Allstate Corp (ALL) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to The Allstate Corporation third quarter 2007 earnings conference call.

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

Later we will conduct a question and answer session and instructions will be given at that time.

(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.

Sir, you may begin.

Thank you.

Good morning and welcome to our third quarter earnings conference call.

Today Tom Wilson, Dan Hale and I will provide commentary on our results, which we released yesterday.

If you need a copy of the press release or our investor supplement schedules, they can be found on the IR portion of the Allstate website.

Following the formal comments we will hold a question and answer session.

We expect this call to last about one hour.

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 these statements.

For information on important factors that could cause such differences, see the risk factor section in our 2006 10-K, our second quarter 10-Q and yesterday's press release.

We may discuss some non-GAAP measures for which you will find reconciliations in the press release and investor supplements available on our website.

This call is being recorded and your participation will constitute consent of any recording, publication, webcast, broadcast of your name, voice and comments by Allstate.

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

A replay of this call will be available shortly after the call ends.

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

Finally, if you have any additional questions at the conclusion of the call, investor relations team will be available to handle them.

Now let's begin with Tom Wilson.

Tom?

Good morning, thank you for joining us.

Our third quarter results continue our record of delivering balanced results in line with our commitments.

Overall I would characterize our results as solid performance in a competitive and volatile market.

We achieved this success by sticking to our strategy and utilizing disciplined and decisive decision making.

We also benefited from the investment decisions we made over the last several years.

Revenues increased $9 billion, a 3% increase over the third quarter of 2006 due to strong investment results.

Net income was $978 million or $1.70 a share.

Operating income for the quarter was $1.54 a share.

That's 18.1% below last year, which is primarily due to lower favorable prior year reserve releases, increased catastrophe losses, and an expected deterioration in our combined ratio when you exclude those two items.

Our return on equity for the last 12 months was strong at 23.2%.

Book value was $37.45 per share, which is 7% above the prior year and 3% higher than the second quarter this year.

Let me walk through the three main components of our business and then Bob and Dan will go through some more details.

Allstate Protection's multi-faceted strategy for profitable growth continues to work, although you can see the impact of heightened competition this quarter.

The combined ratio of 86 for the quarter and 84.7 for the year-to-date, when you exclude catastrophes and prior year reserve releases, continues to be within our expectations for the year.

Margins on this basis did decrease in the quarter and George Ruebenson's team is focused on both cost control and pricing actions to make sure we generate attractive returns.

Standard auto growth was off slightly as we focus on controlling margins and competing on a broader front than just price.

The successful rollout of Your Choice Auto continues and we're now in 83% of the country with Florida being our biggest new state that we added to the list.

We're making good progress in Your Choice Homeowners and Allstate Blue and additional consumer focus innovations are planned for next year.

We were pleased that our customers and shareholders did not have to experience any large hurricanes in the quarter.

Our strategy to reduce our catastrophe exposure, however, has not changed and is on schedule.

There were a number of smaller catastrophes reducing homeowner profitability, but the total was within our expectations.

We are focused on homeowner loss costs and pricing, since frequency and severity increases, when you exclude catastrophes, remain higher than we would like.

Allstate Financial continues to successfully implement strategies to raise their returns.

Fixed annuity sales were down 44% versus last year's third quarter, which reflects lower industry sales and our higher return requirements.

They were higher, however, than the second quarter this year.

Operating income was flat to last year's third quarter as higher spreads and benefit margins were offset by investments in growth and a lower capital base.

The Allstate investment team had a truly outstanding quarter, particularly when you consider the difficult investment market.

Net realized capital gains were $121 million as gains in the equity portfolio more than offset the negative impact of interest rate hedges and minor realized losses on fixed income securities.

The net really reflects the strategy that we've implemented over the last several years and base, which includes a disciplined and analytical approach to market.

Our previous actions to reduce our credit risks served us well as spreads widened.

The credit skills we applied to the selection of investment grade securities, backed by subprime residential mortgages, and I want to stop there for just a second and say a lot of times people talk about subprime with us.

We invest in investment grade securities.

They have to be backed by subprime mortgages.

The skills we brought to that process benefited us unrealized, and these are unrealized losses on the portfolio being only 6% or $280 million.

So, if you step back in summary in a competitive operating environment and rapidly changing investment markets, it's necessary to make conscience tradeoffs to achieve balanced results and we did that well in the third quarter.

The property casualty combined ratio, excluding catastrophes and prior year reserve releases, is 84.7 for the first nine months, which is well within our full year expectation of 84 to 86 that we discussed at the beginning of the year.

Growth in the property casualty business was below target, but we remain convinced that a multi-faceted approach is competitively differentiating and will drive long-term success.

Allstate Financial is improving returns and our investment discipline and skills also served our shareholders very well this quarter and for this year-to-date as well.

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

Thanks, Tom.

Beginning with our Property-Liability results, net premium written of $7.08 billion declined slightly from the third quarter 2006, while earned premium posted a small increase for the quarter.

Top-line growth in auto insurance was essentially offset by a decline in homeowners as we continue to reduce our exposure to mega catastrophes.

The impact from reinsurance seeded on the top-line was negligible as the cost for the 2007 season is stabilized with respect to those same costs for the 2006 season.

Underwriting income for the quarter was $617 million, a decline of $461 million from the $1.08 billion we posted in the third quarter of 2006.

This decline was due to an unfavorable swing in prior year reserve reestimates of $273 million, $81 million more in current year catastrophe losses and the balance of the decline coming from underlying margin pressures.

The posted combined ratio for the quarter was 91% versus the third quarter 2006 result of 84.1%.

However, I must point out that the underlying combined ratio for the quarter was 86%, an excellent result relative to others in the industry but 1.7 points higher than our third quarter results of 2006.

We continue to record excellent underwriting results achieving profitable growth in a very difficult and competitive marketplace.

Going a bit deeper into the operations, we continue to grow our auto business with a 2.3% increase over the prior year quarter in Allstate brand standard auto aided by increases in units and a small increase in average premium.

Your Choice Auto continues to be well received by consumers and has now been rolled out to 46 states with Florida and Hawaii coming on board in the third quarter.

The increasingly competitive auto market has had an impact on our new business generation and to some extent our retention ratio.

However, we remain price competitive in the high lifetime value consumer market.

Further, as we analyze the local markets it seems that the prices have stabilized a bit as competitors react to loss cost pressures.

We continue to believe that the best opportunity for profitable growth over the long run is to offer consumer choice at competitive prices.

Utilizing sophisticated pricing structures and leveraging effective marketing campaigns, we can attract and retain profitable customers winning at the local market level and driving long-term growth.

Shifting to a review of total auto loss cost results for the quarter, the statistics I will be quoting show up on page 19 of our investor supplement if you want to follow along.

The combined ratio for the Allstate brand total auto was 89.3% for an increase of 5.6 points when compared to the third quarter of 2006.

About half of that increase was due to reduced level of favorable reserve reestimates, 50 basis points was due to increased cat losses and the balance was due to loss cost increasing faster than average premium.

Specifically, we experienced continued pressure in property damage frequency of 4.3%, while bodily injury frequency flattened.

Bodily injury paid severity increased 7.3%, while property damage paid severity went up only 2.8%.

To counter these trends in loss cost we filed and received approval for rate changes in 16 states averaging 4.4% on an annualized basis in the quarter.

For the first nine months we've filed and received approval for rate changes in 28 states averaging an increase of 4.2% annually.

This is in keeping with our philosophy of preserving margins to generate profitable long-term growth.

Quickly turning to the homeowner line, net premium written for the quarter fell 3% compared to the third quarter 2006 to just over $1.7 billion, $1.59 billion for Allstate and $145 million for Encompass, as we continue to manage our exposure to mega catastrophes.

The combined ratio for this line climbed to 92.5% from 77.7% posted in the third quarter of last year.

This increase was entirely due to more catastrophe losses experienced this year, as well as a reduction in favorable reserve re-estimates.

That said, loss cost pressures have been increasing for a while and we've responded with rate changes and loss mitigation efforts to protect the margins in this line of business.

Finally, a review of Allstate Financial results reveals the continuation of improvement in return for this business.

Deferred fixed annuity deposits fell during the quarter relative to the third quarter of 2006 but did increase sequentially.

This follows the general trend in the industry, as well as our strategy to raise new business returns.

New sales of financial products by the Allstate exclusive agencies grew in the quarter to $704 million, an increase of 21.8% over the third quarter of 2006.

Operating income for the quarter was $147 million, flat with the third quarter 2006.

Improvements in product margins were essentially offset by increased expenses and taxes.

In keeping with a theme of approved returns, ALIC, or Allstate Life Insurance Company, paid an $85 million dividend to its parent AIC in the quarter and expects to pay another dividend in the fourth quarter of approximately $240 million.

That amount could be increased with the approval from regulators.

With that, let's move on to Dan Hale for his commentary on investment results and other issues.

Dan?

Thanks, Bob.

I will begin with a brief summary of our investment performance for the quarter, including comments on our subprime related holdings, then cover our catastrophe losses.

After that, I will bring you up to speed on the results of our annual third quarter ground up discontinued lines reserve review, then close with a few additional comments on capital management actions and related balance sheet metrics.

At the end of September our investment portfolios totaled $121 billion with a net unrealized gain position of $2.6 billion, about the same as it was at the end of the second quarter.

Fixed income portion of that unrealized loss position amounted to $1.1 billion and is essentially flat with the balance at the end of June as well.

During the quarter, our Property-Liability portfolio generated $474 million of net investment income, which was 4.2% more than for the comparable quarter of '06.

Allstate Financial net investment income grew 2.2% to $1.1 billion.

Net realized pretax capital gains for the quarter totaled $121 million for the combined portfolios, with $225 million of gains related to dispositions of equity securities, offset partially by $32 million of losses on dispositions in fixed income securities, by $50 million of losses related to valuations and/or settlement of derivative instruments and by $24 million of investment write-downs.

And none of those write-downs were subprime related.

And speaking of subprime related investments, at the end of the quarter we had $4.4 billion on a market value basis of investment grade securities where the underlying collateral was subprime or residential mortgages and $84 million in collateralized debt obligations with some exposure to subprime holdings.

As I mentioned earlier, none of these investments were other than temporarily impaired.

We value these securities based on independent market quotations, which were vetted by our internal valuation committee.

At the end of September these securities had a combined unrealized loss position of $280 million compared with an unrealized loss of $44 million at the end of June.

As I said last quarter we expect to receive all payments on these securities in accordance with their contractual terms.

93% of our RMBS securities are rated AAA or AA and only five securities in our portfolio have been downgraded since the end of the second quarter.

Our CDOs, with some exposure to subprime collateral, are also 93% AAA or AA and only one of them was downgraded since the end of June.

One other CDO security was forced to liquidate and we received our full principal and interest payment.

Now turning to our catastrophe losses, for the quarter they totaled $343 million or about 5% of earned premium.

That $343 million also included $57 million for prior year hurricanes.

Those increases were for additional expense reserves needed because those prior year hurricane claims are taking longer to close and had been assumed in our previous estimate.

Now while ISOs property claim services estimates show a reduction in catastrophe losses this year versus last year and only six events in this year's third quarter versus seven last year, the National Oceanic and Atmospheric Administration, or NOAA, their weather data shows that the number of hail and wind events increased 5% for the third quarter of this year.

That was more consistent with our experience as our third quarter cat losses were up about $80 million as a result of 21 events.

When you consider the fact that there have been no major hurricanes, this has still been an active year for catastrophes.

Our year-to-date cat losses total $937 million, which is $406 million or 76% more than last year through the third quarter.

Property-Liability prior year reserve reestimates for the quarter resulted in a $52 million net strengthening of reserves, including $69 million for discontinued lines and coverages and that $57 million mentioned previously for prior year catastrophes.

Those amounts were offset partially by $74 million of favorable reestimates for prior year auto claim severity development that was better than anticipated in previous estimates.

For the third quarter last year there were $221 million of net favorable prior year reserve reestimates.

The Discontinued Lines and Coverages segment includes $1.6 billion in reserves for exposure to asbestos and environmental claims.

As you may recall, during the third quarter of each year we perform a detailed and comprehensive ground up review of discontinued reserve requirements which includes assessments and claim activity trends and other characteristics of potential exposures.

Following this year's review, we added $63 million to reserves for environmental exposures as a result of increased claim activity related to site-specific remediation where clean-up cost estimates and responsibility for clean-up costs have been more fully determined.

Part of the increase reflected increased IBNR to cover future claims based on the recent increase in claim activity.

Additions to the reserve for asbestos amounted to only $6 million, primarily for products related coverage.

I should emphasize that we continue to be encouraged over the slower pace of asbestos claim activity as a result of various state legislative actions and increased legal scrutiny of the legitimacy of claims.

In the third quarter of last year we added $86 million for asbestos exposures.

In the area of capital management actions we repurchased 14.4 million shares during the quarter for $773 million or $53.65 per share.

A portion of those repurchases related to the settlement of our accelerated stock repurchase agreement initiated in the second quarter.

So far this year we've repurchased 50 million shares for about $3 billion or $59.34 per share.

We still expect to complete the current $4 billion share repurchase authorization by the end of the first quarter of next year.

At the end of this quarter there were $820 million remaining under the current authorization.

Our book value at the end of September, book value of $37.45 per share representing an increase of 6.8% over a year ago.

Excluding unrealized net gains and fixed income securities, the increase was 9.7%.

Remember, we generated those increases in book value per share despite the fact that our share repurchases over the past 12 months have reduced shareholders' equity by about $3.5 billion.

In addition the adoption of SFAS-158 related to defined benefit pension accounting in the fourth quarter of '06 reduced our book value by $1.80 per share.

Without that change, our year-over-year book value per share growth would have been up another 5%.

Our return on shareholders' equity at quarter's end was 23.2%, with 21.2% for the operating income return, which excludes unrealized net capital gains as a denominator.

And finally, we're reaffirming our total year adjusted combined ratio outlook within the range of 84% to 86%.

Excluding catastrophes and prior year reserve reestimates, our adjusted combined ratio was 86% for the third quarter and it's been below 88% for the last 18 quarters.

On a year-to-date basis it was 84.7%.

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

Okay.

Matt, if you could start the Q&A session.

(OPERATOR INSTRUCTIONS) Our first question is from David Lewis from Raymond James.

Your question, please?

Thank you and good morning.

Can we talk a little bit more about the prior year reserve development?

If I understand correctly, the homeowner's was adverse $49 million, but I assume that includes the $57 million that you put up from prior year cats, is that correct?

Yes, that net reduction as far as reserves included the $57 million and the prior year reserve reestimates for the hurricanes.

So if we kind of look through that, then maybe in future quarters, if there isn't any other adjustments there, then that may actually be kind of a flatter number if not even some favorable development.

Is that a good way to look at it?

Well, as I did say, we did have a favorable $74 million adjustment in the quarter for prior year auto claims severity development.

And that was as a result of them being better than anticipated in previous estimates.

Again, we look at the reserve positions in depth each quarter and based on the indications of what's happening and reported results, we adjust accordingly.

It's not unreasonable to assume that on an aggregate basis you may have some favorable development continuing over the next few quarters.

As I said, we will continue to evaluate reserve requirements.

Hopefully there will not be any additional prior year reserve reestimates for hurricanes, but again, each quarter we'll take a good look and make sure that we have an appropriate balance so that we're adequately reserved.

Very good, thank you.

Thank you.

Our next question's from David Small of Bear Stearns.

Your question, please?

Good morning.

Just two quick questions.

We've seen now a few quarters where there's been a slowdown in new applications, particularly in what you've called your hurricane-exposed states.

Can you just maybe give us some of the things you're doing as a management team to address that?

Hi, David, Tom Wilson.

Yes, I will.

First, in our overall strategy is to offer innovative consumer focused products at a fair price.

What do you do around that?

First -- and that is not just in the non-cat states.

We do that everywhere, if you're really talking about auto insurance which is, I assume, where you're at.

First is making sure we have good innovative products, which is Your Choice Auto.

We have been rolling that out.

We also have Allstate Blue, which you're seeing picking up a little momentum in this quarter, and Your Choice Homeowners, which is really only catching hold in the non-cat states.

So, secondly, you always want to make sure you have a good price.

And as Bob mentioned, we look hard at prices.

We have some new sophisticated modeling technology to enable us to look at where we are priced well.

And when you look at the high lifetime value segments, which are where we are targeting, we are very competitive in those states and we like our win ratios there.

If you look at the low lifetime value segments, these are people who shop a lot more and are much more focused on price, we're not very competitive when you look at those.

If you look in the middle, I would say we're in a balanced position.

So, when you look at the combination of good products and pricing, we feel good about that.

Obviously, advertising is important as well and we continue with our very successful advertising program and to put a bunch of money in it.

I do think, David, that the increase in advertising that you're seeing in the industry is starting to have some impact on retention ratios, both I think it's obviously our retention ratio is down a little this quarter and I suspect you'll see that with other people as well.

The reason I say that is our quote levels are way up this quarter.

So, the offset to that is, of course, we are taking in more new business.

Good marketing, differentiated product, good pricing and then making sure you treat your customers well is the last piece of that and we've been working hard on a whole long list of customer loyalty efforts as well.

And then maybe I could just ask you a follow-up.

On the last quarter call you indicated that severity, even though it popped up in the quarter, that you look at the rolling 12 months in your pricing, where it was within your pricing ranges.

Now we've seen two quarters in a row where severity looks a little bit high.

Are we still within your pricing -- where you're pricing for this?

I assume you're talking about bodily injury severity.

Yes.

George Ruebenson, who as you know leads Allstate Protection and also led our claim organization for five years before that, is here.

George, maybe you can tackle that one.

Just a couple of comments.

First of all, on bodily injury, I do think the six months increase is more than we've seen in the past and actually more than we would like.

I think you really have to look at the history of it.

We have a long, proven history of being able to handle bodily injury claims.

But having said that, there are a couple of things that are going on.

One of them is is that we've had medical inflation in the 4% to 5% range.

This year we have also had a mix of older report years.

I know we don't disclose report year information but in the quarter we had more older higher-priced claims that happened to be settled.

So it does distort the numbers a little bit.

But maybe more importantly is the question of what does it do to our margin.

Bodily injury is about 25% of the entire auto premium.

Property damage and collision is about 55%.

We're running much more modest increases there.

And I think that we have an integrated profit management process at the local level.

In every one of our states we have local market operating teams that are keeping an eye on this.

And as Bob referenced in his opening comment, we've already taken quite a few rate increases and in those states of about 4% to 4.5%.

So we believe that we're going to be able to take rates that are going to cover the increase in several of the pure premium areas.

Okay, thanks.

Our next question is from Bob Glasspiegel of Langen McAlenney.

Your question, please?

I actually was going to focus in on -- good morning -- I was actually going to focus in on frequency, which standard auto is the first uptick for BI and property damage was ticking up.

The question is, is the gravy train of favorable frequency sort of playing out and does that link to the -- to reserves not being a good guy to a greater extent going forward?

Bob, this is Tom.

Good morning.

Good morning.

Let me answer your question a couple of different ways.

First the gravy train.

I think it depends, we don't really see it as a gravy train, we see it as sort of a trend we react to and we factor in.

If you look at the long-term eight, ten, 15 years, frequency has gone down and we see that trend continuing, that's safer cars, more cars per households, older drivers all that kind of stuff.

So we see that trend continuing.

If you look at this quarter or this year, it looks a lot more like '04 and '05 than '06.

Particularly when you look at -- whether you look at gross or net frequencies.

It's looking a lot more like those years.

So I wouldn't say that the long-term trend has turned and we expect to see people getting into more action.

So those longer term things are still in place.

I think what you just see is that '06 was an abnormally low year.

As it relates to our reserves, our frequency really doesn't have a whole lot of impact on reserves because you know what you got.

It impacts your incurred but not reported a little, but it really has little impact on the reserving.

Okay.

If I could follow-up.

You seem to drop a kernel of we may have to adjust pricing on auto to the trends that are happening, which I didn't know if I'm overreacting or overanalyzing but was that a signal that you may have to be a little bit more aggressive in taking some rate action?

I think what George said, Bob, was that we have and it's an ongoing process.

George's team is doing that by state, is what he said, and they have people looking at by territory, by coverage, ripping it apart and they make changes when they can.

So I think what George is saying, I think George is, you see it in the numbers already.

Yes, it is already there and that if we see upward pressure we'll continue to take rates where appropriate.

As Bob indicated in his opening remarks, 28 states increases averaging 4.2% so that is part of our strategy to file when appropriate.

Thank you very much.

Thanks, Bob.

Our next question is from Jay Gelb of Lehman Brothers.

Your question, please?

Thanks and good morning.

Tom, I was wondering if you could talk about the adjusted combined ratio trend.

The goal is 84 to 86 for this year and Allstate's already at the high end of that range.

What steps are Allstate going to take to prevent that from pushing through the high end of the outlook as you look forward?

Good morning, Jay.

First, the 84 to 86 we always meant it to be an annual number and so not a quarterly number and we're at 84.7.

I might have a slightly different shade on the -- we're at the high end of the range.

Secondly, what are we doing to make sure we maintain margins?

Let me maybe start with sort of what's the overall competitive environment.

It might be helpful to set some context and then we'll go into the things that we've mentioned.

First, if you look at the overall pricing environment, because that's where a lot of people are focused, and if you look at State Farm, GEICO, Farmers, Nationwide what you would see is State Farm took almost all decreases this year.

You would see GEICO's taken a lot, mostly decreases, probably in the 80% plus range and I'm just looking at by state.

I'm not weighting it.

I'm not doing percentage up or down.

I'm saying what was a increase or what a decrease.

What you would find is Farmers has taken a lot more increases than decreases.

And you would see Nationwide has been about 50/50.

If you look at it by quarter, you would see that the first quarter had probably three times as many decreases as increases.

You would see that the second quarter had two times as many decreases as increases.

And you would see in the third quarter there were actually fewer increases than decreases.

So, what that says is the price competition's focused in it with a couple of companies and that those decreases have moderated as we've gone throughout the year.

Keep in mind that about half of the business comes from people who are not in the top five.

And I didn't quote Progressive because I don't have decent numbers on them right now.

So that kind of gives you some sense for where pricing is.

Then let's go over to the loss side and if you look at Fast Track and what's happening there.

Other companies are seeing the exact same trends in frequency and severity and in some cases, on average, in fact, higher than ours, which says that their margins are probably lower than ours.

Then what are we doing in that environment, right?

We talked about having things like (inaudible) where we get higher average premium.

We talked about great advertising.

We talked about taking price when we need it.

We've talked about controlling claims and having next gen claims and rolling that out.

All of our strategies, we think, continue to be appropriate and will help us achieve balanced results in this environment.

Is that helpful?

It is.

Thanks very much for the answer.

Our next question is from Joshua Shanker of Citi.

Your question, please?

Good morning, everyone.

Good morning.

A few questions, one is regarding the marketing budget for 2008 versus 2007.

Can you give us some color on where you think that your ad spend and market exposure is going to be?

And two, some details on progress in finding top management for your direct brand and I would be interested to know where you see that being three years from now.

Okay, Josh, did the marketing people ask you to ask that question?

I'm kidding.

Josh, I think you should continue to see us be aggressive in our marketing next year.

I think you will see us tighten up our targeting a little bit because as you look at the increased shopping behavior we need to make sure our marketing is targeted towards those high lifetime and medium lifetime value customers as opposed to low lifetime value customers because we have much higher close rates when we look at those segments.

We'll make a few changes in some sponsorship stuff we're doing but you should expect to see us continue along with our stand approach with heavy advertising behind it and then broader local marketing.

You should also expect to see us introduce some new products next year to build on the success we have had in Your Choice Auto, Your Choice Home and Allstate Blue.

In terms of direct, you're correct, we have been looking for someone to lead that business for us.

In the meantime, George has that team highly focused on increasing volume and they have made great progress, continuing to increase that business this year.

Would it be incorrect or not yet known to say whether or not 2008 will be a higher year for ad spend at Allstate than 2007 or is that still not yet determined.

I would say we don't know yet, Josh.

I don't think you would expect to see it go down, given what is going on with media prices and things in the marketplace.

You wouldn't expect to see it go down given what State Farm, GEICO and Progressive are doing in advertising.

How big an increase it is is something we're still trying to work our way through.

Okay.

Thank you very much.

Our next question is from Dan Johnson of Citadel Investment Group.

Your question, please?

Thank you and good morning.

Could we talk a little bit about the reserve additions for the '05 storms?

Can you talk a little bit about what drove that?

And then secondarily, can we talk a little bit about if the releases from '06, or the releases that we saw in '06, were those related to '05 storms or '04 storms?

Thank you.

Dan, the increase that you saw this quarter, $57 million, as I mentioned it was related to expenses for those, basically, '05 hurricanes and principally Katrina as it's taking longer for those claims to be settled.

And we're forecasting out longer periods so it requires an increase and provisions for those reserves.

We've had some ups and downs in the reserve reestimates since the initial reserves were set following '04 and '05.

But net-net each quarter, again, we look at what is required and as of this point in time we think we're adequately reserved for both years.

Let me go back and ask the question here again.

The reserve adds for this year, you said you have, of course, higher expenses.

Are you talking about LAE or are you actually talking about higher loss expectations.

It's more LAE kind of expenses.

Great, and then from the storms from, or the releases from last year, were those driven by '05 adjustments or '04 adjustments?

There were some of both, as I recall, but I would have to take a good look at that, Dan, to be sure I'm not misleading you.

I can follow-up offline.

Thank you.

Great, thanks.

Yeah, thank you.

Our next question is from Charlie Gates of Credit Suisse.

Your question, please?

Yes, sir.

In follow-up to your comment or one of your's comments in your introductory remarks, pricing has stabilized in the local markets as competitors witness deteriorating results.

Could you elaborate on what you saw again in the third quarter because I think that was garbled?

I'm sorry, Charlie.

This is Tom.

The question that Jay asked or --

Yeah, just again would you go through basically how you saw the environment?

Sure.

I'll do it again.

What I did, Charlie was we looked at the price changes by state by competitor, right, in the stuff we have.

So I don't have everything they do but we can look at what they've done publicly.

And we just said simply, did State Farm increase it or decrease it?

And we did it both by company and by quarter, looking at states.

And what you would see is that State Farm took almost all decreases and I think there was like one increase that I saw.

GEICO took mostly decreases and maybe it was like 10%, 20% increases.

Farmers took a lot more increases than decreases.

And Nationwide was about equal.

So, what does that say in general is that you see most of the price competition coming from State Farm and GEICO.

You see other participants, like Farmers and Nationwide, in a different position.

And then you also have to factor in about half of the business comes from non-major carriers, if you look, because about half the business is there and that's where we get a lot of our business.

When you're looking at pricing you can't just focus on State Farm or GEICO, you have to look at the overall market.

When you look at it by quarter, Charlie, what you would see is the first quarter had three times as many decreases as increases.

You would see the second quarter had two times as many decreases as increases.

And you would see in the third quarter that there were fewer decreases than increases.

So what does that say?

It says that the number of decreases has gone down as we've gone through the year.

That's what we're exhibiting.

I don't know what that speaks for the future, but what I can say is that when you talk to the people in the local markets they would say that there's not -- the number of price decreases has moderated.

I put on top of that the Fast Track results, which only go through the second quarter, so you're kind of matching apples and oranges here.

That other companies appear to be having the same increase in frequency and severity that we have and on average it actually, in fact, looks like it's higher.

That tells us that we have the confidence to continue to stick with our strategy, which is innovative products for our customers, offering good value, charging higher prices when our cost trends tell us we should charge higher prices.

Is that -- is that?

That was great.

Thank you very much.

Sorry I garbled it last time, sometimes I'm trying to talk fast for you guys.

Our next question is from Michael Phillips of Stifel Nicolaus.

Your question, please?

Thanks, good morning, everybody.

I guess a good question following up from the last one here and it's the classic growth and margin question related to your standard auto business.

Your margins are, I would say, better than a lot of your competitors on the auto side.

You're growing yet taking modest increases where, as you just said, first quarter, second quarter, there were more decreases than increases.

So how do you think about -- one could say you could get more growth if you weren't taking some increases as much as you were and so how do you think about that balance.

I hear you with your goals for this year with 84 to 86 overall, but kind of going into next year how do you think about that balance?

Michael, thank you for the comment.

Actually it sounded positive, which is one of the first few things I've heard.

It was meant to be.

I feel good about the quarter.

It was a tough environment.

We're working hard but we're sticking to our guns and we're making good decisions.

And it's really -- our decision process is really the same as it's always been, which is we want profitable growth.

We're not going to grow and lose money.

We don't think that makes sense.

We think where we're at we can profitably grow from here.

We do recognize that the returns in the standard auto business have been high and that they were going to come down a little bit, which is why we talked about 84 to 86 through the year.

And we've said the average price increases will be less than what we think the frequency and severity increases will be in terms of total cost.

But we think we can manage our way through that and we feel like we are doing that.

And you can see that if you look at our average premium was up about (technical difficulty) percent this quarter, which is higher than it was at the prior quarter and higher than our competitors are.

I can't speak for what they're going to do, but I can say what we're going to do is we want to continue to achieve profitable growth.

Okay, that's fair.

You've been taking kind of these modest increases overall kind of in general for auto for a couple of quarters it seems like and all the while some of your major competitors haven't been doing so.

You're still getting that growth.

Can you talk about where the PIF growth is coming from in auto?

The PIF growth in standard auto?

Standard auto, yes.

In standard auto?

It's coming from - it changes by state, of course, and let me maybe come back to that the modest increase.

I think something George said.

George is doing this by state.

So each state has its own plan, its own strategy.

So in effect in New York we have 12 different strategies.

We have strategies for downstate, upstate, urban areas.

And so when you step back and look at it in total, we feel very good about our growth in the southeast.

California we're off a little bit, but still growing because we're in a debate with the insurance department as to what our prices should be, which we probably will end up lowering price in California auto.

George is shaking his head yes, sometime late this year or early next year.

But so California's off a little bit.

Texas is off a little bit.

New York, we're still doing well.

New Jersey we're doing well.

It varies by state.

The big states continue to be the battle grounds for -- with most of the companies, so each state's a different story.

I don't know how to really answer it other then to say we fight them each block by block.

That's fine.

I appreciate it, Tom.

Our next question comes from Matthew Heimermann of JPMorgan Securities.

Your question, please?

Good morning, everyone.

A couple questions.

First, it was about three years ago I think when you -- as you were going through your capital management thought process where you ultimately increased the dividend by, I think, about 20% after -- out of more 10% in previous years.

As we go into next year and given some of the things we are seeing in the margins and the like, are you rethinking the mix of buybacks or dividends at this point?

Matt, we always do it in February.

We sit down and look at the dividend.

Our track record has been to increase it every year.

We did do that 20% increase, which was really in reaction to the change in the tax laws.

Didn't appear to do much to stock price would be my answer.

So -- but I think you should expect to see more of what you've gotten from us, absent any change in the environment.

But right now we're feeling pretty good about the plan we have in place.

Dan's working away on finishing up the share repurchase program we have going.

If you look at the timing of that, we've kind of set that all up so it happens in the first quarter.

Another quickie was on the loss cost trend side, are there any differences between what you're seeing in Your Choice customers versus the rest of the book?

Why don't we let George take that?

No, actually we're not.

Your Choice we have a pretty good upsell, so we do see some small variations as far as limits to the values of the cars.

But as far as the year to year trends, no.

And then one final, if I can sneak it in.

There's been a lot of runoff companies that have been popping up in places to deal with asbestos.

Is that something -- would you consider trying to sell some of those reserves and has anyone approached you to date on that?

No one's approached us to try to buy it back.

I suspect we probably would not find that attractive.

Typically what happens in a lot of those times, people are trying to work out a balance sheet item and they want some indemnification as opposed to trying to guess what it is.

We think we're adequately reserved.

We like the money.

We like the processes we have in place now.

That said, we do go back and do commutations, which is in a sense the same economic answer that you're talking about and we do that all the time.

Maybe, Dan, you have some view as to what we're doing on commutations these days.

We continue to pursue opportunities to commute where it makes economic sense and negotiate settlements that are appropriate.

So, I think you're right, Tom, if somebody did want to come in and offer us a huge premium, though, we would certainly want to talk to them.

Fair enough.

Thanks.

Your next question is from Brian Meredith of UBS.

Your question, please?

Good morning, two quick questions here for you.

First one.

The BI severity, I know we've talked about kind of what is going on with BI severity in the call, the question I have is if the trends in BI severity continue here, what is the impact in reserving?

I think that has a much bigger impact on your reserving than let's say frequency would have.

Am I correct in that assumption?

We'll continue to look at what they are.

Overall, as we've discussed with you in the past, each quarter we do an in-depth review of our reserves by coverage, by state or groups of states, by report year to be sure that our recorded amounts are consistent with a paid and the current trends that we're seeing.

And this quarter as you saw we did have the $74 million favorable reestimate for auto claims severity.

So overall we think our severity trends are clearly within previous and current inflation assumptions and we'll continue to look at what the assumptions are if they change going forward and what the rate changes are they're able to get as far as pricing.

Right, but am I correct in saying that the BI severity is a big component of kind of what you're looking at and the determination of whether you've got a reserve release in the auto part?

We look at all of our coverages.

Again, as George indicated, a percentage of the book it's about 25% as opposed to property damage about 55% and weight it that way and see if you just look at the changes in severity for total auto for the quarter, that's a little less than 4% when you look at it that way.

Overall, again, we're very comfortable with where we are on inflation assumptions.

The difference, too, is we use report year in setting reserves.

What you see is paid, which has a mix of report years.

So it has got some '03, '04, '05, '06, '07 in it and it's just a -- double under -- triple underline what Dan said.

If Dan thought report year numbers were out of line he wouldn't have released reserves this quarter.

Got you, okay.

That makes sense.

Thank you.

And the second question, I noticed that your other underwriting expenses were up, I think, 6, a little over 6% this quarter versus being down the last two quarters.

Anything unusual in the quarter?

No, in terms of underwriting expenses we continue to be focused on underwriting expenses to make sure we have a competitive price.

A little more in marketing this quarter than in the prior quarters.

And also keep in mind that when average premiums are not going up much and you are paying people more, in effect what you see on expenses if you can keep your expense ratio flat you're actually increasing expenses at less than inflation, which we're doing by off-shoring jobs, technology work by cutting expenses in various parts of the business.

Great.

And the last question, homeowners loss mitigation you said, can you tell us some of the stuff that you're doing to try to get the severity number down?

Well, Brian, first, the severity number should be what it's going to be because we should pay the right amount for people.

We don't look at reducing severities as a way to improve profitability.

What we do do is look at the way in which we settle claims, our loss cost and that sort of stuff, and make sure that we have good, consistent processes that give customers the amount of money they need.

George maybe wants to talk about that in a second.

The other piece to it, though, is to the extent you feel like you have good control over your costs and what George also said or Bob, maybe Bob said in his comments, you look at the average price increases in homeowners and you'll see that there's a lot more there than there is in auto because we are reacting to these trends, which everybody else is seeing as well in a much less competitive market.

George, I don't know if you want to talk about claim practices.

Yes, the claim practices that I alluded to as far as bodily injury, we have had the same success, actually, in homeowners.

If you look at our Fast Track over a long period of time, we have significantly outperformed the industry.

One of the issues to keep in mind on severity for homeowners is changing deductibles and changing the value of the homes.

We've been writing more higher value homes.

You take those two factors together and mathematically that adds about 8% to 9% to severity.

The severity numbers that you see are also incurred severity or paid severity, they don't include the close without payment.

We've had an increase in that and when you adjust for that we're more in about a 10%, 11% range than we are in the higher range.

We're pretty close to what the inflationary pressures are.

Thank you.

But, again, we're taking rates wherever we think it's appropriate.

Thanks.

Our next question is from Tom Cholnoky of Goldman Sachs.

Your question, please?

Good morning, Tom.

I was -- I guess my question really comes down to your ability to actually get rate increases.

If I look at some industry data -- if you look over the last ten, 11 years, auto has kind of run around in the mid-70s loss ratio, you're well below that and I guess how do you sell rate increases to various state regulators when you're generating 20% plus ROEs, you're in the mid-60s or so in round numbers of a loss ratio.

I guess I kind of find it hard how you end up selling that.

Well, Tom.

Good morning.

First, I would tell you every state's different.

So in Illinois there's a lot of pricing freedom.

If you go to California, there's not as much pricing freedom.

Every one's different.

I understand that.

But in the states where you clearly have to get approval.

A couple of things are different, first, then they were back a long time ago, which is you see relatively modest or flat or in some cases declining prices in auto insurance in most states.

So that takes the political pressure off.

The phones are not ringing in the Department of Insurance and saying why is my insurance going up by 10% when I haven't had an accident.

So you have a much more benign overall environment in which to maneuver and make changes.

Secondly, the changes we're talking about are not so high that they're shocking anybody.

So if you take an average of $600 and you apply 5% to it, you're talking about $30 for 6 months.

It's not like you're bankrupting anybody by it.

Thirdly, there's a lot more price sophistication today.

Even seven or eight years ago regulators had much greater capability to be able to look and control the prices.

When you're using algorithms, which are very sophisticated, it is a lot harder for them to be able to get in and say, I don't want you to charge 575 in this particular area because the algorithms are a lot different.

So -- and then, thirdly, it's about -- lastly, I guess, it's about offering innovative products and what your overall price level is.

So, when you have something like Your Choice Auto, which is different than everybody else, and then you have to look at where your price is relative to the other people in the marketplace, and that's where I go back to the comment that Bob made and I made about we feel like we are competitively priced in the high lifetime value segments, which is where we want to be priced.

A lot of times people start talking about increases and decreases and they forget to focus on the fact.

We have this issue with some regulators, as well.

They forget to focus on the fact -- well what's the absolute dollars.

I've had conversation with regulators before where they will say X just took a decrease of five points.

And I'd be like, well, if I was high as they were, I would take a decrease of five points too.

The good news is we're a lot lower than them, so taking an increase is not necessarily a bad thing.

We feel like that's worked okay.

Is there pressure?

Yes, sometimes people make a political issue out of it so they can get some votes yes.

Will we have some places where they negotiate us down?

Yes.

But overall, do I think that changes our strategy of making sure we have good profitable growth at differentiated products?

No.

So should I think, when I think about your accident year loss ratio, should I think that this is the worst that it's going to get given that you're taking these aggressive actions?

Is that what you're -- ?

Tom, we moved away from giving guidance.

No, I understand that, but if you've fixed, if you have reported a certain accident year ratio and you're also telling us that you want to get rates up, it would suggest that you kind of reached an intolerable point with respect to any margin erosion.

That's the only conclusion you can come up with.

I can't answer that question because every state's different.

Right.

Secondly, the concept that we're at an intolerable point when we're earning the kind of returns we are in standard auto doesn't feel right to me.

We're earning good returns in that business and so it is not like if you had said to me we're losing money, then I would say yeah, that's intolerable.

If we weren't earning our cost of cap, I would say that's intolerable.

But given the returns we're operating at, I think we have earned the right to have the flexibility to run our business in a way that achieves profitable growth.

Right.

No, I'm just trying to understand where your goal is in terms of margins, that's all.

Okay.

Great, thank you.

Thank you.

Thanks, Tom.

Our next question is from Alain Karaoglan of Banc of America Securities.

Your question, please?

Good morning, could you remind us what are your financial goals from a return on equity point of view, operating leverage and financial leverage and essentially what does that mean in order to achieve these goals from a combined ratio in personal auto?

Well, I think that you -- boy, there's a whole bunch of pieces to that equation.

Let me start with the capital structure.

And what you see is we've had relatively modest leverage in our balance sheet and that's where we are today.

We've always said if we feel comfortable or if we need to we can take on much more debt than we have today but we have to have a good use for that money and we haven't seen that to date other than to continue to buyback shares.

So, if you want to start with a leverage piece.

In terms of the return on equity, I think our stated goals a long time ago were 15% return on equity.

And you can -- we've obviously done much better than that and we're not out quoting sort of what return on equity targets we have just like we don't want to give guidance for a year.

I don't want to back into guidance by giving you some other number.

Just suffice it to say that we like our returns on equity in the level they're at today and we're working hard to maintain them.

In terms of what combined ratio did that translate into, that would require us to -- we would have to be having a conversation about cats and all that kind of stuff.

But what I would suggest is if you need some help with your model, Bob or Phil can help you get through that.

Actually, I don't need help with the model, but, Tom, but I was focusing more that if your ROE goal is 15%, that would suggest that the combined ratio in personal auto could be well above where it is today and you can still achieve your goals.

And so shouldn't we expect some margin, and I know you like the margins and the returns today, but shouldn't it suggest that you shouldn't expect continuing margin deterioration going forward?

If you are suggesting -- we have not quoted a combined ratio goal, like some of our competitors, that we're seeking to get to.

We prefer the flexibility to run our business with looking at both profits and growth and how do we drive overall shareholder value.

We don't have a simple formula that we use that way.

Okay.

Thank you very much.

How about two more questions?

Our next question is from William Wilt of Morgan Stanley.

Your question, please?

Hi, good morning.

I'll just keep it to one quick one.

The source I was using for measured media spending had Allstate down about 15% year on year through the first half of '07.

I guess A, do you agree that that's order of magnitude correct, that decrease?

It is off of a pretty tough comp, because I think you increased advertising spend significantly in the first half of '06.

But A, is that directionally about right, and B, do you think that that might have contributed to the slowdown, albeit slight, in PIF growth in the first half or first three quarters of the year?

Thanks.

Bill, this is Tom.

First, on an overall basis we will spend more in marketing and more in advertising this year than last year.

When you are looking at '07 versus '06, in the beginning of '06, if my memory serves us right, we put a whole bunch of money in January and parts of February to put a launch behind Your Choice Auto.

Even though we didn't have it in all the states at that point, we made the call that we wanted to go out and pre-seed the market and get in.

That would just be a timing issue as it relates to that piece.

And what was the second part of the question?

Just wondering if you think that -- you think the, albeit slight, slowdown, you've explained part of it but do you think that that's contributed to the gradual slowdown in PIF growth through the -- ?

I don't think it is the decreased advertising.

When you get into sort of share of voice, share of spend, there is all kinds of different measures we use.

I would tell you, economically we like what our advertising and marketing is doing for us.

We think we are getting positive returns off it.

I think what you are seeing is with the increased levels of advertising in the industry, which you have talked a lot about in your reports, is really starting to drive more shopping behavior.

And that was where I said our quotes were way up in the third quarter and I suspect they can't just be because our advertising is good, I suspect everybody's quotes are up.

At the same time, if you look at our retention, it is down a little bit.

In the short-term I would prefer that our items in force had gone up in the third quarter rather than down 50,000 out of 18 million.

But I think it actually plays to our strengths, because as people are shopping we have something nobody else has, Your Choice Auto.

We have a great advertising program.

We have a great brand.

We got 30,000 people out there who only sell our stuff.

So I think on a longer term basis increased shopping behavior will work to our advantage.

Did it work to our advantage in the third quarter?

Hard to tell.

You can't do a variance analysis and get that close on 50,000 out of 18 million.

Is that it?

Yes, that's great.

Thanks very much.

Our final question today is from Jay Cohen of Merrill Lynch.

Your question, please?

Yes, two that haven't been answered.

The first is with Allstate Blue, when did that initiative really kick in and when would you expect to see the non-standard premiums begin reacting to it?

And then secondly, based on your conversations with reinsurance participants, would you expect to see your reinsurance costs going down in '08, assuming no major changes in the programs?

On Allstate Blue, George, we are in 11 states now and the -- .

Two more this year.

Two more this year -- and I'd say that's -- you should expect to see that business turn probably sometime late next year.

Does that sound right, George?

Because right now we are still losing more than we are adding.

But we will double the number of states in '08.

And towards the end of next year we should see an upturn in non-standards overall.

On reinsurance, remember we have some programs which come up for renewal this year, some of which are extended beyond that period of time.

But we would certainly expect that our reinsurance partners find a way to reduce our costs substantially since they have had a good couple of years here.

How about that?

And you can pass that along to them for us.

I'll mention it.

Thank you, we -- .

Won't do you any good, but I will mention it.

We could always use the help.

Great questions and dialogue.

Let me close with a couple of thoughts.

First, our multi-faceted strategy, good operational focus, and the decisive actions have enabled us to generate both attractive returns and meet our commitments.

And I don't want to go past that without saying we didn't really talk about investments this quarter, but we had a great investment quarter.

Secondly, the strategies where we are leveraging our brand, our market position, the investment capabilities, analytical skills work well in this environment.

Our consumer focus is differentiating versus our competitors and it is winning in the marketplace.

This is a very powerful Company.

We have a great team and we expect to continue to winning, so we will look forward to seeing you throughout the rest of the year.

Thanks again.

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

This concludes the program.

You may now disconnect.

Good day.