it's new products, it's the stuff in claims, focus on customer loyalty we haven't talked a lot about, and expanding our distribution and doing all of those things at once is difficult, but it's what we need to do to make sure that we continue on what Dan has talked about, which is profitable growth.

So if we were not to invest in things like Next Gen (ph) today, are expense ratio -- our claim expense ratio would be lower, but we wouldn't have the ability to continue to bring loss costs down in '07 and '08.

So it's about maintaining those margins over sort of a three to four year period.

Thank you very much.

Ian Guterman (ph), Adage Capital.

I just wanted to ask Ron's question on frequency and severity.

Did he call you up and ask you to do that?

No, but I thought he was going to ask this so I'll ask it instead.

The auto physical damage severity picked up the past few quarters.

Can you just talk about what is happening there?

It's moved up a little bit from where it was last year.

Last year it ran very, very low -- low digits.

Nothing really has changed much.

I think if you look at the pattern on property damage severity over time it runs in the 3 to 4% range.

So there really hasn't been much of -- there's no big one thing that you could think about that would move that severity up or down.

Just a quick numbers question.

The $120 million lawsuit in California, can you break that out for us how much of that -- it looked like you hit the loss ratio, but how much of it hit home versus auto versus non-standard etc.?

I think it's really spread amongst all lives, because it's -- the last said about this probably the better off we are.

This is a tentative settlement, not a final settlement.

It is unique to the state of California.

It has to do with worker classification -- are you exempt or nonexempt in the claims area.

And I believe we allocated that pretty much across both auto and homeowners based upon losses.

That's probably as far as we should go right now.

Okay.

Thanks so much.

Bob Glasspiegel, Langen McAlenney.

Good morning.

The life I'd like to dig into.

And I know on page 35 your stat settlement is a step in the right direction to give us more of the world-class disclosure that your property-casualty company gives.

But I still don't fully understand why margins on assets are declining.

I know that's not the right thing to look at, but could you maybe give us some read on what's going on in life and annuity and institutional product spreads?

I don't have that page in front of me.

I'll ask Larry to make a couple of comments.

I will just say it depends on the product you have, Bob, in terms of the margins that you need.

Some products have less capital requirements, depending upon the surrender charge, market value adjustments or equity index annuities and so forth.

As far as investment margins, the investment margin is going up; as a percentage of assets it is going down.

The mortality margin this quarter is down.

We did not have -- we had virtually no deaths on our immediate annuity payments.

So when you have a death you have a reserve released.

So we didn't have any of that.

So that's why the mortality margin was down there.

That was a onetime deal in the quarter.

But just earnings aren't growing in line with assets and premiums across the board.

I assume it's just lower interest rates put some pressure on --

(multiple speakers) classic spread comparison with interest rates, particularly the short rates and long rates are just about at the same point right now.

You would think that would continue, right?

There's no reason to -- if interest rates stay where they are, spreads should continue to narrow a little bit?

Yes.

Two things to hit there, Bob, is the level of interest rates and it's flattening of the yield curve.

Both are going against us.

There's nothing else that we should be thinking of in terms of modeling that's impacting the business?

No, I think you've got it, Bob.

Okay, thank you very much.

Kelly Nash, KeyBank.

The first question I had is do you expect to see a continued negative impact in states such as New Jersey and Florida, particularly in auto?

Or are there certain initiatives that you have in place to drive growth in those areas again?

A state like New Jersey, you may recall our history there.

About six years or so now we made a commitment that we were going to stay in New Jersey and we were going to make it profitable.

We put some of our very best people to work on that initiative.

And it's worked very, very well for us.

We have generated very good combined ratios and good returns.

In fact, New Jersey is set up as a separate capital base for us, so it is Allstate New Jersey.

They've paid a good number of dividends to us since we set them up that way.

As new competitors move into a state like New Jersey, they will be lured into assuming that it's quite a simple state to do business.

There's a good chance that they will under price the product.

As you attempt to establish a claims operation in a fairly difficult state like New Jersey, it at first can look quite easily and then with the passage of time it becomes apparent that it is much more complicated.

I'd go back, Kelly, to profitable growth.

We want to grow in New Jersey.

We want more market share.

But we want that at a profitable level.

I think as some new competitors play in that market it may stymie our growth for a while.

And then you pick it -- 12, 18 months from now it will be apparent that they under priced the product and we will be right back to where we were.

And then Florida, and particularly on the auto side?

Florida probably is a couple of things to focus on.

We're not writing any new homeowners business through Allstate on Allstate paper.

Our agencies do broker and are able to write homeowners business that way.

That probably has impacted our auto growth rate.

I suspect that may last a while.

But we will do things particularly on the pricing side with strategic risk management to make ourselves just as competitive as we can in the state of Florida on our auto products or policies.

Last question.

Could you just provide a little perspective on what you believe in terms of resolving the asbestos situation?

Obviously there's some legislative initiatives.

I just wonder if you could provide a little bit more color there.

I'm been fairly consistent on this.

We think a federal resolution to asbestos is absolutely the right thing to do, not just for the insurance industry, but for business in general, but more importantly for the American public.

It's really been a drain on resources.

I think it is a priority for the administration, although I'm not sure where it falls relative to things like Supreme Court appointees, tackling Social Security and/or Iraq.

So I don't know that it can be pushed to the top of the list.

It is a very complicated issue.

The trust fund that Spector has proposed we think does not work.

A trust fund properly specified and well allocated and with no leakage would be very acceptable to us and to the industry.

This trust fund is not that.

So I just don't know that there's enough political impetus to fix what's wrong with this current trust fund.

If there is not, I just don't know that there's enough energy to go back and start redesigning the process.

I think Spector does have a desire to get this done.

I think it could be his signature piece of legislation.

I'm just a pessimist on being able to get everything lined up so that something could happen in the near term.

I'd love to be proven wrong on that, but I think it is very difficult uphill sledding.

Thanks.

Gary Ransom, Fox-Pitt Kelton.

I wanted to ask on the Citizens charge that was in the quarter how we should think about that going forward.

Was that trying to resolve what you thought would be all the charges?

Or how will that play out in future quarters?

We do expect that that would be the resolution based on the amount of premium last year.

The assessment we're assuming would be about 43 million.

Again, we had to take that through to the bottom line this time because we from a GAAP point of view can't set up the receivable until we bill.

We will expect to get partial recoupment simply because, as you know, we're getting out of the commercial lines of business there.

So we won't be able to bill assessment on those policies or the 95,000 we transfer.

But we think that would cover the assessment for this particular year at least.

I kind of heard two things in your question.

I think we got it all, although you're never quite sure.

It's an estimate.

I don't know that we'll actually get final billing or final resolution from Citizens until third or fourth quarter.

But we thought we could take a reasonable stab at estimating it.

And it will have a very, very, very modest impact on revenue growth in the future as it rolls back into the top line and bottom line over the next four to six quarters.

I'd like to also take a stab at the frequency question too, if I could.

We've watched in go down.

Everyone's wondering how low it could go or whether it turns or flattens at this point.

But I wondered if you could just give your opinion on whether there's a plausible scenario where frequency actually continues to go down.

Or taking it from the other side, are there particular reasons that you can make a case against it continuing going down?

I think the improvement in frequency for the industry, some have benefited more than others, like us.

But I think the continued improvement has been a function of safer cars, safer drivers, and safer highways.

I don't see any abatement in any of those things.

So when General Motors came out as they did -- you saw it four or five, six months ago -- and said they're going to put traction control and anti-lock brakes and anti-roll bars on every car that they make, that has a huge future implication on what will happen with frequencies.

The issue for the industry is that trees don't grow straight to the sky and their roots don't grow straight down.

There clearly will be -- I don't know what will trigger it, and I don't know when it will happen, but there will clearly be some variation around the line of best fit that has a decided downward track to it.

So when people worry about is it going to refer to a mean, I'm not sure what that means.

What mean is it going to revert to?

We're optimistic that there's enough factors in play -- simple things like extending daylight savings time.

Does that help?

Well I don't know.

One would believe that driving when its daylight is probably driving -- is better, safer, less accidents than driving when its nighttime.

Are you going to see that in the numbers?

No.

But when you take a whole series of things surrounding the safer cars, safer drivers, safer roadways, I think there's every reason to believe that long term frequencies will continue to improve, but it won't be every single period and every single year.

There will be some times when it pops up.

If you look at the frequency line over the last -- Gary, you've been in this business a long time -- look at it over the last 10 to 15 to 20 years, it's got a decided downward tick.

I would suspect that continues.

Thank you.

Ira Zuckerman, Stanford Group.

More getting back to the homeowners question, looking back from even three, four years ago the line has improved dramatically and now people may be a writing auto business to get the homeowners where it used to be the other way around.

You have mentioned that basically there had been very little rate changes in the line.

At what point do you envision that competition starts the rear its ugly head in this line?

And what's going to be your response?

A couple of things.

There have been substantial rate increases in the line.

Substantial.

If you look at the industry and our rate increases over the last three or four years, this is a product that was sorely under priced.

I'm not saying rate increases in the past, I'm talking about currently.

I got it, okay.

But you need to have a little bit broader perspective.

I think the line now is probably pretty well priced.

How do we compare to everyone else?

We have tiered pricing in homeowners.

It's very sophisticated.

It's very good.

We will continue to be leading edge in that regard.

There are no monoline homeowners companies like there are in auto.

So in auto you have the Geico’s or the Progressives that pursue a different strategy than we do or State Farm.

But in homeowners the competitive set is considerably different.

So I don't know that you have the classic attacker models like maybe you have in a Progressive or a Geico that are trying to take advantage of what they perceive as competitive areas that they can continue to win on.

We like the homeowners business, and I'm thinking to myself it was a few years ago on one of these calls people would say why don't you get out of the homeowners business?

It is good business, and we are concentrating more on growing that business profitably, preserving and enhancing the levels of profitability that we have.

Thus the emphasis on actions in Florida and reinsurance.

I think the competitive dynamics in homeowners are quite a bit different than auto, and I think where we're very strong in auto, we're very, very strong in homeowners and we will continue to have at lead.

You don't expect that some people may start to shave rates to try and get combined ratios in the 70s and 80s?

I do not see that.

Again, a Progressive and a Geico can't do that since they don't have a homeowners policy.

And I'm back to where we started at the very first -- when you have a company like State Farm who adopts tiered pricing, I think it provides much more rationality and perhaps prevents those kinds of irrational actions from taking place.

Thank you very much.

It is 1 minute after 9.

I'm going to wrap up our phone call.

Thanks for plugging in.

Thanks for your support.

We very much like where we are.

I think you should view the second quarter as another very solid quarter.

We're executing well on our strategies and maintaining good capital discipline.

I think we have the right balance of tactics to generate profitable growth in the future.

I continue to think that things like a measured expansion of our distribution force and a rollout of new products and a refinement of our tiered pricing structures and the investments we chatted about in technology and process improvement, I think they're going to help both our top line and our bottom line.

We continue to generate significant cash flows and I think we're using that wisely for both dividend purchases and -- dividend payments aggressive share repurchases.

We like where we are.

We hope we have more of the same to talk to you about when we're together in three months.

Thank you all.

Ladies and gentlemen, thank you for your participation on today's conference.

This concludes the program.

You may all disconnect and everyone have a great day.