Allstate Corp (ALL) 2009 Q2 法說會逐字稿

Welcome to the Allstate Corporation second quarter 2009 earnings conference call.

(Operator Instructions) Later, we will conduct a question-and-answer session.

I would now like to turn the conference over to your host, Mr.

Robert Block, Vice President Investor Relations.

Sir, you may begin.

Thanks, Matt.

And good morning, everyone and thank you for joining us today for Allstate's second quarter 2009 earnings call.

Tom Wilson, Don Civgin and I will make some prepared remarks and then, we'll hold a Q&A session.

George Ruebenson, President of Allstate Protection; Judy Greffin, our Chief Investment Officer; and Sam Pilch, our Controller, are all available to assist us in the Q&A.

During that session, if would you limit yourself to one question and one follow-up, we can get to more people during our time together.

Last night, we issued our press release, the majority of our investor supplement and our 10-Q.

We also posted the slide presentation that will be used in conjunction with our prepared remarks.

All of these documents can be found on our Website.

On slide one, you will find our Safe Harbor statement.

This discussion may contain forward-looking statements regarding Allstate's operations.

Actual results may differ materially, so please refer to our Form 10-K for 2008, our second quarter 10-Q and our most recent press release for information on potential risks.

We'll also discuss some non-GAAP measures, for which there are reconciliations in our press release and on our Website.

This call is being recorded and a replay will he be available shortly following the call.

As always, Christine Leuter and I will be available to answer any further questions you may have once the call is completed.

Now, let's begin with Tom.

Good morning.

Thank you for your continuing interest in Allstate.

This morning, I'll talk about our overall results.

Bob will discuss business unit trends and Don will cover our investment performance, capital and the minor impact of adopting FAS 115 accounting standards.

I will keep these comments brief so that we have plenty time to hear your comments and questions.

Moving to slide two, we have three priorities for 2009; keeping Allstate financially strong, improving customer loyalty and reinventing our business for the consumer.

We made great progress on the first two of these objectives in the second quarter and through reinvention are laying the foundation for growth.

On the first priority, we continue to build financial strength by generating operating and net income and aggressively managing both the investment portfolio and capital.

Operating income was $297 million despite the continued catastrophe losses that exceeded historical standards and our expectations.

The auto business had a combined ratio of 94.9, which was up from last year's second quarter primarily due to higher frequencies.

Our homeowners business had an unacceptable combined ratio of 116, primarily due to higher catastrophes.

We continue to work on improving profitability and obtained rate approval for rate increases in the quarter, averaging 13% in 16 states.

That raises overall country-wide premiums by 1.7%.

The underlying combined ratio for Allstate protection was 87.2 for the quarter and 88.1 for the first six months, which is in line with the annual range that we provided you at the beginning of the year.

Net income was $389 million, reflecting excellent investment results.

On the risk mitigation front, we continued reducing commercial real estate exposure, we're now down about $2.2 billion for the year.

We reduced the duration of our portfolio to protect against higher interest rates, which also paid off in the quarter.

On the opportunity front, we've maintaining significant exposure to credit spreads, generated substantial shareholder value, generating capital gains, reducing unrealized losses and consequently, increasing book value.

We put over $5 billion of excess liquidity to work as improvements in the markets increased liquidity of our other investments.

We benefited as equity prices rose and made some excellent choices on our hedging program.

Allstate Financial made additional progress in reducing its expenses and downsizing the balance sheet in the quarter.

Annual expenses have been reduced by $65 million and we remain on track to lower annual expenses by $90 million by 2011.

We maintained good pricing discipline in fixed annuities and proactively tendered for institutional market obligations.

The net was that we reduced contract to hold the liabilities by almost $9 billion since June 2008.

Allstate Financial's operating income was $65 million in the quarter, a $53 million decline from last year's second quarter.

This was due to lower investment spreads, reflecting the downturn in the financial markets, abnormally low short-term interest rates and downsizing of the balance sheet.

All of this raised book value by $5 per share or 23% during the quarter.

Capital levels also increased, which Don will cover.

We also continue to make progress on the priority to improve customer loyalty and did better than the competition this quarter.

Ultimately, this should lead to increased retention rates, which will enable to us grow market share.

We made decent progress on reinventing our business but most of our focus has been on the first two priorities so far this year.

Your Choice Auto continues to do well.

Allstate Blue is targeted towards higher risk drivers and new business is up significantly.

The emerging businesses are growing by focusing on redesigned products such as motorcycles, boats and mobile home insurance.

Our acquisition of the partnership marketing group from GE, which doubled the size of our motor club business, is also exceeding expectations.

In summary, we operated our business with precision in a difficult weather and economic environment and continue to make progress on all three of our strategic priorities.

Bob will now go through the results in more detail.

Thanks, Tom.

On slide three, the net written premium for property liability, at $6.6 billion, declined 2.8% from the prior year quarter.

Continued declines in overall units, as well as consumers managing their insurance expenditures, contributed to the drop.

Here are some of the key trends.

In Allstate brand standard auto, units are essentially flat since January 2009, as the inflows of new business essentially matched the outflows from the in-force book.

Average premium increased slightly in the quarter, as approved rate increases of 4.3% in 12 states were partially offset by consumers' actions to lower their premium levels.

We are maintaining our discipline in terms of pricing while exploring ways to provide consumers more choice in their auto insurance options.

Retention at 89% was off slightly from prior year levels as this ratio shows signs of stabilizing.

We continue to see strong new business trends with issued application growth of 11% in the quarter.

And just as a reminder, new business accounts for only a small portion of the net premium written.

For homeowners, net premium written was flat compared to the second quarter of 2008, as increases in average premium and retention offset the unit declines.

On a before reinsurance basis, premium written declined 3%.

We continue to file and gain approval for rate increases as we remain committed to getting this line back to acceptable margins.

Emerging business personal lines grew nicely in the quarter, about 6% year over year.

Finally, commercial lines and encompassed net written premium declined as we continued to improve the margins in those businesses.

Shifting the conversation to margins we recorded combined ratio of 100% as we experienced another quarter of abnormally high catastrophe losses.

The underlying combined ratio of 87.2% remained within our expectations.

On slide four, we provide a graphical display of our catastrophe losses for the second quarter and the first six months.

On both an absolute dollar level and on an percent to earn premium level, 2009 results were the highest on record.

While second quarter weather activity was down, according to the National Weather Services, the severity of events we experienced increased dramatically, similar to our experience in the first quarter.

In the quarter, we experienced a total of 31 events, five of which produced estimated losses of $50 million or more each.

For Allstate brand homeowners, the overall combined ratio remains unacceptable at 116.3%, as catastrophe losses as well as non cat weather continues to pressure this line.

On a non catastrophe loss basis, frequency rose 2.7% while paid severity went up 7% in the quarter compared to the second quarter of 2008.

We continue to take rate actions in order to bring this line to acceptable levels of profitability.

Slide five depicts our auto loss trends.

Bodily injury and property damage reported frequencies rose dramatically compared with the second quarter 2008, up 13.6% and 5.1% respectively.

We talked last quarter about expecting elevated levels of frequency increases to prior year for the balance of 2009, due to the abnormally low frequency levels experienced in the last three quarters of 2008.

As you can see on the left side of the chart, 2009 frequency levels have returned to those experienced prior to 2008.

We watched these results closely and reflect the trends in our pricing indications as appropriate.

Partially offsetting the higher frequencies, auto paid severities posted very low increases to prior year, with bodily injury up 0.9% and property damage rising 0.5%.

In fact, the paid severity trends over the last several years have been very manageable, particularly for property damage.

It's the combination of frequency and severity that determines the losses or the pure premium.

Over time, the pure premium increases have been reasonable.

With our disciplined pricing process, filing for and gaining approval of small amounts of rate increases enabled us to maintain margin.

So as shown in the lower right-hand corner of this slide, the auto combined ratio, while up relative to prior year, remains profitable.

Lastly, we have proactively managed expenses in the face of declining revenue.

Excluding restructuring charges, the expense ratio declined by 0.4 of a point from the second quarter 2008, as we took aggressive actions to maintain efficiencies throughout the organization.

Slide six details the results for Allstate Financial.

Our Focus To Win program is progressing well.

Premiums and deposits were well below second quarter 2008.

We kept our pricing discipline on new business where crediting rates are below that of our competitors.

Also, we issued no institutional markets business this year, compared to $2.5 billion issued last year.

Operating income of $65 million in the quarter was $53 million lower than the second quarter 2008.

The benefit spread improved slightly, primarily due to higher premiums on accident and health insurance business sold through the Allstate workplace division and favorable life mortality.

Investment spread fell primarily because of lower average investment balances and proactively maintaining higher liquidity levels, hence lower yields.

The Focus To Win program has resulted in run rate annual expense savings of $65 million out of an expected $90 million.

That concludes my review of the business units.

Now, Don will cover investments and capital.

Thank you, Bob.

I'm going to cover the investment portfolio and results during the quarter.

I'll talk about the progress we've made on capital and liquidity levels and briefly cover the effects of FAS 115-2.

Our ongoing proactive programs, to strategically manage risk and return, paid off as the markets rallied in the second quarter.

Slide seven displays our portfolio mix at the end of June 2009.

The value of our portfolio increased during the second quarter by $2.6 billion to $96.5 billion at quarter end.

About 3/4 of the portfolio remains invested in fixed income securities, of which 93.6% were investment grade rated.

Some key points.

We continued to reduce our exposure to commercial real estate, down $1.2 billion in the quarter.

This follows a similar reduction in the first quarter.

We continue to reduce our exposure to rising interest rates decreasing the overall duration by 8% in the quarter, again similar to first quarter decrease.

And our position on maintaining exposure to credit paid off as spreads continued to tighten during the quarter.

All three of these were the right calls this past quarter.

Also, as the markets stabilized, we took the opportunity to invest more than $5 billion of excess liquidity into higher yielding securities in order to generate future income and capital appreciation.

Slide eight provides a quarterly tracking of net investment income and realized capital gains and losses.

The shortfall in net investment income relative to the prior year quarter primarily reflects the negative effects of lower yields and lower average investment balances.

The lower yields were exacerbated by our decision to maintain elevated levels of liquidity in anticipation of more stable market conditions.

And as I said, during the second quarter we began to invest some of that liquidity, which should generate additional income and capital appreciation in future periods.

We produced $328 million in net realized capital gains in Q2 2009, a $1.5 billion positive swing from Q2 2008.

$263 million of gains were generated from sales, mainly of US and foreign government fixed income securities sold in anticipation of rising interest rates.

Offsetting realized losses resulted from impairment write-downs of $291 million, limited partnership valuation losses of $37 million and $26 million of intent losses.

$419 million came from net gains on derivative instruments, including the favorable benefits of our proactive macro hedging programs.

While higher rates generally hurt our fixed income portfolio valuation and rates did increase during the quarter, our strategy to hedge those risks created investment gains.

Unrealized net capital gains and losses are displayed on slide nine.

Our position improved from March 31 levels by $3.2 billion, before the effects of the accounting change are included.

You can see that the majority of the improvement came from our corporate portfolio, which is the largest asset segment we have.

I would point out that while the unrealized loss position in the structured portfolio also improved during the quarter, the benefit was more modest.

The adoption of FAS 115-2 increased the unrealized loss balance by $1.1 billion.

The vast majority of the unrealized loss position remains in fixed income securities, of which nearly 2/3 are investment grade rated.

With our highly rated fixed income portfolio continuing to throw cash to us, $2.4 billion this quarter, we expect to hold these assets until they recover in value.

As a hedge against unanticipated asset sales, we continue to hold sufficient levels of liquidity.

Moving to slide 10.

As Tom said earlier, our first priority for 2009 was to keep Allstate financially strong.

Through the first six months, we've made good progress, with shareholders equity growing to $15.1 billion, up $2.8 billion in the second quarter.

We held $3.4 billion in deployable assets at the holding company level and continue to have access to $1 billion of funds from either commercial paper issuance or an unsecured credit facility, neither of which were utilized at June 30.

AIC's statutory surplus is estimated to increase by $700 million in the second quarter 2009.

And estimated statutory surplus for AIC and ALIC remain at adequate levels.

Our continued focus on liquidity paid off this quarter as well.

We estimate that we have $26 billion of liquidity we could raise within one quarter without generating additional significant net realized losses.

This, in spite of the progress we've made putting substantial amount of our assets back to work.

Further signs of strength came in the second quarter when we accessed the capital markets in May to refinance our debt maturing in December of $750 million.

The offering was substantially over subscribed, so we raised it to $1 billion and came in at attractive interest rates.

During the second quarter, we made significant progress in strengthening our financial position.

Our capital and liquidity levels increased.

We hold a significant amount of deployable assets at the holding company.

We have full availability of our $1 billion line of credit.

We were able to access the credit markets successfully.

Market conditions have improved, leading to higher asset valuations.

And we have a minimal amount of debt maturing over the next three years, most of which comes due in 2012.

For these reasons and our confidence in the earnings power of the Allstate franchise, we feel good about our capital strength and accordingly, we declined the offer of TARP funds.

Finally, slide 11 documents the overall effects of adopting FAS 115-2.

Essentially, the adoption resulted in a reclassification of $1.1 billion of previously, other than temporary, impairment write-downs.

Net of related DAC and tax adjustments, the impact was an increase in retained income, a decrease in unrealized net capital gains and losses, with a net benefit to shareholders' equity of $285 million.

There was no impact to the income statement as a result of this reclassification.

Tom.

So in summary, it was a good quarter.

We made progress in all three of our priorities.

We made money and strengthened our capital position.

Our customer loyalty results improved overall and relative to the industry, which should lead to more referrals and better retention in the long term.

Our reinvention efforts continue as we pursue new ways to satisfy customers' needs for both protection and retirement.

With that, Matt, let's begin the Q&A session.

Thank you, sir.

(Operator Instructions) Our first question is from the Jay Gelb from Barclays Capital.

Your question, please.

Thanks, good morning.

Tom, what do you feel is a reasonable return on equity expectation for Allstate in the current environment?

We look at the long-term return on equity, Jay, and we've been targeting 15%.

What do you think it will take to get it back there on the core business?

Well, I think there are two businesses that we need to improve the performance on.

One, is the fixed annuity business.

So, if you look at our fixed annuity business at Allstate Financial we used to make about $125 million a quarter.

It's now down to break even or slight loss.

So we need to either downsize that business or reposition it.

We think we -- and we have some ideas on how to reposition it in terms of offering different product, still helping people for retirement but not the traditional products that have been used in the past.

And then secondly, we have to improve our homeowners business and get the combined ratio below 116.

If you look at our historical results on auto, you'll see that we've always generated an extremely high return on -- or not always but for the last decade or so, extremely high return on capital in that business.

And of course, that's 2/3 of our business.

So we feel good about that business continuing forward from here.

So you feel auto is generating in excess of 15% returns?

It is, yes.

And then on the capital position, you mentioned in the prepared remarks the decision to decline the TARP equity.

My sense is that would make Allstate the only Company with a life operation to decline TARP and then not go out and raise common equity.

Is there anything that would change your position potentially on that decision?

Well, we've turned down TARP.

We're comfortable with our capital when we turned it down, which was in the first quarter or right after the first quarter.

We've continued to build capital, so we don't have any anticipated need to raise capital at this point, either from the government or in the market.

All right.

Thank you very much.

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

Your question, please.

Great.

Thank you very much.

Let's see, for the two questions, let's start with the unrealized loss position on the balance sheet.

I think we're looking at -- we're down to just, what, a little over $4 billion or so remaining, if I'm looking right on the balance sheet?

And the question related to that is, with the shadow DAC that went up this quarter, I was thinking it would have come down because we would have had the -- my basic understanding of how that worked was, as we took out the unrealized losses, we would also lower the DAC asset that we put up against the losses when they were created.

So could you help me with what went on in that shadow DAC category?

And then, if we eventually got rid of some percentage of these unrealized losses, how much of that would actually come through to the book value versus how much needs to be offset by the shadow DAC asset?

And I do after follow-up after that.

Thank you.

Okay.

Dan, this is Tom.

I'll start off and then, Don will fill in on shadow DAC.

First, we label them as unrealized because we think they are unrealized, and we don't expect them to be realized.

So it's merely a mark-to-market on one half of the balance sheet, called the asset side, since we don't mark our liabilities to market.

But when we -- because we don't believe those will be realized, we then try to show what the net impact would be had they been realized but we don't expect them to be realized.

So to your question of if we don't realize them, we don't expect to realize those as losses.

It will take some time on the structures in particular, so the -- I think it's about $3.5 billion of the amount is really due to RMBS, CMBS.

It will take some time to work that way through the system but we still don't expect to lose money on those other than the amounts we've already written down through the income statement.

Don, you want to talk about shadow DAC?

Yes, Dan, I think there's a couple of answers to the question.

First of all, shadow DAC, obviously, is there to mute the impact to the balance sheet and equity lines of what happens on the unrealized loss or the unrealized gain.

I think the answer to your question is that previously, when you looked at prior quarters, the shadow DAC was -- the amount that we were booking was actually capped.

And so the answer to your question is you have to take into account that you can only book shadow DAC up to the original amortized cost -- the original cost, essentially.

And we were not at that level.

Furthermore, when we transferred the assets to OCI from the adoption of 115-2, we reduced DAC balance by $180 million associated with it, which also went to increase shadow DAC.

So I think those two answers are probably the piece you're missing.

Yes, I'm probably a little slow, so I didn't quite get all of this.

So, maybe we'll try just a bit different.

On page nine of the supplement, or maybe you want to direct me to 10, I'm not sure which of these two pages, where do we see the amount of shadow DAC that's sitting on the balance sheet?

Because I see the total amount of DAC but where do we see the piece that's related solely to the remaining unrealized losses?

So then, that way, if we wanted to assume that unrealized losses went to zero, we'd know how much to actually offset on the other side?

That was the gist of the question.

Dan, if unrealized losses go to zero and we don't realize all those losses, the net impact on the balance sheet is the number that's -- if you go to the balance sheet, $2 billion that rattles through.

And that is the gross unrealized.

We get all that money back.

But then we write off DAC associated with it and we don't have any tax savings associated with those losses, so the deferred tax asset goes down as well.

So if you're really trying to get to what the net impact on book value is I think you should just look at the balance sheet itself and the net amount on unrealized losses.

I think maybe what I would do is, if you want to work through the specifics of where it is in the investor supplement and the 10-Q and all that, let's have --.

We can follow up later, is where you're going.

Then on the follow-up was just, where are we comfortable in running the premium to surplus levels on the P&C Company?

I know that's not the most sophisticated metric but we don't have a whole lot to go with.

It's not the most sophisticated metric and it's not the way in which we run the Company.

It's clearly one of the measures that we look at in determining what economic capital is but we look at economic capital from several different ways.

First, we look at what the risk of ruin is.

And so we have pretty high -- or low tolerance, so we run a large number of scenarios and have a low tolerance for risk of ruin.

That's one standard.

The second standard is; under what case would you need to go get money?

That's a -- and the third standard is; How do you maximize shareholder value?

We look at all three of those measures and we select an economic capital by line of business to determine how we want to run the business.

So when you look at the auto business, if you look out at the external world, you would conclude in item two, you could probably run that business at 3 to 1.

If you look at the homeowner business, you would conclude that the number has to be lower than 3 to 1 because of the volatility in item one, that is the risk of ruin.

And trying to maximize shareholder value becomes a little bit of a challenge at the current combined ratios, which is why we're trying to improve that business.

And you could go through similar kind of analysis for the various product lines in Allstate Financial, which is what we do.

So we spend a lot of time on economic capital.

We use that to drive our decisions on where we're putting our resources and what profit improvements.

When you sort through all of that Dan, if your question is really; what businesses do we like the most right now?

We love our auto business.

It's doing great.

Frequency is a little bit this quarter but on a trended basis, that business is doing quite well.

Our life business is working quite well, and as I said, our emerging businesses are working quite well.

We still have some work to do in fixed annuities and homeowners.

Thank you very much for taking my questions.

Thank you, Dan.

Our next question is from Bob Glasspiegel from Langen McAlenney.

Your question please.

Good morning.

PC investment income, we've got some moving parts of dividends up, perhaps reducing short term and reducing duration at the same time.

Sort of who wins the battle of sort of those three forces going forward, as far as direction in investment income?

Good morning, Bob.

Let me make sure I get the three parts.

So you had reducing duration was part one.

What was the other two?

Reducing short-term assets.

I assume you're reducing some liquidity at PC as well, maybe not.

And dividends up to the parent.

Well, first, we look at -- let me deal with the third one first and then, I'll make a couple of comments about how we manage risk.

And maybe Judy can talk a little bit about where we're investing money today.

First, in terms of dividends, the dividend -- we look at investment income in total for the whole Company.

Where we move money between entities is really a regulatory and capital management perspective, which Don runs.

So to the extent we can take money out of Allstate Protection and Allstate Insurance Company and move it up to the Corporate, that's really a capital management effort, not an income basis.

So it could be invested in the different things.

On the reducing the duration and short-term assets, reducing the duration was part of our risk mitigation program.

We've done that largely in the protection business because in the Allstate Financial, of course, we have a lot of asset liability matching.

And so, the net economic exposure in Allstate Financial is still large but we needed to focus first on Allstate Protection.

So you will he see a shorter duration in Allstate Protection.

In terms of investing the short-term assets, we really try to do all of these things on what's economic, Bob, as opposed to trying to get to a quarterly investment number.

Judy, maybe you want to talk about where you've started to put that money back to work?

That's the $5 plus billion.

Sure.

On the $5 billion, it's -- if you look at it, we've put about 80% of it in fixed income, which much of that is in our traditional fixed income investing, high-grade corporate, municipal bonds.

We also bout some TIP's, some sovereign debt and to a far lesser extent, some discounted securities where we felt that we had a good handle on what was going on with those particular securities.

So the vast majority of it went into fixed income, which will earn operating income and the yields were approximately 6% on the fixed income portion.

The balance went largely into equities, about 15% of it went into equities and that was split between domestic and foreign equities.

And then a small portion of it, we went into hedge funds and that was largely a call on looking for global macro hedge funds.

Okay, thank you.

My follow-up is, Encompass is showing more a significant premium decline than your other segments and is over 100.

Where do we stand sort of in your sort of IA strategy from here?

Just fix it, get the underwriting right and don't worry about the top line?

Or is this potentially an area where we could see some growth looking out?

Bob, since that follow-up is so directly related to investment income, I'll have George answer it.

Bob, thanks for the question on Encompass.

It's nice to get back to the operations.

What happened last year is we started showing some significant growth in Encompass.

Unfortunately, it wasn't in the quality of business that we wanted.

And because of that, we've intentionally cut back on the number of producers that we have, some areas that we're servicing and we're taking rates necessary.

We're still committed to the IA business.

Encompass is still part of the portfolio.

But as Tom said, the number one priority for Allstate is to keep Allstate financially strong.

And because of that, we are diminishing our prospects for growth right now.

Thank you, George.

Our next question is from Matthew Heimermann from JPMorgan.

Your question please.

Hi, good morning, everybody.

Just a quick question.

As you look at the economy going forward, I'm just curious whether or not there are any issues if the economy recovers with respect to inflation, that you have your eyes on in particular?

Especially given that, obviously, auto continues to kind of be the ballast of your operations while you're trying to take care of the homeowners issues.

So, just curious about that.

Let me go way up and then, I'll come down pretty quickly.

First, in terms of the overall impact on the Company, of the economic environment, of course, most of it shows up in investment portfolio.

There are small ups and downs that show up in the property/casualty business.

Fewer new car sales, people adding fewer additional cars to their personal fleets.

Fewer home sales, which give us less opportunity to quote on new business.

A slight uptick in theft in homeowners.

But these are all small, manageable and just work through.

We deal with those in the way we deal with the rest of our business, which is proactively and upfront.

So we feel pretty good about that.

With respect to inflation, last year -- first, we started our risk mitigation and return optimization work back in 2007.

So this is a -- we're a couple years into this.

And back then, we decided we needed to reduce our holdings in financial services companies, a lot of the banks and we did that.

As we moved forward on that, last year, we did some scenario planning and looked at a couple of different scenarios.

One was deflation, one was inflation.

And the one that, of course, that can really hurt a large fixed income investor like us is inflation.

That's why we started to bring our duration down, even though it has a substantial hit to operating income.

So while nobody believes interest rates were going to take way off, of course, they're up 90 basis points in the second quarter, we were not hedging in close on those.

Our hedging program was really for big, large macro moves, up 300 basis points, because we didn't want to have additional unrealized losses in the portfolio.

We are still concerned about inflation.

We continue to reduce our duration and are willing give up operating income to do that.

And it is not insubstantial amounts of operating income but we believe when you look at the balance sheet driving in the results this quarter, first, were spectacular driving book value by $5 per share.

But we still believe it's the right economic choice to make.

Just to summarize, it's fair to say that to the extent there were any pressures on loss trend that emerged from a pickup in the economy, if we think about the duration of your portfolio and leverage the short-term yields, we should kind of think about those things potentially offsetting?

I'm not sure I get to the offset.

There's some math required in that piece, which I'm not prepared to do right now.

I would say, to the extent there are inflation in the bond portfolio, that reduces the value of the bond portfolio.

And we're take proactive steps to minimize that impact while still earning some money.

In terms of inflation in severities, we're not seeing that in our business today.

If you look at the auto business, the paid severities are quite low.

And that's both in the physical damage coverages and in bodily injury.

Now, frequency is up.

So as Bob talked about a little earlier, you've really got to do the multiplication because those things bounce around a little bit.

So, it's better to do multiplication.

But in total, Matt, our loss costs associated with the auto business are well under control and we're not seeing runaway inflation there.

Nor do we see trends that lead us to conclude that in fact it's coming.

In the homeowner business, of course, frequency is way up because of the weather and we need to reflect that in our pricing.

We're working hard on doing that.

But if you look at the loss cost themselves, we're actually not seeing the downward move in building materials and labor costs that we felt we would in this environment.

Given that so many -- so few less houses being built, we would have thought that construction labor and drywall prices and that kind of stuff would have come down more than they have.

They have not.

But that, again, if you look at our combined ratio, the big challenge there is we have to just raise prices but it's not runaway inflation.

Okay.

And then, just on the demand side with respect to government programs, either healthcare or Cash for Clunkers, is either of those have any impact, either on how you think about loss cost trends over time?

I know it's really days.

Or two, just what you'd expect to see with respect to fleet and average age of fleet insured?

Well, I'll do healthcare, George can do Cash for Clunkers.

In terms of healthcare, of course, very little of our actual claim payments are made for directly for medical expenses.

And so, about 55% of our auto insurance premiums go out as physical damage stuff.

Only about 25% is bodily injury and a large portion of that is for suits and litigation and damages we pay to people, as opposed to direct medical costs.

Those sometimes can be based on medical expenses, so they are somewhat related to medical inflation.

So we'd have some exposure but depending what comes out of healthcare, what we're seeing is not, perhaps, programs being -- they may drive overall increased costs for the country in terms of healthcare.

We're not seeing trends that would raise individual treatment costs up.

In fact, I think what you're seeing now is a debate on how to get the individual costs down, so that people can pay for their broader coverage.

With regard to Cash for Clunkers, the program itself has only been out for a couple of weeks but in the short term, we are experiencing an increase in additional change car.

People are buying more cars and they are retiring the clunker.

What happens with that is that the average premium goes up and they are also opting for coverages that they had declined before.

So they're putting collision and comp on it.

And they're being more careful, I think with some of the deductibles that they have.

But it's pretty early to tell.

It's a small part of the business.

But I do think that replenishing the fleet is probably good for us long-term.

The newer cars are safer and I think the long-term trends will benefit from additional new car turnover.

Thank you.

Our next question is from Paul Newsome from Sandler O'Neill.

Your question please.

Good morning, everyone.

I'm having a little trouble understanding what seems like a recent trend in increased cat losses, particularly the sort of non-hurricane cat losses following what appeared to be a couple of years of very significant efforts by Allstate to reduce PML's and improve their sort of overall exposures.

I buy that some of this is due to Midwest storms that are up a little bit but I'm asking, is there something going on with terms and conditions that may have changed?

Is there a possibility that you ended up sort of swapping hurricane related exposure for more Midwest cat exposure?

Because it does seem like we are having a much higher severity for these Midwestern storms than we've seen for awhile.

Paul, let me start and maybe, George, you can fill in.

First, as we've said, we have unacceptable levels of profitability in the homeowner business paying out $0.16 cents for every $1 you take in is not a strategy for success.

And we're working hard on improving that situation, in large part, by increasing rates.

We did look in 2005 at the profitability and risk return profiles of the entire homeowner business.

We broke it into three categories.

One, which you mentioned, hurricanes and earthquakes.

Two, non model cats.

Three, slip and falls, kitchen fires, broken windows, stuff like that.

When you looked at the profitability, we concluded that in item one, that hurricanes and earthquakes, that that was not a good business for us.

And so, we set about a massive program, which you're familiar with, which is basically to divest ourselves from that line -- that coverage.

Some of that's reinsurance, some of it's deductible, some it's not offering continuing coverage to people, getting smaller in Florida.

All the things we've talked about for the last decade.

In bucket two, the non model cats, they bounce around a lot but over a longer period of time, three, four, five years, that is a profitable business.

It is what customers want insurance for but it's a little more volatile.

So we've been working to make sure we get that properly priced.

On the baseline business, that's a lot like homeowner -- or like auto.

That's just very good business.

We know how to underwrite it, we know how to service those claims well and efficiently and we make good money there.

So you are right, it has bounced around a little bit.

2006 and 2007 were very low years.

2008 and 2009 are ones we're not happy with.

And George can talk to you about the things he does to control those exposures on a regional basis.

But we have not swapped, so it's not like we quit writing on the coast and we wrote a whole bunch of stuff in hurricane alley and Oklahoma.

So we didn't swap but George can talk about the things he's doing to make sure we get the right return on that business.

To reinforce what Tom said, Paul, if I could take you back to slide four in our presentation, you can see we have a 15-year average of catastrophes in the first half of the year.

Catastrophes in the first half of the year are predominantly non model.

The only modeled cat that you could have in the first half would be an earthquake, which is what we did have back in 1994.

But ex that, if you look at it, the results for the last two years, both '08 and '09, are more than twice as bad as any other year in the 15-year period.

We do have a meteorologist on staff.

We have been checking with him to see if there's any changes in weather patterns that we would need to do to adjust what our exposure is or our pricing mechanism is.

He says there is not.

It appears there is some inherent volatility in the business itself and a lot of this could be just bad luck.

That is not acceptable to us, which is why we're take rates and looking at our risk profile in the central part of the United States.

But your statement that it was just a little bit worse, we've had, in the country, $11.1 billion dollars worth of natural disasters in the first half of the year.

I want to go back over that.

On a national underwriter, two weeks ago, they said it was $11.1 billion.

We have 10% of the market, we pick up about $1 billion, so our exposure is about the same.

We've done a real good job, I think, on handling non modeled cats, buying reinsurance, reducing our exposure, eliminating our exposure in places like Florida.

We have not concentrated very much on the heartland, because our loss profile has been pretty good up until the last two years.

Having said that, we are going to take rates aggressively to return this to profitability.

So in your view, it's really just purely a rate issue on non model cats.

It appears to be.

We've found by looking at changes weather patterns that the water in the Atlantic and in the Gulf of Mexico did get significant warmer over the last few years, which does fuel more severe hurricanes.

We have not seen any significant change in weather patterns in the heartland of the United States that would lead to us believe that this is a long-term trend.

Paul, and I don't want you to think, though that there's -- George is always doing things like looking at types of roofs we write, the age of the home.

So there's plenty of operational excellence things that go on that would go on whether we had a lot of cat losses or not.

This might put a little more heat behind those.

But we're always working to try to make sure we get the right price for the right risk.

We don't want to charge people too much, nor do we want to charge them too little.

No.

And we do look at it on a local market basis.

It's not just state by state but it's also market by market within those states to make sure that we're not overexposed or that our pricing is out of whack.

Thank you.

I'll look forward to getting my higher homeowner insurance bill.

Just buy your auto from us and we'll be in great shape.

Our next question is from Meyer Shields from Stifel Nicolaus.

Your question, please.

I'm going to continue to beat the drum on the catastrophic losses.

In the supplement, you showed that the country-wide impact of homeowners rate increases in the quarter was 1.7%.

Can you give us a sense what that needs to be to get the non model cat rate provision about right?

Meyer, the way we have to get that right is to get it to an underwriting profit and that's more than 99 -- or less than 99 as a combined ratio.

I think, to give you some sense.

It varies, of course, obviously by state.

But if you look at the last three quarters in that supplement, in fact, you'll see a steadily increasing overall increase in the amount of rates, both by individual state and in terms of the country-wide average.

You should expect that trend to continue until such time as this business makes money.

Okay.

Do you have -- can you give us a sense of the elasticity of demand.

In other words, do homeowners -- do multipolicy customers care that much about homeowners rate increases?

Is that going to start to affect retention?

Maybe to answer it, I'll answer it both from a macro homeowner sense.

George, maybe you want to answer what you have going to make sure we protect those multiline customers.

In terms of overall price sensitivity, homeowners in general is less price sensitive than auto insurance.

There's a couple of reasons.

One, is people value their homes a lot and they really want the best coverage.

So when you look at your choice home, we sell much more platinum coverage there than we do for auto insurance.

Which tells you that people value their homes, want to pay to protect their homes and want the right kind of coverage.

So it's not nearly as price sensitive from that standpoint.

Secondly, I would say there's not nearly as much advertising going on in homeowners insurance about low prices.

And third, most people buy this indirectly through -- and their mortgage companies pay the bill, so they're not writing the direct check every month.

So it also tends to be less -- they don't see it every month and so they don't -- it's not as price sensitive.

So, I would say homeowners in general is less price sensitive.

George, maybe you want to talk about what we're doing to make sure we take care of our multiline customers.

Yes, multiline customers get a discount.

And what we're trying to do is reinforce that with everyone who does have insurance.

And even for people who have mono lines, we have customer contact programs where we'll call the customer and explain if they would migrate to higher deductibles there is a way to manage some of these rate increases.

It has proven in the past to be very successful.

If you go back to the beginning of the decade, we took significant rate increases.

A lot of it was because of what happened in Texas and mold and different things that were migrating throughout the country.

And we do know how to moderate these rate increases, especially for our high-value customers.

Okay.

That's very helpful.

Thanks so much.

Our next question is from Josh Shanker from Citi.

Your question please.

Thank you, good morning.

Following up on Jay Gelb's question, I'm wondering if you guys can talk about the way you view capital cushion a little bit?

We've talked about how much capital you have and you how you're confident in that.

But what would make you under confident?

Is there any metrics you can give us around capital cushion per se?

Josh, we don't give out what we think is excess capital but I think you could get to it different ways.

We look at the two insurance companies.

We have Allstate Insurance Company, Allstate Life Insurance Company and then we have the parent Company and there's capital basically in all three of those businesses.

We believe that the two insurance companies are well capitalized.

Then, we also have $3.4 billion at the parent Company.

Now, not all of that would be excess because would you want to have some in case something bad happened, that you alluded to, that you want to make sure you give them money.

We also have fixed charges called interest payments, potential dividend payments, debt repayments, out of the parent Company.

But we feel very comfortable with the amount of capital we have.

And in fact, we were comfortable at the end of the year and we're even more comfortable at the midpoint of this year.

So that's not as specific as you want but I'm not going to give you a real specific excess capital.

Okay.

And do you have any thoughts on where your unrealized loss position or your book value is today?

We don't give it out.

I think you could go look at what's happened to spreads since the end of the quarter and you would you see that they've continued to come in some.

It varies, obviously, by asset class.

It goes up and down but when -- our investment strategy is largely the same now as it was the last time, when we talked to you a quarter ago, which is we're maintaining our credit exposure.

We like that we're continuing to shorten duration, not as aggressively as we have in the past because we've gotten a lot done in the first six months of the year.

We're continuing to invest in our excess liquidity.

We will probably move some of that into less liquid, higher return vehicles as we go throughout the year.

Not clear to me whether that will be split between operating income and capital gains.

Just out of curiosity, did you give us some mark-to-market last quarter.

In terms of at this point right now, you just decide to aberrate from that policy?

No, it's not a policy.

The time we gave mark-to-market was when we put out the release on TARP.

So, that was why we did it.

It was related to the TARP decision, not related to putting out mark-to-markets every month or when we do the call.

All right, well thank you very much.

Our next question is from Vinay Misquith from Credit Suisse.

Your question please.

Hi, good morning.

This quarter, Allstate Financial generated about an 8% ROE.

That's what I estimate.

What do you think is the long-term ROE for this segment and how long do you think it's going to take to get there?

Vinay, the ROE would be 8% on some basis and it would be a lot lower on another basis, if you went down to net income because we only made $19 million in net income.

I prefer to look at cash in total and over a long-term period of time.

That business should compete and get to the same kind of returns we get in our other opportunities.

I know other life companies believe that their returns will stay down in the single digits for some period of time.

We have been downsizing our business in those areas where we're not getting acceptable returns.

And those places where we do get good returns, we're trying to grow those.

So if you look at our life business, it's up some.

If you look at our workplace business, that's up.

So we are trying to grow those pieces that are successful.

I think on the Allstate Financial in total, though, should still have high return expectations because we have other places to put the money, too.

So I'm not in the permanently accept low returns in the life business.

Would you be willing to accept low double-digit ROE in this business and sort of mid teens ROE's in your P&C operations?

Well, low double digits could be anything below 50.

So, I think all the businesses go through cycles, up and down.

Sometimes homeowner business does not have a good year, sometimes auto business is not having a good year, sometimes life business is not, sometimes the annuity business is not.

So in total, I believe the Corporation should earn a 15% return on our capital.

We manage through that in various times.

That means you've got to have some people do better than 15% and some do less than 15% but in total, everybody should to see a way to get to 15% over time.

And we believe that's necessary given our cost of capital and given the other opportunities we have to invest money.

All right.

And the follow-up question is on the auto business.

Curious what you are seeing in terms of shopping trends?

Has that receded now?

No, people are still shopping.

The economic environment is still fairly dire.

What we're seeing is more and more people opting to our value product.

And we're also seeing people basically engineering their policy by going to higher deductibles or actually dropping some coverages.

I think as long as employment stays high, you'll see shopping activity fairly high.

Thank you.

Okay.

Matt could, we have the last question?

Yes, sir.

Our final question is from Brian Meredith from UBS.

Your question please.

Thanks, just got it in.

First question, nonstandard auto, looking at the big increase in frequency in the quarter, understanding, auto is getting back to normalized levels but that just seems like a large number.

Are there any underwriting issues kind of evolving there or any issues with Allstate Blue that have come up?

First, in looking at that time auto business, I would encourage you to look at both the frequency and severity combined.

So always -- and you know this, Brian, so I'm telling you what you already know.

But it is important to look at that because you'll see it's bounced around a lot in the last couple years.

So if you look at frequency is, particularly bodily injury, is way up this quarter but it was way down a year ago.

But paid severities were higher a year ago and paid severities are way down.

So really, the best way to get a read on the whole business is to look at it in total.

Frequency is up some in Allstate Blue.

We're comfortable with the new product.

We're comfortable with the rollout.

You always get a little bit of upturn in frequency when you had a new business.

So you should expect to get it.

We price for it and we're comfortable with that part of it in terms of looking at the total loss cost of Allstate Blue.

So we feel comfortable about that.

We do not think it's going to be the kind of growth we had in Encompass where we're downsizing the

Great.

And then, just one follow-up question.

What's the trend in close ratios going on right now?

It looks like it improved a little bit sequentially but year over year, it's still down.

What are you doing to probably to improve close ratios?

George can answer that question but I want to make sure I get the right close ratio.

Close ratio on new business?

Yes, exactly, new business actually "to close."

What we're doing, Brian, is trying to make sure that we have less variability in the way that we go to the marketplace.

And specifically, at the agency owners' offices, what we were doing is simply quoting higher limits and lower deductibles.

And I think in response to the changing economic environment, we've changed the way that we ask people questions.

Specifically, why did you come here?

What existing policies do you have?

And we try to give them the best possible quote for themselves.

That seems to be panning out quite a bit.

In addition, we have discounts that we have not used before.

If we can automatically take money out of their checking account, if they'll buy in advance, we're pushing our multiline discounts.

And so, it's our sales and service process at the point of sale that is actually making the difference.

One other thing, we've changed their advertising and we're now emphasizing the fact that Allstate is not as expensive as people might think.

If you look at our ads, it says, "Call Allstate first." What we've found from our consumer-focused research, is that if people can save some money, they will stop the shopping process at the first person who can save them some money.

So we're trying to get a call to action, as opposed to simply doing more institutional and product advertising.

And it seems to be working.

So to summarize, we've made good progress in all three of our objectives this year.

You can expect us to continue us to be proactive, whether that's managing our businesses, our investments, our capital.

We'll keep Allstate financially strong.

We will get customer loyalty to continue to improve.

And we'll reinvent the business for the consumer, which will drive long-term shareholder value.

So thanks again for your interest and we'll talk to you next quarter.

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

This concludes the program.

You may now disconnect.

Good day.