Allstate Corp (ALL) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Allstate Corporation third quarter 2009 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 turn the conference over to your host, Mr.

Robert Block, VP, Investor Relations.

Mr.

Block, you may begin.

Thanks, Mac.

Good morning, everyone, and thanks for joining us today for Allstate's third quarter earnings conference call.

As is our custom, Tom Wilson, Don Civgin and I will provide commentary on results for the quarter followed by a question-and-answer session.

Joining us for the Q&A are Judy Greffin, our Chief Investment Officer, Sam Pilch, our controller, George Ruebenson, President of Allstate Protection and Matt Winter, President of Allstate Financial.

During that session, we will ask you please limit yourself to one question and one follow up so that we can hear from as many people as possible during our time together.

Last night we issued our press release, the majority of our investor supplement and our 10(Q) for the third quarter.

We also posted a 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, will you 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 third quarter 10(Q) and our most recent press release for information on potential risks.

We will 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 be available following the call.

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

Now I'll turn the call over to Tom Wilson.

Good morning.

Thank you for your interest in Allstate.

I'll make some brief comments on our overall results.

Bob will then cover Allstate Protection and Allstate Financial.

Don will cover our investment results and financial position.

Let's begin with the third quarter.

If you reflect on our three priorities which are shown on slide two, you'll see that we made progress on all of those.

First, keeping Allstate financially strong in what has been a volatile economic environment.

We continue to perform very well on this objective.

We generated $538 million in operating income and $221 million in net income in the third quarter.

Book value per share grew by 15.9% from the second quarter to $32.29, which is a result of solid operating results, our proactive focus on risk mitigation return optimization and improving financial markets.

Our capital position remains strong on both a statutory and GAAP capital basis.

Our auto business continues to perform very well.

Margins remain strong and the new business momentum and improvements in retention are beginning to build a foundation for sustainable growth.

We do remain vigilant in our efforts to improve profitability in the Homeowners line, gaining needed rate increases while maintaining a prudent risk appetite.

Our overall recorded combined ratio was 94.7, the underlying combined ratio was 88, which was within the range of expectations we set earlier in the year.

Allstate Financial has made progress on its efforts to improve returns and is 80% of the way home to completing the focus to win efforts.

Investment evaluations improved dramatically as we maintained our exposure to corporate credit, and that paid off big time in the quarter.

We also invested in another $4.6 billion of excess liquidity.

On the risk mitigation front, we continue to lower our exposure to real estate and have begun to slightly reduce our exposure in municipal debt.

We have also maintained our program to protect our economic position if interest rates rise.

So we are laying the foundation for sustainable growth through work on improving customer loyalty and reinvesting protection retirement for the consumer.

Our measure of customer loyalty improved for the third consecutive quarter, which is making inroads on our deficit to the industry.

Both auto and homeowners retention ratios increased from the prior quarter.

That's a result of a number of reinvention efforts, including things like next gen claims which improve customer satisfaction on property, and we've calibrated, of course you'll remember our 401(k) match on customer loyalty rather than profits.

Our reinvention efforts to provide choice for customers, things like Your Choice Auto, Allstate Blue, combined with more targeted marketing and improved sales processes at our agencies and direct operations contributed to a 12% increase in auto new business over the prior year quarter.

This is the third quarter in a row of increased new business which, when you combine it with a higher customer retention, will drive market share growth.

On the leadership front, we had several significant changes.

Matt Winter joins of us as CEO of Allstate Financial.

The breath of his experience, his track record of success and his passion for reinventing financial services for middle income customers will enable to us build on the success of our focus to win initiatives.

Mark LaNeve joins us as Chief Marketing Officer.

His success in repositioning brands such as Cadillac, his general management experience making brands live at the local level as well as the national level will help drive our efforts to reinvent protection retirement.

This also frees up Joan Walker to build on the success in improving our reputation and to make reinvention self sustaining.

George Ruebenson has decided to retire at the end of the year after a successful three years as President of Allstate Protection.

Allstate Protection, their strategy in leadership team will enable us to continue to build on the momentum he started for growth.

We'll miss George, but thank him for his almost 40 years of service.

Overall, it was a solid performance in the third quarter.

Our shared vision has grown roots, and we are building a competitively differentiated strategy to drive sustainable growth.

Now I'll turn it back to Bob.

Thanks, Tom.

Turning to slide three, property liability and net written premium at $6.8 billion fell 2.2% compared to the third quarter of 2008.

The reason for the drop remain the same.

Overall units continue to decline and consumers continue to manage their insurance expenditures.

That said, when you look at the details by line, there are some trends indicating positive results in the future.

Beginning with the Allstate brand standard auto, net written premium was flat as new business applications increased 12% quarter-over-quarter, the third quarterly increase in a row, as Tom said.

Retention increased two-tenths of a point to 89.1%, the first year-over-year increase since the first quarter of 2005.

Average premium climbed 1.9%, reflecting our consistent approach to seeking rate changes where needed while continuing to provide distribution and product choices for consumers.

Allstate brand homeowners net written premium declined two-tenths of 1%.

Increases in average premium and retention were essentially offset by a reduction in units as we continue to manage our exposure to catastrophic losses.

We continue to focus on gaining appropriate rate changes in order to bring this line of business back to an acceptable return on capital.

During the third quarter, we received approval for rate changes averaging 6.9% in 19 states which will be earned over the next two years.

The two major lines of business then were essentially unchanged in the third quarter from a topline perspective but for different reasons and with different future trajectories.

The source of the overall decline in the quarter came in compass and the smaller lines.

Efforts to improve the margins here are limiting topline growth as we maintain our philosophy of profitable growth for all areas of our business.

Shifting to a discussion of margins.

Our overall combined ratio for the quarter was 94.7%, a dramatic improvement from the third quarter 2008, driven by a relatively benign hurricane season so far this year.

The underlying combined ratio was 88%, consistent with the first two quarters of the year and right in the middle of the range we expect for the full year.

While the hurricane season has been light, we still experienced a number of catastrophic events in the quarter.

In the third quarter, we recorded $407 million from catastrophe losses with 24 events versus $1.8 billion experienced in the third quarter of 2008.

This quarter included $80 million of favorable prior year reserve reestimates primarily related to subrogation recoveries from the 2007 California fires.

It also includes $86 million of upward development, the cat losses experienced in the first two quarters of this year.

On slide four, we give you a look at the loss trends for auto.

As we expected, reported frequencies for both bodily injury and property damage increased significantly in the third quarter compared to prior year, but remained at levels comparable to 2007.

Auto frequencies in 2008 were favorably impacted by a variety of factors, high gas prices, a drop in miles driven, rising unemployment to name a few, with last year's third quarter being the most favorably affected.

This year's results look more like the results we experienced in 2007.

Auto based severities continues to perform better than anticipated, offsetting to some extent the increases in frequency.

The combined effects of frequency and severity of pure premium are well within our pricing expectations and produce a standard auto combined ratio of 92.7%, 1.7 points higher than the third quarter 2008, but better than the first two quarters of this year.

The loss cause trends for homeowners continues to be negatively impacted by non-catastrophe weather.

Non-cat frequency increased 13.5% from prior year with water, lightning and wind hill claims being the primary drivers of the increase.

Homeowners based severity went the up 9% quarter-over-quarter as increases in labor rates and roofing materials more than offset reductions in costs for other building materials.

We remain focused on gaining approval for appropriate rate changes to return this line to acceptable returns.

On slide five, we shift to Allstate Financial results.

We generated an operating income of $95 million dollars in the third quarter, an increase of 8% from the third quarter 2008.

This increase was driven by favorable results in benefit margins and reduced operating expenses, somewhat offset by a lower investment margin.

The benefits spread increased almost 50% from prior year with improved mortality experience, higher premiums at the Allstate work place division, and increase in contract, charges on interest sensitive light products being the main drivers.

The reduced operating expenses reflect proactive management actions taken through the Focus To Win restructuring program.

We will -- as will you recall, the Focus To Win initiative is expected to reduce annual operating costs by $90 million by 2011.

Through the third quarter, we've attained 80% of the expected annual expense savings.

The lower investment margin was the result of intentionally maintaining higher than normal levels of liquidity, effectively lowering the portfolio yield as well as reduced asset balances, partly offset by lower interest credit on contractor holder funds.

From a topline perspective, premium and deposits fell by $863 million to just over $1 billion as we continue to focus on generating acceptable returns for fixed annuities.

Our focus remains on improving the overall returns for this business while seeking longer term solutions to consumers' retirement needs.

Now I will turn it over to Don.

Thanks, Bob.

I'll cover our investment performance in the third quarter and finish with some quick details on capital and liquidity.

Our proactive approach to risk management and return optimization led to continued improvements in our investment portfolio and an increasingly strong capital position at the end of the third quarter.

We continue to be mindful of challenges within certain segments of our portfolio, but our decisions and performance to date give us confidence that we are on the right track.

Slide six gives a breakdown of our portfolio now valued at just over $100 billion, a growth of over $4 billion during the quarter.

While the overall makeup of the portfolio remains about the same, over three-quarters invested in fixed income securities with concentrations in investment grade corporate and municipal bonds, we continue to execute well on some key things.

We continue to reduce our exposure to commercial real estate, trimming positions by almost $2 billion during the quarter, bringing the total reduction for the year to over $4 billion.

We remain defensive regarding interest rate movement and have kept the duration of the figured income portfolio under four.

We reduced our exposure to municipal bonds by $2 billion during the quarter through targeted sales, improving the overall quality of the portfolio along the way.

Net sales and principal repayments in below investment grade assets totaled $1.6 billion, which helped to offset the ratings drift in the portfolio.

From a cash flow perspective, the fixed income portfolio generated almost $2.2 billion this quarter and $6.6 billion through the first three quarters.

And finally, we've put another $4.6 billion in excess liquidity to work as we look to produce more income and capital appreciation overtime.

Slide seven shows the quarterly progression of investment income and realized capital gains and losses.

Net investment income declined 20% from prior year, driven primarily by lower yields and to a lesser extent, smaller average asset balances.

As we continue to put more of our excess liquidity into higher yielding securities and interest rates begin to rise, we should generate greater levels of investment income.

We had $519 million in pretax realized capital losses, driven primarily by $392 million in other than temporary impairments and $361 million in derivative losses, offset somewhat by $201 million in gains from sales of securities.

Our impairments continues to reflect the weak economic environment, though the pace has improved from prior quarters.

On the derivative front, most of the losses are due to our efforts to protect the portfolio against rising interest rates.

As I mentioned last quarter, while we recognize losses here, we did have gains in asset valuations that more than offset the realized losses on derivatives.

Unrealized gains and losses are displayed on slide eight.

Our unrealized position improved by $4.8 billion on a pretax basis to an unrealized loss of $2.5 billion.

This was the result of tightening credit spreads, declining interest rates and positive equity returns.

Structured fixed income securities remain in an unrealized loss position of $3.6 billion, an improvement of $1.4 billion from the prior quarter.

Virtually all of the remaining asset classes moved from a loss at a gain position by the end of Q3.

Slide nine shows that these results have further strengthen our capital position and liquidity at the end of the third quarter.

Shareholders equity reached $17.5 billion with book value now at $32.29 per share, an increase of $2.4 billion from Q2 2009 and $567 million more than a year ago.

Statutory surplus levels at both the property, liability and life companies remain strong, and we have $3.36 billion of deployable assets at the holding company level.

Our liquidity levels continue to get stronger.

We can now generate $33 billion within 90 days.

And as a reminder, we have very limited debt refinancing needs with the 2009 debt maturities successfully refinanced earlier this year and zero $40 million and $350 million of debt maturities in 2010, 2011 and 2012, respectively.

Lastly, we continue to have our untapped $1 billion credit facility which doesn't expire until 2012.

Now I will turn it back to Tom.

So slide ten is a repeat of our priorities for 2009.

We remain financially strong.

We've come through a very difficult economic climate and improved on our strong financial position through proactive management, improving customer loyalty in reinventing protection retirement for the consumer and laying the foundation for sustainable growth.

So we'd now like to hear what's on your mind.

(Operator Instructions) Our first question comes from Jay Gelb from Barclays.

Your question, please.

Thanks, good morning.

Looking at the underlying combined ratio for the entire property casualty business, it looks like it will be up around two points year-over-year 2009 versus 2008 for the full year.

Should we anticipate that that trend might continue or if you don't want to get into those details, what do you think will be the contributing factors to say determine which way it will head directionally?

Good morning, Jay.

This is Tom.

Of course, we are not going to give our outlook for next year until we get to the next quarter.

So thank you for reminding us we need to be there.

But when you look at it, it's really frequency driven this year.

And I think the thing to look at is frequency, of course, is a little unpredictable.

This year it looks a lot like 2007, as Bob said.

It looks like 2005.

It looks like last year was abnormally low, so I don't think we will go back to next year's level -- or last year's level in the future, but that will bounce around a little bit.

I think if you want to look at the trends, really, I think the best analytical approach is to look at both frequency and severity combined, which we of course call paid peer premium, and then compare that to the trend line in the average premium, and that can give you an estimate as to what you think the combined ratio will look like next year.

What we are also doing though is, as you know, this year we've done a good job of controlling expenses, which doesn't show up in that statistic I just gave you.

So we are committed to do making sure we control our expenses to get to our target combined ratio.

So we feel pretty good about the run rate of the business, I guess I would say, and when we get through this year, we'll give a new forecast for next year.

But we feel very good about being inside the range of 87 to 89 this year.

Thanks.

And then my follow up is looking at the run rate of Allstate Financial's earnings are there any items in there we should consider as one time?

And what's the dollar amount of expense savings coming out in 2009?

Let me back up a little bit.

First, Allstate Financial, of course, used to make $140 million to $150 million a quarter.

As we decrease the size of the balance sheet as investment income has come down, it's been sort of in the $80 million to $90 million range.

When you look at this quarter, mortality has had a more positive impact than I think would be sustaining.

But that bounces around a little bit too.

So this quarter we had the benefit of both lower deaths in the life block and more deaths in the annuity block, which is kind of a twofer for you.

And so that has made the number go a little higher than I would expect.

The Focus To Win expenses were well on track to getting those down, all that stuff we publicized.

Some of that comes through the P&L, Jay, but it's also gets into what I call the Mr.

Coffee approach to accounting in that business, which is you cut a bunch of expenses, it goes into all the calculation of expected gross profit and only a little bit comes through in the bottom line.

So you kind of pour in all this stuff a little bit and it drips out slowly.

We do think that that business, we have it on the right track to get its returns up.

We've stabilized its performance.

We've got more variable expenses in there, and Matt's challenge now will be to build on that and find a way to grow in the middle income space, which we have some very good ideas on.

Thank you.

Our next question is from a Matthew Heimermann from JP Morgan.

Your question, please.

Hi, good morning everybody.

I guess my first question is on Allstate Financial as well.

But I guess -- with leverage, I think you articulated that your goal was to bring operating leverage down in that business.

So my question is if you bring leverage down in that business, is it possible to generate a return that's good enough to cover the cost of capital in that business?

Matt, I wouldn't have stated our goal as bringing operating leverage down.

I would state our goal as making sure we make the right amount of money on that which we do.

The net result of that has been we've substantially decreased our size in certain products at this point in time, particularly fixed annuities and the institutional markets.

So if you look at the size of the balance sheet, it's come down.

but not because we think small is better.

We just didn't like the returns in those businesses.

I do think that that business can earn an appropriate return.

I go all the way up to the top and say, we are serving middle income Americans.

They have tended to allow people to make adequate returns on capital if you provide a good service in a way they like it.

That's a little different than in the institutional markets where it's big company versus big company.

So we think that there have been other places in serving those customers where they allow to you make an adequate return.

Our challenge is to figure out how to do what they want, how to meet their needs and structure our products so that we can make a good return and it meets their needs.

I think we can absolutely do that.

I would also say we sometimes get too focused on just the financials of there, but there are some real gems in that business.

Our workplace division is doing quite well, and it's continued to grow.

So there are other businesses that as this strategy unfolds, we'll end up spending more time talking about.

So is it fair to say that -- so my focus on leverage probably isn't the right one because to some extent, depending on what happens with fixed annuities or other products, the leverage might swing depending on mix and as a consequence, it's not necessarily fair to focus on that when you think about a return.

Matt, I don't know that I would say it's wrong one.

It all depends on what you are trying to do with the numbers.

I think if you look at the size of the balance sheet, it's come down at Allstate Financial.

It is not our strategy to make it small.

Our strategy is to a make it profitable and meet the needs of our customers.

Okay.

The other question I have would be with respect to the structured product portfolio, just the RMBS, CMBS and ABS.

Those are still in a loss position.

What's the average duration of those securities at this point?

And I guess I'm asking that because I'm just curious about how much runway you have to kind of wait to see those recover if they are going to?

Well, it is a good question, because of course, we spent a lot of time focused on it.

I will make a couple of comments and then turn it over to Judy.

First, if you look at our portfolio, those -- that's about 3% of our assets, depending -- which you are putting into the all those categories, because there's some agencies included in RMBS and stuff.

But of the structured stuff that we have losses on, that's about 3% of the portfolio, and that's more than 100% of our unrealized loss.

So that 97% of the portfolio is in great position.

When you look at those structured products which are at a substantial discount, the cash flow associated with those this year for three quarters is about 17% of the fair value of those assets.

Judy might want to comment some on the types of securities we have in there to give you some sense as to how they pay out, but there's all kinds of stuff rattling through there.

Right, and there is differences between each of them.

So if you look at the CMBS portfolio, it's by its nature a longer duration portfolio, doesn't have much prepayment risk, but it does have some extension risk.

So that portfolio has more runway, as you might say.

The RMBS portfolio bounces around a little bit more because you do have prepayments, and what Tom has referred to in terms of the cash flow, a lot of that principal repayment is coming off of the RMBS portfolio as prepayments increase in prime alt-A and in subprime to some extent.

So nailing the duration on those securities right now, I don't think it's that helpful because it does bounce around a little bit.

Probably the one that you could get closer to is the CMBS portfolio, and that's a longer duration portfolio.

RMBS should be shorter.

Okay.

Thank you.

Our next question is from Cliff Gallant from KBW.

Your question, please.

Good morning.

Your balance sheet's obviously rebounded pretty strongly, and -- but when we look at your internal cash generation, that hasn't really gone back to the levels where you were 18 months, two year ago.

I'm curious, one, what is your outlook for that and then as a follow up, when we think about your ability to one day go back to buying back stock and returning capital, is it that internal cash generation that we should be watching or is it simple balance strength that's the deciding factor?

I will make a comment and then Don might want to talk some about cash flow and capital.

First, when you look at our cash flow, I mean I struggle a little bit in terms of the -- where we were 18 months ago because we had a bunch of catastrophes 18 months ago.

So I'm trying to get my head into it.

First I would say in general, the -- our income, both operating and net, is what generates cash flow.

That by and large generates capital, from which we get to grow the business.

So we don't have a lot of capital expenditures or things like that.

Then it's really a question of how quickly are you growing the business relative to how much money you're making.

Our auto business, George has got that business in very good position.

It continues to generate excellent cash flow and large amounts of capital, because it isn't growing today.

But he has it positioned to grow, so we are hoping that we can take that profit and reposition it to grow.

In the homeowners business, our challenge will be to get returns up.

So we had a combined ratio which was below 100 this quarter, so that's a good thing.

It's not where it needs to be, but that business will probably get smaller.

So as its profitability goes up, it will generate more capital.

Probably won't use that capital in growth.

Allstate Financial is in a position where it's needed capital because of the state of its investments that we've had to support that business, so we've been using capital from those other two businesses to support Allstate Financial.

I believe Allstate Financial will get its profitability up and its growth up.

How much -- what the capital balance will be in the future it's not clear yet.

We have to -- Matt's got to figure out what that strategy is, figure out how fast he can grow the business.

He has a lot of work to do.

But -- I'm looking at him, suggesting he's got work to do.

(laughter) But -- so I think from a company standpoint, we feel pretty good about where we are at.

Don may want to make comments about capital levels and share repurchases.

Yes, Cliff, I'll just add one more thing on the cash flow.

Internal cash flow, Tom is right, it's generated by the earnings power of the company, which continues to be strong, and the investment portfolio which continues to throw off attractive amounts of cash for us.

That said, even when we were doing the share repurchases, we didn't -- we obviously make sure the liquidity is not an issue, but we don't expect it ever to be an issue.

The bigger I think we have to deal with is capital strength.

We do feel very good about where we have come to this year, both at the operating subsidiaries and at the parent company.

So I think we are comfortable with where we are.

Again, we will be mindful of the corporate level cash that we have to make sure that we preserve that $3.36 billion we have this quarter prudently.

But it's going to be, I think based more on capital strength than kind of internal cash flow generation.

Internal cash flow generation, given the kind of cash and liquidity availability we have shouldn't be the limiting factor.

So, Cliff, when you go back then and say, okay, what does that mean for share repurchase and dividends?

We've always had the approach if we can't use the money and we think we are well capitalized and we have extra, we buy back shares and give it back to the shareholders whose money it is.

So you can look at our -- I've been here 15 years, you can look at our track record, we've been very consistent about that.

Right now, we have no share repurchase program in place, and so you should not expect to see share repurchases.

In terms of dividends, we did reduce the dividend last year, remember, which was really based on earnings because the dividends should be a payout of how much money you make.

We look at that every quarter.

My board sits down and I decide what we are going to do, and that's an every quarter decision.

Okay, okay.

Thank you.

Our next question is from Dan Johnson from Citadel.

Your question, please.

Thank you, and good morning.

These are investment related questions.

First one would be on the reinvestment of, I think it was $4.5 billion.

Can we talk a little bit about what it went into and when during the quarter it went in?

And then on the second question, can we maybe give a little more color on the $1.9 billion of CRE reduction, how much of that was just sort of normal maturities, cash flow, meaning just payments or sort of actual sales of CRE?

Thank you.

So on the deployment of the excess liquidity, if you think about it in composition of the portfolio, it's primarily fixed income.

Their redeployment went along the same lines, about 85%, 90% to 85% figured income, 10% to 15% equities.

On the equity front, we continued with our theme of mostly investing in foreign markets rather than domestic markets.

On the fixed income front, it was deployed in pretty much the way the portfolio looks on taking into consideration that we are reducing our commercial real estate and our exposure to municipals.

So a lot of it went into investment grade corporate.

And some of it actually did go into taxable municipals as we reduced the overall exposure to municipalities, we are reconfiguring the mix a little bit and buying some of the Build America bonds.

In terms of timing, it was pretty much throughout the quarter.

Maybe a little bit more towards the end of the quarter, but pretty much throughout the quarter.

And then on the CRE front, in terms of what was in the 1.9 billion, it was primarily -- this quarter it was a mix, but primarily a reduction in CMBS.

Mix across the CMBS portfolio, but most of it was higher quality CMBS where we saw an opportunity those securities had rallied significantly and decided that it was just made more sense to reduce there, even though we did take down some of the lower quality CMBS as well.

Then on the whole loan front, we also made some progress there, bringing down our exposure.

Dan, I think on the whole loans I think were down $1.2 billion this year, so from 10 and change to 8,9.

500 of that was due this year, of which we collected, and 700 would have been due in the future, which was prepaid.

Judy's group is out actively saying, give us our money back.

Finally, Tom, then for you, where do you think we are with the homeowners business in terms of getting additional rates?

Anything you can do on the loss cause side, just to try to bring some resemblance of acceptable profitability to the business within the next 12 months or less?

I will make that comment, and then George will probably want to jump in.

First, this is what we know how to do.

We know how to run property casualty businesses, we know thousand run the homeowner business.

We know how to underwrite, we know how to price.

We know how to set up claims.

We are adapting to a new environment which is we first adapted to higher hurricanes, and we've gotten through that successfully.

And now we are adapting to higher non-model cats.

We prefer not to have to be adapting to that, but we are, and we know how to do it.

So I feel very good about the skills, capabilities and the strategies we have in place to do that.

George, you might want to make some comment on specific things you are doing.

Yes, the last two years for the regular weather related losses have been significantly worse than any other two year period in the history of the company.

So then the fundamental question is, is this the change in the weather patterns where our risks are located, or is it simply an anomaly?

We've decided that it's not an anomaly.

We've decide to do take a much more aggressive stance with regard to our risk management programs.

And probably more importantly for your question, is we've been way more aggressive on taking rates.

Specifically in the monoline homeowners, we have about 20%, 23% of our homeowner policies don't have auto with them, and we are changing our pricing structure so we are more aggressive with those policies.

So if we can't reduce the exposure through our risk management, we will simply price our way out of the problem.

Dan, if you look at our investor supplement -- this is Bob -- on page 16, it will show how much we've taken in rate over the last three quarters.

State specific average in the first quarter we took 7.4%.

Second quarter was 13.3% and this quarter was 6.9%.

So we have been able to gain approval for significant rates and actually, that totals to like 40 some states.

Very good.

Thanks guys, very much.

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

Your question, please.

Just two quick ones.

The statutory capital and the life operation fell just a tad.

Is that entirely due to the size of the statutory loss in the quarter, or is there some capital shifting going on as well?

It's a combination of earnings and what happened in the capital, I'm sorry, the realized losses in that portfolio as well, but there was no dividend out or any capital contribution in during the quarter.

All right.

Just back to the homeowners a little bit.

It looks like a lot of your peers are considering the non-modeled cats as being temporary and I guess, is that your sense as well?

And is there some concern that the market is not going to follow you and that may affect sales otherwise?

I will make -- first, I think George said we think it's real.

If we are wrong, then we will adjust.

But in the meantime, we are not earning an adequate return on that business and we need to -- when you look over almost any period of time, we've struggled to earn a decent return in homeowners and we could and deserve to have an adequate return on that business.

If you look at our targeted customers, which are multiline households, house, car, boats, jet skis, whatever else they got, we think we are adequately pricing.

George might want to talk about the things we are doing to implement this kind of product line increase, but still maintain strong relationships with the household.

In 30 states so far this year, we've refined our pricing structure so that we are more price competitive to people who have a couple of cars and a home.

Where we are taking the rates, the rates that Bob talked, about where the greatest impact is is the people that are monoline homeowners.

Now our competitors do think that this is temporary displacement.

They may or may not be right, but we are not going to wait.

It's always been our practice to be very aggressive on rates.

That's the reason that over the last several years we've been able to hold our combined ratios within all of the guidance that we've given you regardless of what the competitive landscape does.

Our first priority is to keep Allstate Financially strong.

We will take the rates that we need to.

But in addition to that, we are trying to make sure that as we try to reinvent the company, we do add more multiline customers who have a homeowner.

They have a greater tendency to stay with us.

They also have better loss experience.

So in these 30 states where we've introduced the different rating structure, we are looking at a 20% increase in production for auto insurance and the commensurate increase in homeowner production.

We are seeing that our homeowner retention is still flat.

Our loss experience compared to our competitors, if you look at fast track, has been and continues to be significantly better than them.

We do not think that there is much price competition in homeowner as there is in auto.

So again, we will go to the priority.

The priority is to add -- to earn an adequate return,and that's what we are committed to do.

Great, and we'll miss you, George.

Congratulations on your retirement.

Thank you very much.

Next question is from Ian Gutterman from Adage Capital.

Your question, please.

Hi, I have a math question because I'm sure I'm doing something wrong, but I'm not quite sure what.

If I look at the auto accident year and your frequency of severity statistics, it looks like loss trend is up about 10%.

And it seems like price impact is pretty minimal.

So simplistically I would say that should mean your accident year should be up six or seven points and it's up two to three.

So what's the assumption that I'm missing there?

I think if you're looking at using the frequency and severity statistics that we provide you, the frequencies are on a recorded basis.

The severities are on a paid basis.

So you are mixing apples and bananas, kind of.

And -- this is George again.

If you look at our paid pure premium, the money that's going out the door, we only have a 2% increase in standard auto year-over-year.

Okay, so does that mean -- so help me understand exactly what the reported metrics mean, then.

Is that saying that over time we will see those loss trends as --is there basically a lag over the next few quarters we will see the overall loss trends higher?

Not necessarily.

Okay.

So what exactly does the double-digit increase in frequency mean as far as trying to think about where loss trends is going on a reported basis?

Ian, we can take you through the math with greater specificity.

Here's what I would say is that the frequency is up.

Some of that's because it was down so much last year, so you have to look at it over a longer period of time.

Right.

Also, what's embedded in all those numbers are averages.

So to the extent your number of claims go up but the number of claims that don't actually turn into payments goes up, then the actual amounts you pay might not go up as much.

Right?

So if you're up, just to make it up, if you are up 10% but then you paid fewer claims that are real claims, then you end up paying less.

So I think I would say when, you are looking -- clearly, after the profitability of the auto business, which is an important thing to focus on and we focus on it, we feel good about the combined ratio in that business.

We continue to earn an adequate return on that business and we think the trends are right in terms of how we are priced.

I think maybe what we can do is get Bob or Christine to sort of walk you through all that, because we give you different statistics, and I recognize it means more to us than it does to people who don't spend as much time on our statistics as we do.

So we can work you through the math, but I think I would leave it with the conclusion that we feel good about the profitability in the auto business.

As we look forward into next year, we are comfortable with it.

Yes, frequency is up, but if you look at our paid losses, particularly other physical damage side this year, we are doing very, very well.

So we are feeling very good about the profitability of that business.

Okay, that's helpful, thank you.

Just one other quick one is on the stat surplus, it looks like the (inaudible) component of AIC was up over $1 billion the income was about half of that.

Was there something else that brought in about $0.5 billion of stature plus?

Yes, we transferred an OPEB liability out of AIC, and that was responsible for the difference.

Can you just tell me a little bit more what that means, you transferred it?

It went to the parent company.

Oh, got it.

Okay.

So it's still an obligation of the company.

It hasn't changed the overall obligations of our corporation, but it's -- we moved it from the statute -- the Allstate Insurance company up to the Allstate Corporation for most of the employees.

There's a certain group of the employees who are left down because it has to be left down there for a variety of financial reasons.

We also -- there was a small decrease -- I don't know if this impacted the OPEB change as well.

We changed our retiree medical plan which reduced the OPEB liability by a little less than $100 million.

Okay, that makes sense.

So then on a GAAP basis, does that mean we will see some expenses essentially move out of the P&C expense ratio and into corporate?

No, because it will actually will be funded from -- most of it will be funded from AIC to AllCorp.

Got it.

Okay, thank you very much.

Our next question is from Bob Glasspiegel from Langen McAlenney.

Your question, please

Good morning, everyone.

I would like to microscope the muni bond reduction.

I understand trying to upgrade the quality within muni bonds, but I'm not sure I understand why reducing muni bonds is part of a risk mitigation strategy.

Is there something about the overall ratings of munis versus corporates or duration or a tax position that is driving that or maybe something else?

Let me make a general comment and then Judy can take you through the specifics of what have we are doing.

First we owned $23 billion of municipal bonds at the end of last quarter -- at the end of the second quarter.

That has come down, obviously, as you can see this quarter.

When we look at our asset allocation, in addition to looking at it as a percentage of the overall assets, we also look at it as a percentage of our surplus, and we concluded that $23 billion as a percentage of our surplus was more than we felt comfortable with, given that we feel that the long-term trends towards -- of the financial wherewithal of state and local governments has a negative focus on it.

Muni markets are doing well this year, but if you look at the accumulated deficit of all these companies, it's is something like $168 billion this year as sales, tax revenues go down, income taxes are going down.

They haven't really adjusted their spending patterns to do that.

And so when we looked at the $23 billion and we looked at those macro trends we said, it's probably time to cinch up the sale a little bit, to put it in a nautical term, and get focused on the parts of that business we like the most, and Judy can talk about the things we are doing to do that.

So as Tom said, this is an overall view on municipals within our portfolio (inaudible).

The portfolio continues to be very well diversified, very high quality.

But within the portfolio, given the macro trends that we see, what we are looking at reducing includes things like appropriation risk where state and local governments appropriate the funds for the debt.

We are also looking at reducing our exposure to healthcare and also reducing our exposure to zero coupon bonds, which tends to be those longer duration bonds which again, given our view on reducing our exposure to interest rate risk, that's part of the reason why we want to reduce our exposure to zero coupon bonds within the municipal portfolio.

But I think just another example of proactive approach to investment.

I will follow up with Bob.

I'm not sure I understand completely.

Is Matt on the call?

If so, I'd be curious in hearing what attracted him to Allstate, and I know he's not been there long and it would be premature to talk about strategy, but I was wondering what he thought the strengths of the job -- the company was that attracted him.

Sure.

Hey, Bob, how are you?

Good morning.

It is premature for me to talk about strategy.

I think today is day nine, and I'll need a couple more days at least for that.

But I will tell you that pretty much five factors attracted me to this organization.

And I think whatever the strategy ends up being, we'll leverage those five competitive advantages, and they are pretty simple.

I think Allstate has one of the finest brands in the industry, and it's a brand that is powerful and well regarded and well respected.

And I think that is a tremendous competitive advantage, especially in this economic time.

Secondly, I think it has an extraordinarily broad, deep and powerful distribution capability.

And as I've watched the reactions of life in retirement distribution over the last 18 to 24 months, I think the type of distribution capabilities that is are embedded in this organization will be a huge competitive advantage on a going forward basis.

Third, really the market and the customer need that Allstate is targeted on is to me, a huge advantage.

We often find in the life and retirement space products and services being forced on a market and you have to convince a market that they need those products and services.

And fortunately, Allstate is in a space and in a market segment where consumers truly do need these products and services and it's under served, under penetrated and in my opinion, not sufficiently respected by a lot of our competitors, and I think that is huge opportunity for to us serve a market that deserves the products and services we can pride.

The fourth feature that attracted me personally was a culture of innovation in the organization.

Because I think not only will that allow us to take those other capabilities and leverage them, but it allows us to do it in a fun and exciting way.

And fifth, financial strength, because if you don't have the financial strength, the rest of that is pretty much irrelevant because you can't do what you'd like to do with those opportunities.

So as I looked at it and as I talked to the team here during the process, I became pretty convinced that it's an extraordinary -- extraordinarily rare combination of those factors that give it a potential that I think is very rare right now, and I think we are very well positioned to take advantage of those five components as we pull together a refinement of the existing strategy that's been put in place over the last 12 to 18 months.

Thank you, Matt.

Our next question is from Vinay Misquith from Credit Suisse, your question, please.

Hi, good morning.

A question once again for Matt.

I know it may be too early in the game, but could you help us understand what specific actions you are considering on the life insurance book for improving the profitability on the existing block.

I'm not talking new business, but really on the old business because looking at the investment spreads and fixed annuities, they are only 90 basis points right now.

Was wondering whether you have any actions planned that will take up profitability on that business.

Vinay, let me help Matt out since he has only been here a few days.

We have -- obviously, we had our Focus To Win strategy, which was about changing our cost structure.

We also have a strategy and a group of people working on the existing block of business, whether that's our investment profile, asset liability matching the amounts we charge for various things.

So if you look underneath the hood in the release, you will see -- and in the Q you will see things like higher contract charges and a variety of other things that we have in place.

I think we ought to give Matt a little time to get comfortable with all those before he takes you through it.

But it is not as simple -- our strategy as much more complicated than just cut expenses and get smaller.

It is, we are using all the tools and capabilities we have.

We have a good team in here.

They have great experience, they know how to manage business at a micro level.

The one thing, of course, you are always going to say about Allstate is we know our businesses well, and we manage them proactively and with some level of precision and detail, and they are doing the same thing there.

So let's give Matt a little time to get his feet on the ground before we drag him through that.

Sure.

The second question was on homeowners.

With severity rising low double digits, -- I'm sorry, with frequency rising low double digits, could you help us understand how the 6% plus rate increases will help to improve margins?

I missed -- the 6%, you mean the 6.9% that we took in the quarter?

Yes, correct.

Okay.

I'm sorry.

With severity rising, what I mentioned before is that we are also taking risk management actions, pushing much higher deductibles, even in the non-hurricane prone areas.

That obviously is the good risk mitigation.

It worked for us and the modeled cats, it will work for us and non-modeled cats.

We are being selective on monoline homeowners as far as how many we actually want.

But finally, I want to assure you that we will continue to press the rates until we get this to a 15% return.

How long do you think before the rate increases flow through earnings?

It takes 24 months for a rate increases in homeowners on twelve month policy to be fully effective.

All right.

Thank you.

Our next question is from Meyer Shields from Stifel Nicolaus.

Your question, please.

Yes, thanks.

Tom, good morning.

In your commentary, you mentioned that you are going to be using capital to build up the auto growth, and I was wondering if you could a talk about that specifically with regard to, I guess acquisitions, independent agency and direct?

Good morning, Meyer.

Those are all different pieces, so let me go through them maybe in reverse order.

Our direct business, as we've now begin to disclose, of course is growing quite rapidly.

It has over half a million customers in it and it is doing quite well.

It is integral, though, to the way in which we approach the market.

So we are -- our customers come to us.

They pick up the phone, they might call one of our call centers.

They might call one of our local agencies.

They might get on the internet.

So 60% of our business today starts on the internet and most of that gets closed in our local agencies because our target customers decide they want to have somebody local that they can talk to, and there's benefits to that.

So it is an integrated approach to the market under the Allstate brand.

The direct business is growing.

We've never really disclosed it never because we do see it as sort of the tote, I don't disclose how much every agency does either.

But because people had some interest in it, you can see that those capabilities work for us.

Now, what it also does is give us the ability to take better sales practices and new sales practices, test them in those call centers and then roll them out to the agencies so our agencies get stronger.

So think of the Allstate brand as one overall approach to customers and how are we available for them.

In the independent agency business, that is, as Bob pointed out, the biggest -- it's one of the biggest drivers of the reduction in items in force this quarter and this year.

Our encompassed business grew rapidly over the last couple of years by picking up some new distribution points.

Those new distribution points didn't generate the level of profitability we had hoped, so we are now shedding that business.

So you'll see that the items in force are way down in encompassed.

We are still committed to do that channel, we would like to grow in the independent agency channel.

This is just, in my -- a profitability adjustment, not any strategic decision on our part as to where to go on that piece.

In terms of acquisitions, we look at everything that comes available.

If it fits, if it's a good business strategically and we can by it right, then we pursue it.

If not, we don't.

Okay.

If I can follow up on one other point, I think you mentioned in homeowners that labor costs are up, and that's one of the reasons why the -- that one of the issues that influence the non-catastrophe loss ratio.

I guess I was surprised by that because my understanding of the construction activity is down so much.

Well, we had -- it's a little surprising perhaps to everybody that labor costs for carpenters and electricians and roofers, of course it all varies geographically, right, but those costs have not come down.

They are up, I think in the 3%to 4% George, something like that.

The bigger thing that I think surprises people is you would expect building materials to come down, but roofing materials are up over 50% because they are oil based.

Right, and the labor costs are really tied up in a lot of union contracts.

The unions have not negotiated any contracts lower.

So -- but I think go above that a little bit, our approach to this is we need to give our customers value.

We need to make sure they get their house fixed by the right people with the right materials.

We always -- we make sure they do that.

We need to make sure we collect enough money to do that, and -- but we don't try to make money on sort of the swings and pricing of those things.

We just reflect it back into our cost.

Okay.

Thanks very much.

Your next question is from Brian Meredith from UBS.

Your question, please.

Thanks, good morning everybody.

First one, I guess for Judy.

You deployed a lot of cash again this quarter, and I guess looking at portfolio yields here, they obviously dropped because of the lower yield environment.

But with the deployment of the cash, should we expect to see maybe some stability in the portfolio yields here coming going forward or maybe tick up a little bit?

Brian, I'll maybe answer the beginning part of it, and Judy can jump in here.

First a large portion of the -- first, investment income is down.

You have to kind of go through that by piece.

So investment income is down, but some of it is down because interest rates are down, and a large driver has been just lower yields.

Whether you look at long-term rates or you look at short term rates, they are down this year.

Some of that rattles through the other side of, doesn't all go through the P&L, because we lower crediting rates in Allstate Financial.

And so it doesn't all go through the bottom.

But you have to look at sort of the complete piece of it.

And a little bit of it is due to the size of the business being down.

The investment income drop.

And, of course, that all goes -- that's almost all offset by lower credited interest as well.

Judy, maybe you want to make a comment about your deployment and what you -- I don't think we are in the business to give an interest rate projection.

Right, that's what I was hesitating about.

But as we deploy the cash, what you'll find is because the curve's so steep and we are mostly a fixed income shop, you would find that we are going to pick up from the deployment of cash but -- and the reinvest off the portfolio or from the sales that we make on the risk mitigation activities.

For the most part, that's a little bit of a give in the portfolio.

So net/net, what we are finding is that we are redeploying the cash and we're picking up -- giving up a little bit on the sales, but overall, as we do redeploy the cash, and we do expect at some point that interest rates will rise, you'll find that the income from the investment portfolio will go up.

Okay, great.

And then, Tom, I want to follow up on the M&A question that was asked just a bit ago.

A year, year and a half ago, you used to always talk about M&A and you'd categorize it in the three categories, one of them being transformational.

The question I have is given where Allstate is today, are you in a position right now to make a transformational acquisition if one was available?

There's obviously a lot of assets right now in the marketplace.

We think we have plenty of capital.

We have plenty of capital to run our business.

We think, as Don pointed out, deployable capital at the parent company level that we can use.

Transformational, of course, is in the any of the beholder and always makes it sound giant.

Sometimes you can do transformational acquisitions that are smaller.

So we are always looking for ways to try to grow our business.

So last year we bought a partnership marketing group from GE that doubled the size of our motor club business.

We picked up a number of affinity groups that we do business with.

That's turned out to be a great acquisition for us.

George has run that incredibly well.

We have very high returns on it.

So we will do a variety of things.

But I don't think you should walk away -- I think walk away from this thinking the markets -- there are more properties available today than there have been in the past because of people's troubles, but we continue to maintain our financial discipline and strategic focus so if something falls into those two buckets, we'll do it.

If not, then we don't feel like we have to do it because we have plenty of growth opportunities for the reasons Matt suggested and all the other things we talked about.

Mac, could we do one last question and then we'll be done?

Our final question today is from Susan Ross from Wells Fargo Securities.

Your question, please.

This is John Hall.

How are you doing, Tom?

Good, John.

I have a question on the improvement in PD severity for the auto line.

I was just wondering if you could talk about the factors that have been contributing to that and how sustainable or whether they are on a sustainable glide path?

First I'm glad you identified yourself because I would have been shocked by the tenor of your voice.

George, I think a lot of it has to do, first we are doing a good job of managing lost cause with next gen new claims system, and I think there's also been some trends in used car pricing.

George, you might want to --

The economy, actually in this case has been working in our favor.

Used car prices are down dramatically, and a lot of the underlying inflationary pressure that we have probably with the absence of paint has also been fairly benign.

We have had a history of very low severity increases in PD and collision and in comprehensive, and this is simply a continuation of that.

A little better than we have in the last couple of years, but we've been looking at low single-digit increases for a number of years.

The way that we manage our proshop, our preferred shop network, the way we triage claims, figure out the correct method of inspection, the method of settlement, about 40% of all the cars that we have go through our 1,000 drive ins.

That turns out to be a very efficient way for us to do it, but it's also very good from a severity control standpoint.

We started our concierge service in 1952.

That was the year that George started, right?

(laughter) Very, very funny.

Close.

Just one last question.

Was there any effect from the Cash for Clunkers program?

It was minimal.

For a few weeks there was a little bit of a spike in what we consider the add cars or change cars, but it's not sustainable.

We are still, on an add car basis, down about 9% year-to-year.

Great.

Thanks very much.

Congratulations, George.

Thank you very much.

Thank you all.

Let me close with a couple of comments.

Our businesses are operating well because we are good at executing our strategies.

Customer loyalty continues to improve.

Our retention of new business has turned a corner in the auto business, which is beginning to build a foundation for growth.

Our investment portfolio, we are actively managing it, and it's well-positioned in this economic climate.

We hare ample capital and earnings power to build competitively differentiated strategies, again to drive sustainable growth for shareholders.

So as we close out 2009, we are going to keep focusing on our three priorities, which is to keep Allstate strong financially, to improve customer loyalty and to reinvent protection retirement.

Thank you for your interest in Allstate.

We will see you next quarter.

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

This concludes the program.

You may now disconnect.

Good day.