Allstate Corp (ALL) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Allstate Corporation third quarter 2006 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, Vice President of Investor Relations.

Sir you may begin.

Thank you, [Matt].

Good morning, everyone, and welcome to Allstate's third quarter 2006 earnings conference call.

Ed Liddy, Tom Wilson and Dan Hale join me today to give their thoughts on our quarterly results.

Following these comments we will take your questions and after the call the IR team will be available for any further inquiries you may have.

Yesterday we issued press releases covering our financial results for the third quarter and our new share repurchase authorization.

We also provided most of our investor supplement.

Please note that the following discussion may contain forward-looking statements regarding Allstate and its operations.

Actual results may differ materially from those projected in the forward-looking statements.

For information on important factors that could cause such differences, see the Forward-looking Statements and Risk Factors Affecting Allstate section of our 2005 Form 10-K as well as yesterday's press release.

In this call we may discuss some non-GAAP measures, for which you will find reconciliations in our press release and investor supplements that are available on our website under Investor Relations.

This call is being recorded and your participation will constitute consent of any 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 of the call will be available following the conclusion of the call.

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

Now, I will turn the call over to Ed Liddy.

Ed?

Thank you all for joining us this morning.

Let me start by pointing out that this will be my last earnings conference call.

As you all know, about a month ago, we announced at the end of the year I plan on stepping down as CEO.

And Tom Wilson will move into that role.

Our Company is in such great shape, strategically, operationally, financially and from a leadership standpoint, that now is the perfect time for this transition, and Tom will do an absolutely terrific job.

I have to tell you that I have enjoyed my many interactions with each and every one of you over the years.

I thank you for supporting our Company and me personally, and I'd like to think that your support has been very well rewarded.

Now, to today's business.

We reported another terrific quarter, while Mother Nature provided a relatively quiet third quarter this year, Allstate continued its positive momentum, reporting excellent financial and operating results.

And hopefully you notice also continuing our focus on efficient capital management with our announcement of another share repurchase authorization.

As I said many times, the strategy that we developed several years ago continues to be the right one.

That's to become better, bigger and broader, generating long term profitable growth while maintaining capital discipline.

And the guidance we gave you for the balance of the year reflects our belief that the favorable underlying trends we have enjoyed this year, and frankly over the last several years, will continue.

Let me briefly cover a few of highlights and then I'll turn it over to Tom and to Dan.

We continue to grow our business, with standard auto PIF increasing 2.6%, and homeowner's increasing 0.6% versus September 2005 levels.

That is in the face of some very aggressive efforts to management -- to manage our catastrophe exposures down.

The increase is driven by strong renewal trends and the continued progress of Your Choice Auto with almost 1.5 million items sold to date.

And a similar product for homeowner's insurance is currently being tested.

Two of the primary drivers of our profitability, that's auto frequency and auto severity, continue to perform very well.

Frequency improved in the quarter and severity increases were within our pricing assumptions.

Our disciplined innovative approach to pricing has contributed greatly to the excellent results and underwriting margins that we have been producing and we expect to maintain that pricing discipline in the future.

Our claims organization continues to enhance our competitive advantage in terms of loss cost performance and operating efficiency.

As we have shared with you from time to time, we are looking forward to extending that advantage with the development and implementation of our next generation claims system, that will rollout over the next few years.

Like many of you, we believe that book value per share and ROE are important financial metrics.

Both were outstanding in the third quarter.

We are investing aggressively in our business to capitalize on future growth opportunities while still generating tremendous free cash flow, reflecting our confidence in the future.

Our Board of Directors approved a new $3 billion repurchase program.

It's interesting to note that over the last ten years, ending roughly September 2006, we have repurchased 321 million shares of our stock, for about $12.5 billion.

We paid $5.8 billion in shareholder dividends and we've increased our market capitalization from just under $22 billion to over $39 billion.

Finally, based on our strong third quarter performance and our expectations for it to continue, we've substantially boosted our operating EPS guidance for full-year 2006.

It short, it was another very good quarter for Allstate.

I will have a few more comments after the Q&A session, but now, I will turn it over to Tom.

Thanks, Ed.

I will focus my comments today on three areas, the current competitive environment, some additional thoughts on growth and our latest efforts in catastrophe exposure management.

If you look at the competitive environment, we have continued to grow in what is a highly competitive environment.

The overall environment and the results are basically the same as our last call.

The company continues to compete aggressively for auto insurance but there is much less competition in the homeowner's line.

For auto insurance, companies are really focused on the consumer by doing more advertising and doing things for customer satisfaction.

We're beginning to see some product enhancements in reaction to our successful campaign to provide real customer choice through Your Choice Auto.

What we have not seen in auto is a return of irrational pricing, which is on a sustained basis from major competitors.

Don't misunderstand us, it is very competitive from a price perspective as companies fine-tune their pricing structures to more effectively match risk with price.

There is some additional regulatory pressure on rates, although it is moderated by the lack of significant price increases overall.

The homeowner's market is more balanced, which is enabling us to recover our additional costs of reinsurance and reduce our without creating availability issues.

At Allstate, what we do is we continue to compete by using a multifaceted approach.

We've talked about this many times before.

It includes sophisticated pricing, effective marketing, product differentiation, broad distribution and excellent claims management.

Successful execution of that strategy has enabled us to continue to grow, and we intend to have it continue to drive successful results for the future.

The competitive conditions for Allstate Financial are also challenging, and our focus on returns in this environment is the right one.

The most difficult challenge for us right now is to find investments with adjusted -- risk-adjusted spread to improve margins.

What we do is we modulate volume to get adequate returns.

So you will see we issued no institutional products in the third quarter.

This quarter's results add further evidence that our strategy is working.

Ed went through some of the highlights, but let me provide a little more color on the trend.

In Allstate Protection we continue to see excellent trends in standard auto, which is of course, our largest line.

The Allstate brand standard auto continues to grow profitably with 2.6% increase in units and a 2.2% increase in net written premium when compared to last year.

Retention is stabilized around 90%.

The introduction of Your Choice Auto continues to gain both consumer and agency acceptance in the marketplace.

Advertising continues to be a battleground, but our programs are working quite well.

The number of quotes we do has increased dramatically but our close rates have declined a little bit as consumers shop more, and as competitors adjust prices.

As a result, our overall new business production of Allstate brand standard auto was down slightly in the quarter.

We are responding by using our data capabilities and local execution models to capture additional growth.

In addition, we will rollout a new non-standard product later of this year and throughout 2007.

Our catastrophe management action at this point can reduce our homeowner's growth, but it is in the right places.

The loss cost trends for both standard auto and homeowner's remain good, and our claim results have been outstanding this quarter.

Auto frequency has once again declined despite having a tough comparison to last year.

The auto claims severity trend remain consistent, were in line with our pricing expectations, and once again show that we can run the claims operation incredibly well.

The result is another great quarter for the underwriting margin on the auto business.

In addition to auto, the underwriting margin at homeowner's posted solid results and the other personal lines group of products recorded an impressive margin in the low 80s.

That latter group is a real growth opportunity for us as we go forward from here.

At Allstate Financial, we made additional steps toward our goal in improving returns.

Operating income did decline slightly, but when you put the results on an equal footing, apples-to-apples, we were just a little bit better than as of last year in the third quarter.

From a top line perspective, we posted an increase in fixed annuity premiums in the quarter, and our Allstate agency distribution system also grew about 6% in the quarter.

As importantly, we lowered our non deferrable operating costs and reduced capital in the business through a dividends to the parent.

Let me finish up with an update on our catastrophe exposure management action.

In addition to the ongoing programs we have to reduce hurricane risk, we began executing changes to reduce earthquake exposure.

In the third quarter we began a process of not offering optional earthquake coverage on about 330,000 property policies.

We did enter into an arrangement to make earthquake coverage available from other insurers to our customers in nine states, that's in addition to some previous agreements in a couple other states.

These actions show the balance of what we're trying to get done with this strategy, which is one, to make sure we provide our shareholders with an acceptable return on the risks that we assume in that property business and two, to reduce the variability of our earnings but three, to make sure we provide protection to our customers.

So with that, let me turn it over to Dan.

Thanks, Tom.

Once again, I would like to begin my comments by reemphasizing the high quality ongoing trend in our underwriting performance.

On a run rate basis, we continue to sustain an adjusted combined ratio in the low 80s.

As we pointed out last quarter, it was in the mid 80s or below since the first half of 2003.

For the third quarter after excluding 2.4 percentage points for cash or reserve reestimates, and for the seeded premiums from our expanded reinsurance programs, our adjusted combined ratio was 81.7%.

It would be 80.5% if you also excluded the $79 million pension settlement charge recorded for the property liability segment this quarter, which I will expand on a little later.

Either way, a low 80s run rate represents outstanding sustained underwriting performance.

As Tom mentioned, our frequency trends continue to be favorable, severity results are well within our pricing assumptions, and we don't see any significant changes in those trends.

For each of the adjustment items I mentioned, getting to a run rate combined ratio, and they were cats, reserve reestimates and seeded reinsurance premiums, for each of those I would like to provide a few additional comments, beginning with cats.

Obviously, this was a very light cat quarter especially for the third quarter.

It was dramatically better than last year's unprecedented hurricane season.

Catastrophe losses totaled only $169 million, or about 2.5% of earned premiums.

That was $4.5 billion less than the third quarter last year.

That $169 million included a net $9 million favorable reserve estimate for prior year hurricanes and a $12 million reduction on our accrual from an expected settlement from Citizens Property Insurance Corp of Florida.

We have paid out about 90% of our projected total losses from last year's hurricanes, and are pleased that the results today continue to validate the greater detail and increased modeling sophistication used in developing those reserves.

In addition to the favorable reserve change for prior year hurricanes, we also have other favorable prior year reserve reestimates totaling $315 million.

The total, including prior year hurricanes, was $336 million with Allstate protection offset partially by $115 million of unfavorable reestimates in our discontinued lines and coverages segment.

The net of all of the reserve reestimates then was a favorable $221 million.

The favorable reestimates for the quarter were primarily the result of claims severity and late reported loss development that was better than anticipated in previous estimates for Allstate protection.

After our annual detail and comprehensive roundup review of exposure to asbestos, environmental and other discontinued coverages, as I mentioned, we increased reserves by $115 million. $86 million for asbestos and the bulk of the remainder, about $26 million to increase the allowance for future uncollectible reinsurance recoverables.

As we have pointed out in the past, as a provider of excess policies and assumed reinsurance, we don't have access to claims that are filed at the primary carrier level until such time as the insured or insurance carrier decides to seek recovery on their excess policy or assumed reinsurance contract.

So there is a time lag as the exposures travels up the chain of coverage.

On that note, we are somewhat encouraged that the pace of industry asbestos claim activity seems to be slowing, perhaps reflecting recent state legislative action and increased legal scrutiny of the legitimacy of claims.

Now back to the seeded reinsurance premium items.

This was the first quarter to reflect the full cost of our expanded catastrophe reinsurance program on premiums written than premiums earned.

That cost was $214 million in seeded premiums.

It should be roughly the same in the fourth quarter.

We also continue to submit rate filings to recover reinsurance costs and have now submitted 350 rate fling in 29 states, including rates approved in Florida and other states related to our reinsurance programs, rates that are currently affected reflect approximately 35% of the total cost of our reinsurance programs and will be included in premiums written during 2007.

We expect rates in effect will reflect over 50% of the total cost of these reinsurance programs by the end of 2007, and will be included in premiums written during 2008.

Keep in mind in accordance with regulatory requirements, rate filings include an assessment of expected recoveries of catastrophe losses for each reinsurance program, the amount of expected loss recovery can vary considerably depending on the attachment point and other terms for a particular program, which is another way of saying that rate filings alone should not be expected to recover the full cost of reinsurance.

They cover the net of reinsurance costs less the amount of cat losses expected to be recovered from the reinsurers, so you have to look at recoveries from rate filings and the expected loss recoveries from reinsurers to see the total economic recovery on our reinsurance program.

Now for a brief explanation of the pension settlement charge recorded in the quarter.

Statement of Financial Accounting Standards number 87 requires recognition of a portion of previously unrecognized actuarial gains and losses when lump-sum payments to retiring employees exceed an allowed threshold.

The threshold for our plan was exceeded because of higher lump-sum payments this year due partly to the voluntary termination offer program we discussed last quarter and this year's low discount rate used to calculate lump-sum payments.

The estimated total settlement charge for the year is $118 million, $89 million of which was recorded in the quarter to cover the first nine months of 2006.

That $89 million breaks down to $79 million for the property liability segments and $10 million for Allstate Financial.

Recording this settlement charge now will reduce future year pension expense.

While we're discussing pensions I should also point our in keeping with SFAS number 158, which was issued in September, as of year end we will be adjusting shareholder's equity for the difference between the fair value of post-retirement plan assets and the projected benefit obligations for the pension plan and the accumulated benefit obligation for other post retirement benefit plans.

If this standard had been effective and adopted as of last year end, it would have resulted in a decrease in shareholder's equity of approximately $1.4 billion, or about $2.10 in book value per share.

The offset is other comprehensive income, so there is no impact on results of operations or cash flow.

Speaking of book value, as of the end of the third quarter, our book value per share was $35.08, which represented a gain of $5.42, or 18% over the past 12 months, 13% since year end.

Excluding the impact of net capital gains on fixed-income securities, the increase was 22% for the past 12 months and 15% since year end.

In addition, we wanted to point out that since 2005, hurricane season is now 12 months behind us, our operating income ROE, which we calculate, as you know, based on the previous 12 month results was 25.4%.

From a capital management perspective, we repurchased 5.4 million of our shares in the third quarter for $308 million, or about $57 per share.

This was a little slower paced than in prior periods as we enter the 2006 hurricane season.

However, as you can see from our accompanying press release, our Board has authorized a new $3 billion share repurchase program to follow the $4 billion program we announced about two years ago.

This new program should be completed in less than 18 months starting in the fourth quarter and finishing in the first quarter of 2008, so we will be repurchasing at a slightly faster average pace than the previous $4 billion program.

By finishing this program, the first quarter of 2008, we will once again be able to announce both our dividend and share repurchase actions and more complete capital management plan at the same time in the first quarter of each year.

That also gives us the benefit of knowing actual statutory results for the previous year and therefore having more certainty around insurance company dividends available to the parent.

This new $3 billion program represents approximately 7.5% of our outstanding shares at today's price.

Combined with a dividend yield of around 2.2%, you can see that our disciplined capital management actions continue to result in very significant returns of capital to our shareholders.

Finally, a few comments on guidance.

Assuming the level of average expected catastrophe losses for the remainder of the year, which is about 6% of earned premiums, and no additional reserve free estimates for the balance of the year, we expect annual operating income for diluted shares in the range of $7.35 to $7.50.

That essentially means that our third quarter underlying trends will continue for the rest of the year.

As you know, those are excellent underlying trends.

And now Bob, I think we are ready for questions.

Matthew, if you could start the Q&A session?

Thank you. [OPERATOR INSTRUCTIONS].

The first question comes from David Small of Bear Stearns.

Your question, sir?

Good morning.

In the press release, you give the change in newly issued applications for a few states including California for standard auto.

I was just wondering, how much do you think the competitor's pricing moves that we heard about during the quarter impacted the results where it looks like there is a 5% decrease in applications?

Let me answer is that in macro rather than individual states.

First, what we have is a multi faceted strategy which is a combination of sophisticated pricing, which you point out, our product differentiation, great marketing, improving customer loyalty and then making sure we have distribution that is both effective and expanded.

Over time you modulate each of those elements due to the local conditions you are in.

Different pieces generate different amounts of growth or create different challenges for you at different times, so pricing might make a difference or you might do something different on expanding distribution at that time or product differentiation.

It is a little more complicated model to execute and analyze but it has great strength in its balance.

Overall, I would say we held our position in all of our markets.

It is a different story by every market as you point out.

In 34 of our 49 states we are growing, that ranges from modest growth to a few states that are in the upper half of single digits.

The trend is off a little last quarter, as you point out, particularly in new business.

What we are doing is -- it is really a couple of states really out East as opposed to California.

We are adjusting some of our programs.

What we are doing is first, improving our sophistication in pricing, and what we're doing is moving beyond getting the best individual price to getting the best competitive array of prices.

With a floor on the most accurate individual price.

It is a new level of pricing sophistication for us.

We are continuing to push on product differentiation and YCA is making a difference.

From a marketing standpoint, we have some great marketing going on right now.

We are getting more aggressive in attacking that competitors that really only have one value of their component, most notably price, so you will hear some of our radio ads are really going after the price-only message and saying it's not the right way to think about it.

And then lastly in distribution, we focus more on effectiveness in the last couple quarters than on expansion.

If you look at the breadth of our distribution platform, that is not driving as much growth for us and that has a little bit to do with our growth rates as well.

We've had such big growth over the last three years, we thought it was time to take a breather, get the distribution productivity up so we can continue to grow from a stronger platform.

Excellent, If I could just ask a follow-up.

I was wondering, have you seen any change in claims activity from the customers who are in the Your Choice policy?

It is early to tell.

I would say that the Your Choice auto policy margins look as good as all of the other products we sell.

One of the things we had been counting on, or hoping for, not actually priced in, was better retention and we are just starting to coming around to first time renewals on that and those results look good although it is too early to declare victory there.

So when you put that same margin and better retention together, that should create greater lifetime value for us as it relates to Your Choice Auto.

Excellent.

Thank you very much.

Our next question is from Jay Gelb of Lehman Brothers.

Your question, please.

Thanks.

First, Ed, I just want to congratulate you again on your retirement.

You have done a phenomenal job, best of luck in everything going forward.

Thank you, Jay.

Separately, digging into some of the details, Tom, can you talk to us a little bit about the claim process redesign and how you expect to keep the claims advantage at Allstate versus the rest of the industry?

Yes, I can, Jay.

First, we call it NextGen, which is Next Generation Claims Initiative and it is really looking at our claim processes and doing a holistic change to them.

We have done it very successfully in the past.

We have a core claim process redesigned a decade ago.

You see the huge advantage we have in bodily injury.

Three years ago, four years ago, we did Claim Footprint where we took a couple million of our six million claims and moved them to call centers so they weren't handled in local offices, we got greater consistency and we reduced the number of offices from over 200 to about 120, I think.

That gave us the confidence that we were able to execute broad-based changes to improve claim results.

What NextGen Claim does, it has a number of different pieces to it.

The processes we used to settle claims, we like to speed them up some because we think that improves customer satisfaction, or know it does.

Secondly, the information that we gather and utilize to manage claims and set up claims is important, and thirdly, what people do, so which people we deploy against which claims, having more sophisticated homeowner adjusters work on more sophisticated or more severe claims is obviously something we want to do and it requires a work flow process.

Underneath all of that is technology.

I don't want to sell it really as just technology initiatives.

It is much broader than that.

It is really a restructuring of the whole thing.

We have started rolling it out of property.

The advantages that it will have for us is, one, it will lower our expenses because we'll have a lot less technology systems that will make us faster and settling claims, and we will be able to start to build algorithms on claims settlement just like we have built them on pricing and marketing and some of the other data management stuff we've done.

What that means is when a claim comes in, it goes into one of our call centers, we can get into the right person very quickly.

Today we used what I would call standard operating procedures, but not artificial intelligence to do that.

It should help us do that.

It will also enable us to then deploy the right people against it.

Using information, getting the right people in the right place, should help us control our costs.

We want to pay the right amount, not too little, not too much, it will help us to improve our loss cost expenses, which are already better than almost everybody in the industry.

What we would like to do as well, is drive increases in customer satisfaction.

Thank you.

Separately, Tom, as you step into the CEO role, any thoughts on strategy going forward?

If there's anything that will be different from currently, whether that is business mix or growth strategy?

I would say it is more of the same.

Ed and I have worked closely together for 12 years here, so it's really more of the same.

I think you might see the life cycle of our strategy, you might see some different results begin to grow.

A key part of our strategy is to become more consumer focused, do things like Your Choice Auto, be a little more innovative there.

That is the key part of our strategy we have been working on for three or four years pretty aggressively.

You will see more of those things come to fruition but that is just the natural maturity of the strategy as opposed to a change in strategy.

Okay.

Thanks very much.

Your next question is from Ken Zuckerberg of Fontana Capital.

Your question, sir.

Yes, good morning.

A question and a comment.

The question is for Dan.

Dan, share buyback and reauthorization have continued through much of the last five years.

Can you speak to the sustainability of the cash flow that Allstate it is generating and how that could impact buyback beyond 2007?

We don't want to project beyond the program we have just announced, but as you see, with the underlying combined ratio, we generate substantial cash flow, profitability, book value growth.

As I indicated before, we don't see anything on the horizon that would indicate those trends are changing in terms of frequency or severity.

We would expect to continue generating significant profits, significant excess capitol and we will make the right decision as we have in the past going forward with our Board of Directors on how best to deploy the capital.

Ken, this is Ed Liddy, I have said frequently the best predictor of what someone will do in the future is what they have done in the past.

If you look at our ten-year history where we have repurchased $13 billion of shares or $12.5 billion worth of shares, we will continue to generate excess cash and we're smart about what to do with it.

Ed, maybe a follow-up, would it be fair to conclude that with respect to higher capital requirements by the agencies, you're looking at RMS and other models pretty carefully that the four billion -- sorry, the new three billion not only contemplates excess capitol generated in '07, but again, just your conviction about the underlying profitability of the end force book?

That is a fair conclusion.

You are right as far as you went in your statement.

We look at RMS and we look at increased capital requirements there, but that on the other hand is balanced by less capital because we have more reinsurance, less capital because we have been fairly aggressive in managing our exposure to catastrophes down in those coastal areas.

When you look at it holistically, we are pleased with where we are from an operating standpoint, and we believe we can continue it.

That generates excess cash flow.

We're investing aggressively in our business.

It still leaves us with excess cash flow, and our philosophy, and it's worked really well for us has been to return that to our shareholders either in the form of repurchases or dividends.

For the comment, Ed, we met and worked closely together in the past when the stock was at 24.

I just want to tell your record speaks for itself.

Thank you as a shareholder, and as my daughter might say, "Give it up for Ed Liddy" that's a great job.

I didn't know your daughter knew me!

Thanks.

She's seen you on TV!

But best of luck.

Your next question is from Charlie Gates of Credit Suisse.

Your question, please.

Hi.

Congratulations on a great quarter.

Thanks, Charlie.

Could you speak to the current trend in auto insurance claims frequency and to what extent you believe that trend might be influenced by what recently occurred with regard to gasoline prices?

Charlie,I'm going to try and to take a crack at it , this is Ed Liddy, and then Tom will have his view, and his view probably counts more than mine.

I have said many times over the last couple of years that I believe frequency for the industry will continue their long-term pattern of declining.

That does not mean that they will go down every quarter, every reporting period.

But as you look at safer cars, safer drivers, safer roadways, that trend has been in place for 10 or 12 years.

My instincts are that it will continue.

It's clear that we build safer cars in this country now, it is clear that with the different demographic makeup of the country, there are more better drivers on the road.

It is clear that the enforcement of driving under the influence laws is very rigorous, graduated driver's licensing that now exists, and I forget, but I think it is pushing 40 states or so.

Those things have a dramatic impact on frequency.

That would be my first point.

Second, we have always thought, whatever happened with higher gas prices or lower gas prices was something that had a transitory effect on frequency.

What really drives frequency from the model that we have run and others in the industry have run, is more overall economic conditions.

If you remember in September of last year, when the hurricanes hit, frequencies were way down.

For us to be even better than last quarter's frequency this year I think is a pretty good indication that what we have been advocating for quite some period of time is in fact the case.

Frequency improvements will continue over a long term.

Tom, I don't know if you have a --

No, I would agree with everything Ed said.

Charlie, just to give you some sense for it, if you look at beyond the gross national numbers that you see, if you look at states on a year to date basis, 44 of our 49 states in the Allstate brand have had declines.

Look at the third quarter, 38 of 49 had declines.

You get a little more bouncing around in quarterly numbers because some of it is weather-related.

We feel good about where we are in frequency decline.

There has been a gain in the whole industry which continues to benefit from this, which we see on a one quarter lag.

Everybody benefits in the second quarter.

I haven't seen industry third quarter numbers.

I expect they will look similar to ours.

My follow-up question, we have witnessed the decline in the import of nonstandard auto for some period of time.

One of you made reference to rolling out some, I believe, new nonstandard auto coverage later this year.

Can you elaborate on that strategy and its import?

I can, Charlie, this time.

First, the choice we made a couple years ago in allocating resources both from a product, technology and distribution standpoint was to prioritize Your Choice Auto above nonstandard.

That was a choice that we feel good about today.

We think it has worked for us.

The choice was based on a couple things.

One, our strength in standard auto, its relationship to leveraging the strength in distribution because we are one of the few people who can actually control the sale in a way that makes it easier to sell Your Choice Auto, so it helped us from a competitive standpoint.

Thirdly, we thought the nonstandard market would get soft before the standard auto market margins were turned down, so we said let's not rush into that.

Now, we have been right on the first two.

Our nonstandard profitability has held up obviously, very well.

Probably the overall industry profitability didn't decline the way we thought.

You could argue that was not a correct assumption on our part.

We still feel good about the choice.

That said, we have looked at the nonstandard business quite aggressively over the last year.

We have developed some new products for the nonstandard business which are really targeted towards high-risk drivers, but higher-risk drivers that value insurance as opposed to those that are just high-risk drivers that are going to churn you to get an insurance card.

It is hard to make money on those types of customers.

So we will roll out, we'll get at least one state done this year, maybe two.

Then we will have in that 10 to 12 range next year.

We might get up to 14 different states.

There are some states we will never get back aggressively in the nonstandard business because we don't like the regulatory and pricing environment.

There are other states where our choice is not to do that.

You should expect to see some turnaround in the nonstandard business, which has been red for four years that I have been leading Allstate protection, it's been red the entire time.

Some of that was a conscious choice on our part, though.

Thank you.

Next question is from Bob Glasspiegel of Langen McAlenney.

Your question, sir?

Good morning.

First of all, let me echo Jay and Ken's thoughts and best wishes to you, Ed.

I know you're not punching out forever, but thanks for everything.

Tom, congratulations on your new assignment.

You are saying California is not a sign of increased competition,Tom, did I misunderstand?

Is New Jersey one of the states that in the east where you're seeing more pressure?

Bob are you --

New applications.

In California you're talking about homeowners or auto insurance?

Auto.

My point was that different things affect different parts.

California is not just one market, of course California is many different markets.

You have different things going on in different places.

I don't feel any differently about California's results than I do some of our other states.

New Jersey to your question, has been not as good of growth.

In fact, we've gotten smaller in New Jersey with the entrance of Geico and a few other competitors.

We decided not to chase volume in New Jersey.

You'll remember we used to lose a ton of money in New Jersey.

We got ourselves to where, at one point, we made more than the whole industry in profit.

That was written up in the Wall Street Journal and then everybody decided they wanted to come to New Jersey, too.

When they all came in we decided not to chase volume.

We now, have done some changes in our programs, our pricing models gotten the use of credit there, some of the new competitors came in with credit algorithms, so we changed our pricing.

We are ready to grow in New Jersey.

I expect we ought to be able to start growing there next year.

My follow-up, is Encompass at all levered to get growth back?

Will it be a steady state decline for 2006 and 2007?

I would like to be able -- I don't know that we will have a huge growth in Encompass in '07, but I would like to stop being red.

The challenges we face there are a little different than the Allstate channel which speaks to the breadth of the strategy that Ed talked about, which is in the Allstate brand, we are subject to less competitive pressure than we are in the independent agency channel.

When you look at Encompass, the competition is much more agressive, particularly on the East Coast, through some national carriers like Travelers and then some regional carriers, our challenge there is compounded by the fact that about 60 to 66% of our policies, depending on the state, are package policies, which means they are auto and homeowners linked together.

And our catastrophe management programs, particularly on the east coast, obviously make it more difficult to grow when you are trying to get smaller there in the face of aggressive competition on auto.

That said, I think there are ways we can grow Encompass.

We are focused on a couple handfuls of states as a way to drive that business.

Some of those states have started to grow individually.

Others are still in the red zone but we're hopeful we can grow those businesses next year.

Thank you very much.

Our next question is from Gary Ransom, of Fox-Pitt Kelton.

Your question, please.

Yes, good morning.

I had a question on loss trends also.

I wanted to ask in the context a not just what we see in your supplement, but what you see in terms of claims arising in BI as opposed to paid or other adjustments you might make, has in fact the trends continued to improve over the last several quarters right up through the third quarter?

Gary, this is Bob.

We have seen that continue to drop in frequency, and a fairly consistent performance on the severity.

Nothing in the trends we have seen.

We don't see any material change.

I have a question for Dan, also, you mentioned in your opening remarks 81.7 that I think was the combined ratio adjusted for the cost of reinsurance.

What were the other adjustments in that number?

Adjusted for cats, cost of reinsurance, seeded premium, and for reserve reestimate, favorable reserve reestimate.

So if you take out all of those items, adjusted, that you get 81.7, if you also take out that $79 million pension settlement charge, you are down to 80.5%.

One last thing.

Can you update us on where you are with the California regulatory rating plans in auto, where your filing stands there?

Gary, Phil is going to do that because he is our resident California expert.

Phil?

We actually have made a filing to comply with the new auto regulations in California.

The department hasn't gotten back to us yet.

The filing is revenue neutral, which means some people's rates will go up and some will go down because of the changes in the territorial relativity.

Also, importantly for us, we proposed including Your Choice Auto, for the first time in California.

And trying to maintain as much of the segmentation that the California Department insurance allows us to do.

We have a pending filing on homeowners, which was public news a few weeks ago.

We haven't heard back from the department on that.

We believe there will be a hearing on that in December.

Harvey Rosenfield's organization has notified that they plan to formally intervene in that hearing.

Our expectation is that there probably won't be any final settlement on that until after the beginning of the year, at which point you'll have a new commissioner in place.

You also have the issue of the legal challenges to the new auto regulations.

There was a hearing.

We did not get an injunction to prevent the implementation but there has been no hearing on the actual merits of those regulations and how they address territorial ratings.

We don't anticipate that being settled until after the first of the year.

Thank you very much.

Your next question is from Joshua Shanker of Citigroup Investment.

Your question, please.

Good morning, everyone.

A few questions.

The first involves the homeowners excluding cat losses severity numbers up a bit.

That doesn't include the cat numbers, is the reason it is up is because cost materials and cost of labor has gone up in the wake of the catastrophes?

Joshua, it is a couple pieces.

When you look at homeowner's severity in particularly the fire and lightning coverages, are pretty substantially.

We have been all or of those for the better part of a year.

They are higher than we would like, but we have been managing very aggressively.

That means well, not trying not to pay people the right amount of money.

It comes from a couple things.

One is a trend that started in 2003, the rapid increase in deductibles which takes away the little claims and leaves you with the big claims.

That trend continues although the slope of the line has come down a little bit.

That is not as big a driver any more.

Then what we're seeing is larger losses, which is related to the point you made.

The amount we have insured has increased at a fairly rapid rate.

That is due to what it costs to replace homes and building materials and stuff like that.

As a result of that, as the amount of insurance goes up -- now we collect some premiums for that too, by the way.

As that goes up, you will see a lot larger losses.

We have been, from an operational standpoint, very aggressive at improving and modifying claim practices to make sure we go after moderate sized losses.

I feel like we have been managing it very aggressively and we are dealing with these two trends called higher cost to rebuild and increased deductibles.

Thank you.

Additionally, and I realize you don't break it out, but I would be curious if you have any commentary on what might be called the preferred auto market in terms of pricing competition for a long term high-value type customers.

If you look the pricing in total, what you have seen is the market is much more sophisticated.

That is true particularly on preferred customers.

Until you have seen a wider spread of prices, we and other people have gotten there.

But a point I made earlier which I should go back to reemphasize is, as that world gets more complicated, you need to develop different skills.

Let me give you an example.

One is, you you want to get to right price for somebody, right? so we went from having just do the extremes, went from having one price in a state to having 100,000 prices.

That has enabled us to get much more sophisticated.

We have the right price for an individual.

As our competitors move to the same way, your relative competitive position gets a little more difficult to determine.

If you have three competitors, and they have the same price it is easy to compare.

If you have three competitors, and each have 100,000 prices and they have different algorithms for different types of preferred drivers, it gets a lot more complicated.

We are starting to break some ground in the competitive analysis area to improve our pricing capabilities there, and I think that will be the next way in which we make sure we compete and get profitable growth without just going in and cutting rates across the line as a way to get growth.

It is like using a sledgehammer when you want a drywall hammer.

Are you seeing the effect of State Farm getting more aggressive particularly on those types of customers?

No, State Farm has some new sophisticated models, they don't use them as aggressively as we do.

When you look at our new business comes from, and where our losses go to, we're not seeing a huge change.

Thank you for all your questions.

Still a lot of them but I don't want to dominate the phones.

So I'll talk to you guys soon.

Thanks.

Next question is from Jay Cohen of Merrill Lynch.

Your question, please.

A couple of quick ones.

With the SFAS 158 adjustment, does that change at all your pension expense going forward?

Not necessarily.

There will be other changes to the regulation that we will be having to look at.

Whether or not a change is moving, there is more to come on that.

The number you gave was as of year end '05.

Based on what has happened in '06, would you expect a material difference, and if you can suggest a difference, up or down?

That is a good ballpark estimate at this point without having all of the final details, the pieces do change but it will be somewhere in that neighborhood.

Okay.

Second topic, the favorable prior year reserves development has probably been the most surprising thing relative to the market's expectations.

Can you talk about in more detail what you are seeing and what would have to happen for that to essentially dry up as suggested in your guidance?

Hi, Jay.

This is Ed Liddy.

Prior year reserve releases are a very sensitive subject.

We make an assumption that our reserves are adequate to cover all of our liabilities.

We tend to be a conservative organization.

We aren't anxious to be unpleasantly surprised.

The assumption we make at the end of each quarter is as I said, so when we put out guidance, we are not saying anything different than what we have always said with respect to guidance.

It assumes there will be no additional prior year reserve releases and it assumes a level of catastrophe that we normally see or that we assume in pricing.

I wouldn't read too much into that.

The past year or so or few years, the frequency, severity, actual trends have been better than what people had assumed.

That is the real driver.

The prior estimates when they were derived were based on a set of assumptions that actual results have shown were a little more conservative.

It depends on what happens in reality going forward, what that would mean, whether these reserves are more or less redundant.

I guess it's fair to say that you have been surprised by it too given that each quarter you think your reserves are adequate.

That's always a pleasant surprise to see that the trends continue to get better.

Thanks.

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

Your question, please.

Yes, good morning.

Congratulations all around.

Recently there appeared to be some changes in how Louisiana was allowing claimants to file claims -- they're apparently extending the time frame that claimants had to file claims.

I was wondering if that could have any impact on those claims for you in Louisiana and if that has been fully taken into account with your reserve development to date?

We feel good about our results, everything we have put up for last year's catastrophe, Katrina and everything else.

The change you are talking about is giving people an additional year to sue if they are not happy.

We have a lot of claims settled already.

We are in the 94, 95% zone in terms of claims that are closed.

We did a couple things early on which have set us up well to get through this.

We always go out and advertise for claims, around, which always kinds of surprises people.

We do radio ads and say "Call us if you have a problem. "

What we did this year was we were getting a lot of calls in our call center, on, "I don't know if I got the right number", and stuff, so we decided to advertise for what we call supplement.

So you close a claim, you give somebody a check, they go away, we went out and started advertising and said this is Allstate, if you don't think you got the right amount of money, call us and we would be happy to talk to you.

We did it really because we were getting a lot of calls in, and we thought "gee, customers must have a need", and let's go out and let them know how to do it.

It also helped us with regulators and our customers in terms of where we are on this potential to be sued for an extra year.

Thank you and congratulations on the quarter.

Thank you.

Your next question is from Meyer Shields of Stifel Nicolaus.

Your question, please?

Ed mentioned in his comments that you're not seeing a return to irrational pricing.

I think with profitability levels where we are, we could see more aggressive pricing but still rational.

Have you seen any change in aggressiveness without dipping into irrationality?

Let's talk about parsing words.

Beauty is in the eye of the beholder.

Everybody has different profit targets and different returns and that they want to try to get on their capital, and different views of what the right price is.

I could make a couple comments.

We are sticking to our strategy, which is a broad-based, multi faceted strategy, which is product differentiation, price competitiveness, great distribution, good marketing, so it is not all about price.

If you sell all about price, that is the only weapon you have in your arsenal.

We don't believe that is the right way to run our business.

That makes us a little less subject to having to automatically lower prices every time somebody else does.

Secondly, I would say that the sophistication that we have enables us to have really have a good sense of where we are.

When we change price it, you can be sure it is with the mantra of profitable growth as opposed to growth that is unprofitable.

I do think you see some of our competitors as they have gotten more sophisticated, sometimes they some in and buy a little business and they might not know they are buying business or maybe they do it intentionally.

I can't speak to their motives.

What you will see is them then change.

You saw that earlier this year when some large carriers got in very aggressively on pricing and then subsequently raised their prices, because obviously they had enough data to show them they were not getting the right price.

What you are seeing is a more rational and knowledgeable auto market, which I think is a good thing for everybody, a good thing for consumers, because it keeps prices in line and not highly volatile, and obviously, that is a good thing for the industry in terms of profitability.

I would add to that something that Tom said earlier.

The battlefield we think really got shifted to more to the advertising world.

That is an area we are prepared to compete in very effectively and then I think in the independent agency world, I think it has shifted maybe toward commission structure and buying books of business.

That is a different game than we play.

It has added to the competitive thrust in the independent agent channel, may be more competition that's not existent in our channel.

That is helpful.

It looks like the anticipated recovery of property cat reinsurance premiums was reduced from 65% or so to 50%.

Can you talk about what's underlying that change?

We just said it was going to be in our view, over 50%.

It is in still in excess of 50 but we're not trying to get any more precise than that at this point.

Maybe let me add something on top of that.

Our goal is to recover the net economic costs to us relative to our current pricing position in each market.

You wouldn't expect to get that 100%.

First, and of course, is we'll have lower losses as a result of that.

Secondly, in some places, we actually captured a portion of that in our existing pricing.

Since we aren't fully compensated for these risks, we think we will get back a lot of reinsurance premiums as we go forward.

You just wouldn't expect that to be 100 cents on the dollar.

In Florida we have done a good job of getting back a lot of it and in Texas we have done reasonably well in the countrywide program.

It is more complicated because you have all of the states to roll it out to so we haven't gotten back as large of a percentage there.

The open issue for us is California.

And Phil mentioned that in homeowners, we went in for a price change, we went in for an increase when the department was calling for a decrease because we think if you buy reinsurance, which is there for risks that you ought to be able to recover the costs.

The department is not in the same position at this point, but we intend to make our case aggressively because we think it's the right thing to do.

That is very helpful.

Thank you.

Matt, could we take one more question, please?

The final question is from Matthew Heimermann of JP Morgan.

Your question please?

Good morning.

In under the wire.

The only question I have that hasn't been discussed that I thought I would propose, was on the capital management side, now with the new dividend program, you said that in one queue you will be reviewing your buyback position which happens also to coincide with when you announced dividend.

From a dividend perspective, is there any -- does thinking those out change the usefulness as a dividend of the alternative return capital?

I am thinking about what perhaps is the right payout ratio for dividends?

Matt, once again, history is obstructed.

If you look at what we have done in the past with increases in dividends I think it will give you a pretty good sense of what we may well do in the future.

The linkage of those two really reflects Dan's thinking on two fronts.

One, it is smart to get them all lined up, to get them both lined up at the same period of time after you complete a year.

We are a company that worries and wonders about statutory capital.

Equally importantly, you just don't know what would happen with change in administration and a change in congress Congress to the dividend deductibility and share repurchase and how that may get taxed.

So by linking them up, we think that gives us more thoughtful and holistic way to think about the changes in policy that may emanate from places other than Northrop.

Fair enough, and with that, best wishes to you.

It is 9:00 here in Chicago.

So we would like to stick to an hour.

I would like to bring our call to a close.

I will leave you with a couple thoughts.

We absolutely have the right strategy and we are executing on that strategy very well.

This quarter was another indication of that.

We remain very disciplined when it comes to our capital model.

We have a powerful, winning business model that has been true in the past.

It will continue to be true in the future.

We have the right people throughout our organization to carry out the promise we have made to our customers and the latest senior management transition confirms the very strong bench that we have at Allstate, it's something I am proud of.

We are in excellent shape financially, we're generating shareholder return in excess of a market benchmark, over just about any meaningful period of time that you choose to use, and you have heard me say on many occasions in this is a business of size, scale and people and we have all three.

I think it is also a business where success in the future will be garnered by the swift and the smart.

We are among those.

Our very innovative approach to the business whether you talk about new products like Your Choice Auto and our treasury link, or marketing with our stand campaign, pricing with SRM, claims management with CCPR in the past and Next Gen in the future, all of those things have put us clearly ahead of the pack, that's a place we intend to stay.

It has been my privilege to have led this organization over the last eight years and I am very proud of our achievements, but the simple fact is that the best is yet to come.

Thank you all for your support.

Tom will talk to you in February.

Ladies and gentlemen, thank you for participating in today's conference.

This concludes the program.

You may now disconnect.

Good Day.