Allstate Corp (ALL) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Allstate Corporation third quarter 2010 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 turn the conference over to your host, Mr.

Robert Block Vice President, Investor Relations.

Sir, you may begin.

Thanks Matt.

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

This morning, Tom Wilson, Don Civgin and I will give some commentary on our results and, then we will open it up for your questions.

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

During the Q&A session, we ask you that you limit yourself to one question and a follow-up so that we can hear from as many of you as time allows.

As it is our practice, yesterday we provided our earnings press release, investor supplement and filed our 10-Q for the third quarter of 2010.

We also posted a presentation that we'll be using on today's call.

All of these documents can be found on our website.

As noted on slide 1 of the presentation, this discussion may contain forward-looking statements regarding Allstate's operations, and actual results may differ materially.

So refer to our Form 10-K for 2009, Form 10-Q for the third quarter and our most recent press release for information on potential risk.

Also, this discussion may contain 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 shortly following the completion of the call.

Christine Ieuter and I are always available to answer any additional questions you may have after this call ends.

Now, I will turn it over to Tom Wilson for his perspective on the quarter.

Good morning.

Thank you for investing your time to hear about Allstate and the progress we are making to deliver value for shareholders.

I am going to start with a quick overview of results for the quarter.

Then Bob will go through each business unit and Don will cover our investment performance, balance sheet and capital positions, then we will open up for your questions.

In the third quarter, we were again successful in executing strategy that creates shareholder value despite a weak economy.

So why don't we begin.

Go to slide 2.

In total, we generated $367 million in net income on $7.9 billion of revenue.

There was an increase in that income of $146 million that was primarily due to less realized capital losses this quarter than in Q3, 2009.

Operating income was $452 million, or $0.83 per share which was $86 million below the same quarter last year, and that's the result of lower operating income from Allstate Protection, our property liability segment.

Property liability had an underlying combined ratio of 89.2 for the quarter, bringing the full year -- or the nine months up to 88.8.

That's squarely in the middle of our annual outlook of 88 to 90 that we provided in February.

We did experience an increase in frequency in the third quarter but remain comfortable with loss trends.

Growing Allstate Protection is critical to our success.

While we were able to largely maintain revenues from prior year levels, we need to generate more unit growth.

Standard [overall] policies in force declined from 17.8 million to 17.5 million this year as strong growth in new business in most of the country was offset by declines in several large states where we have taken action to improve profitability.

These actions also had a negative impact on improving customer loyalty in the quarter.

Since our major competitors also had declines in customer loyalty this quarter, it was really a missed opportunity for us to improve our relative position.

Efforts to improve returns in homeowners in the Encompass independent agency business also had a negative impact on growth.

New business growth was a result of several things.

It was up 2.4%, increased advertising; the successful addition of the Mayhem campaign to our marketing programs and targeted pricing actions to improve our auto competitive position.

Homeowners profitability remains a concern, though progress is being made as our rate actions work into the numbers.

Catastrophe losses this quarter were low relative to other third quarters, but we had no major hurricane losses.

The amount of non-model cat losses remained at high levels.

We continue to see price and tightened underwriting standards while we deploy better risk management tools in order to generate acceptable returns.

Allstate Financial continues to generate -- to strategically reposition its business while raising returns.

Operating income of $108 million was below the last few quarters due to several positive one time items earlier in the year.

Premium deposit volume was down as expected as we shift from spread-based businesses to mortality and morbidity products.

Allstate Financial did grow both the work site and Allstate agency businesses where premiums and deposits on underwritten products were up 33% and 2% respectively compared to the Q3 2009.

Allstate Financial also completed its Focus to Win cost reduction efforts.

Investments had another great quarter from a total return prospective as the portfolio continues to generate substantial cash and improve in value.

The net unrealized gain on the portfolio rose to $2.7 billion.

This gain reflects lower interest rates and improved valuations on structured securities.

While lower interest rates do translate into higher valuations, it puts pressure on operating income.

We have continued to reduce our municipal bond and real estate holdings which also puts downward pressure on operating income.

Don will cover the impact of that in a few minutes.

The net result of this operating performance was to raise book value per share to $35.48, that's up 6.7% over the last three months and is almost 10% higher than a year ago.

And now, let's have Bob go through the results in greater detail.

Turning to slide 3, here are the property liability premium and underwriting income results.

In the third quarter, we produced a net premium written of almost $6.8 billion, which was a slight decline from Q3 2009.

Total net written premium for the Allstate brand increased slightly, but was more than offset by a decline in our Encompass brand.

Within the Allstate brand, our standard auto net written premium fell by 0.5% after small increases in the first two quarters of the year.

Increases in new issued applications of 2.5% and average premium of 1.4% both compared to prior years quarter were more than offset by a decline in retention, resulting in the premium shortfall.

Total units also fell 0.3% sequentially and 1.7% from third quarter 2009.

Homeowner net written premium increased quarter-over-quarter by 2.4%.

Increases in average premium driven by approved rate increases and retention were more than enough to offset the 4% decline in total units.

The recorded combined ratio for the third quarter was 95.9%, 1.2 points higher than third quarter 2009.

The underlying combined ratio, which excludes the effects of catastrophe losses in prior year reserve re-estimates was 89.2, right in the middle of our annual outlook range we provided at the start of the year.

Catastrophe losses for the quarter were $386 million on a recorded basis.

This result was made up of $371 million of current quarter losses and 29 events, $57 million of additional losses from events occurring earlier in the year, primarily second quarter hailstorms and a $42 million reduction of prior year reserves.

While the catastrophe loss was much less than the first two quarters, it was still relatively high for a third quarter, given the absence of a major hurricane loss.

A few words on prior year reserve re-estimates.

Besides the $42 million reduction in catastrophe loss re-estimates, the third quarter included a $22 million increase for discontinued lines, primarily for environmental reserves as we completed our annual reserve study for the discontinued lines and coverages.

It also includes a $70 million litigation accrual charged to homeowners.

On slide 4, we provide a look at auto loss cost trends which in total, remained within our expectations.

On the left-hand side of the exhibit, we provide the quarterly frequency results for bodily injury and property damage.

In both cases, the level of frequency is elevated relative to the previous five years.

In the upper right-hand corner, we display the paid severity change over time.

Here, the results remain very good with only slight increases in the quarter.

When these results are combined with those of the remaining coverages in auto, the result is a combined ratio that is fairly flat for the quarter compared to the third quarter of 2009.

On slide 5, we show similar loss information for homeowners.

On the top half of the exhibit, you can see the frequency, excluding catastrophe losses was 2.3% less than the third quarter 2009 results.

The paid severity, excluding catastrophe losses, increased 2.1% compared to the third quarter of 2009.

With the increase in average earned premium for rate increases working into the results, the underlying loss ratio, which excludes catastrophe losses and prior year reserve re-estimates, improved again this quarter.

We continue to execute on our profit improvement actions designed to get home owners to an acceptable level of profitability.

Shifting to Allstate Financial, slide 6 displays the top and bottom line results for the last two years by quarter.

The trends continue to reflect positive momentum in our efforts to produce higher returns, shift our focus to underwritten products versus spread based products and serve our customers through Allstate agencies in the Allstate Workplace division.

Premium and deposits on underwritten products increased 8.6% compared to the third quarter of 2009 while annuities declined, consistent with our strategic direction.

Operating income for the quarter was $108 million, or $13 million more than the third quarter of 2009.

I would describe this quarter's result as relatively clean in terms of one-off items.

When we adjust the first two quarters of 2010 for these kinds of items, the operating income drops back to a range of $110 million to $115 million for those quarters.

The benefit spread was slightly lower due to higher but typical immediate annuity benefits this quarter compared to the third quarter of 2009 which had favorable results for that product.

The investment spread increased to $127 million, reflecting decreased interest credited to contract holder funds, partly offset by lower net investment income.

Operating costs were slightly elevated this quarter due to higher marketing cost and certain acquisition related expenses associated with growth in the workplace division premium.

The expense reduction actions associated with the Focus to Win program initiated in 2009 are now substantially complete and the program has met our target.

For the quarter, Allstate Financial recorded net income of $85 million versus a net loss of $38 million last year.

Realized capital losses were significantly lower this quarter compared to the third quarter of 2009.

At this point, I'll turn it over to Don.

Thanks, Bob.

I'm going to cover our investment performance for the quarter and the status of our capital position at the end of September.

As you can see on slide 7, the value of our investment portfolio increased to $102.2 billion in the third quarter, largely reflecting the benefit of the decline in interest rates during the quarter.

We continue to be proactive in risk management activities and again this quarter, we reduced exposures in our municipal bond and commercial real estate portfolios while also protecting against an increasing rate environment.

We reduced municipal bonds by $2.4 billion of amortized cost in Q3.

The reductions targeted specific sectors and higher risk geographies.

Commercial real estate reductions totaled $484 million of amortized cost, and this was accomplished through a combination of maturities and prepayments, with some offset due to refinancing activity.

The total portfolio maintained a defensive position against interest rate increases.

Reinvestment proceeds were placed in shorter duration instruments with derivatives being used to further manage the overall duration.

That said, the continuation of lower rates in combination with our risk mitigation and duration management continues to adversely affect investment income.

On slide 8, you can see that net investment income fell to $1.0 billion, a 4.2% sequential drop and a 7.3% decline from Q3 2009.

Property liability investment income dropped 8.4% sequentially and 12.9% from Q3 2009 on reinvestment of the proceeds from our risk mitigation, rate management and investing activities and lower yielding and shorter duration securities, as well as the timing of equity dividends.

Allstate Financial investment income dropped 2.2% sequentially and 5% from Q3 2009, primarily the result of a drop in average portfolio balances.

Our return optimization program included purchasing high yield corporate and asset backed securities which have only partially offset the significant decline in interest rates.

We continue to focus our investing activity to optimize both risk and return opportunities.

Net realized capital gains and losses shown on the bottom of the slide improved this quarter.

We posted a pre-tax loss of $144 million compared to a loss of $519 million in Q3 2009.

Other than temporary impairments were $167 million in the third quarter, less than half the amount experienced in Q3 2009, and they were concentrated primarily in the RMBS and CMBS portfolios.

Trading activity and risk mitigation actions drove net realized capital gains from sales of $319 million in the quarter, $118 million more than last year's third quarter.

Most of the gains came from the fixed income portfolio, in particular, public corporates, municipal bonds and agency paper.

Equity has contributed about a third of the gain.

The derivatives loss for this quarter at $285 million was slightly better than the loss in Q2 2010 and $76 million better than Q3 2009.

We added additional breakout on this page to show our derivative experience by key risk.

Our interest rate hedges produced a loss of $181 million this quarter, $100 million less than Q2 2010 and $219 million less than last year.

These losses reflected the continued cost of protecting our portfolio from rising interest rates.

Our equity hedges lost $115 million as equities rallied about the same as last year's Q3.

All this detail can be found in our 10-Q filing.

On slide 9, you can see that our unrealized net capital gain position improved by $2.3 billion on a pre-tax basis from Q2 2010 and is $5 billion better than Q3 2009.

After tax and DAC we stand at $1.3 billion, $964 million better than Q2 2010.

Virtually every asset class participated in this improvement as we benefited this quarter from the decline in interest rates and higher equity markets.

The improvement in the portfolio valuation more than offset the cost of our risk mitigation programs.

While our net unrealized gain position is clearly a substantial improvement from levels over the past two years in terms of our book value, the current low rate environment that creates this unrealized gain is also the reason we've been actively working to reduce exposure rates -- increases in rates.

Finally, on slide 10 we provide you with a look at our capital position on both a GAAP and stat basis.

Our overall GAAP equity climbed to $19.3 billion in the third quarter, a little more than 15% increase since year end.

Our current estimates of statutory surplus for Allstate Insurance Company and Allstate Life Insurance Company show stable to increasing capital levels in these companies.

During the third quarter, the holding company received a $400 million dividend from AIC, bringing the total for the year to $600 million.

With that, I'll turn it back to Tom.

Okay, before we move to your questions, let me summarize the quarter, really with six items.

One was disappointing, one was mixed and four were -- we had strong performance.

Let me start with the disappointing.

Our auto retention was down as we started managing profits in a couple of big states.

That offset the benefits from more marketing, and the result was that items in force in our standard auto business did not grow this quarter.

That's the disappointing part.

The mix, the homeowner is making progress, although we still had a high level of cats.

In the good category, our property liability combined ratio was in the middle of the range that we gave to you in February for both the quarter and the nine months.

And this is -- our auto combined ratio has been in the positive zone that is below 100 for over a decade.

Investment results, we had great investment results, risk mitigation making a lot of progress on that, and our return optimization, obviously, we stayed in the right stuff as we had a good increase in the value of our portfolio.

Allstate Financial, it's Focus to Win program is done, and it's got a balanced approach of raising returns, and book value is up 7% for the quarter and 15% for the year.

So, that's a summary of the quarter.

Let's turn to your questions.

Okay, Matt, do you want to start the question-and-answer session?

Thank you, sir.

(Operator Instructions) Our first question is from Matthew Heimermann from JPMorgan.

Your question, please.

Hi, good morning, everybody.

A couple of questions.

First, just with respect to the policies in force and retention, can you give a little bit more color maybe on those dates?

If not specifically, maybe generally, that are affecting the retention?

And also, just would continue to be curious, how much of the PIF decline you are seeing is also tied to -- would also be a customer that potentially is leaving because of the homeowners underwriting actions.

The second question I have was just on the G&A.

I was curious if whether or not there was a pick up in ad spend just because it's the fall and college football is picking up and baseball playoffs, et cetera.

And then the last one quickly was just, there's obviously -- it's in the press that Bank of America is potentially looking to sell Balboa.

You've been mentioned.

I don't know if that's realistic or not, but be curious if -- what the strategic rationale would be for that, given it's predominantly property.

Thank you Matt, good morning.

I'll take all three of those, even though we're, I think 50% over Bob's request.

I can deal with the last one easier, and then I'll get Joe to take on the states, the question of the state's retention, what is happening with homeowners, both as we improve profitability and as we seek to increase cross line sales.

On the B of A Balboa, we obviously don't comment on acquisitions.

And if we were to buy it, we would have a strategic rationale for it.

Given that property is not a high focus area for us in terms of growth right now, I wouldn't put that at the top of anybody's list.

In terms of ads, we are doing quite well there.

Not only has it just been fall football season, we've increased our spend to be more competitive as Geico and Progressive increased their spend.

And Joe, you want to take the retention and growth?

Yes, from a retention and growth perspective, Matt, we've talked a couple of times in the last couple of quarters about some specific states where we've been targeting profitability focuses, and I think we give you a little bit of an outline of it in the Q.

We have seen some issues in those states, we've pushed prices up a little bit, some underwriting actions.

We see some of that rippling through new business in Florida and California.

We see some of that rippling through retention in California and a couple other states.

It's driven, again, by trying to get our selection mix from an underwriting perspective in the right spot and getting our pricing where we want it to be.

From a homeowners perspective, there is some impact, but not a big impact on the homeowners actions that we are taking.

We have talked before about a preferred package discount that we have used from a pricing perspective that makes it more attractive to have your auto and home with us, and that helps mitigate some of that issue.

I guess just to follow -- it sounded like -- even though we've talked about some of these actions, that PIF, in your comments, at least, it sounded like maybe it was a little soft relative to what you had hoped it would have been.

So, I guess if that -- one, is that true and if it is, where -- what types of accounts are -- where is it -- is it just a general across the board issue where it maybe slipped a little bit more, or is there some more specific type of customer?

I'm trying to hone in on the part of the follow-up question.

If you are reading that it's below our expectation from comments this quarter, I'm not sure that's exactly where I'd say it is.

We've -- we are seeing a little more of a retention impact than we've seen in prior quarters, and we are seeing consistent trends on new business with what we have seen in the past.

And it's not a huge change in the retention impact, it's a little bit.

Matt, let me just add one thing to that which is, we believe in talking about our results in total.

We'll be happy to give you components of it to make sure you know we understand and you can have a better understanding of it.

Our new business, while it is up 2%, there are many states where it's up double digits.

So, we just -- so we think our marketing programs are working, back to the ads program.

We give you the number in total.

That's fair.

And I guess I would also argue that margins are important too, so.

Thank you, we think so.

We agree with you.

Sure, bye.

Is our next question is from Bob Glasspiegel from Langen McAlenney.

I guess if I could follow up -- good morning.

If I could follow up the Balboa question, you are up $3.5 billion of cash at the holding company.

Does acquisition and corporate development factor into where you would stand on initiating the buyback program?

Well, I don't know where this Balboa drumbeat is coming from, but it wouldn't be us.

Let me start with capital, Bob, because we ought to probably talk about it.

We obviously have been doing a good job of building capital, whether that is statutory capital or book value, from a GAAP basis.

We feel good about that.

As we've said, the first thing we use with capital is to make sure our business is sound and stable and in a good position, and given the economy and investment markets over the last year and a half, we've done everything to keep ourselves in the right position and fully capitalized.

Second, then we obviously try to deploy that in growth of the business.

The easiest place to do that would be to do it -- the most opportune place would be to do it by growing our business organically, and we'd love to do that.

We've also said if there are acquisitions that we think fit, we'll do those.

You've seen what we've done over time on acquisitions.

We are not in the market all the time buying all kinds of stuff.

We do try to buy stuff we think will grow.

So the Workplace business was number three when we bought it, it's number two now, and we are liking its trends.

So, we try to be smart about what we buy.

And obviously, then we return it to the shareholders.

We've talked before about our dividend policy which I have my board look at every quarter.

We do that based on a percentage of earnings.

I think you should expect us to continue to set dividend policy based on the amount of money we make.

Then if we have capital above that, then we've always bought back stock.

We have not announced a stock buyback program today.

I am not about to, but I'm feeling we're in pretty good shape.

But if you could look at our track record on giving -- returning capital to shareholders, it's been great.

So, I think you should expect that same philosophy to apply going forward.

Okay, if I can just follow up, your stat capital went up by $600 million if we add back the dividends, which was a decent bit more than your GAAP income this quarter.

Do you have -- what were the key drivers of the differential between stat and GAAP?

Are you talking about -- which entity?

The insurance companies.

The insurance company had an improvement of the unrealized position as well.

Okay, and that drew the stat capital and the unrealized?

Yes, we had -- remember, we pick up the improvement in equity at AIC.

Okay, thank you.

Our next question is from Keith Walsh from Citi.

Your question, please.

Hello, good morning, everybody.

First for Joe.

I saw the press release a few weeks back about the Idaho service center.

I just want to know if this more indicative of a more aggressive push into the direct market.

Maybe if you could put a little color around that, why you're opening that up maybe just update us on direct.

And then I've got a follow-up.

Let me talk first about the call center.

We obviously, opened a call center in San Antonio.

We opened one in Idaho just recently.

That is in part because not only do we do direct business, but we handle all kinds of service related work on behalf of our agencies because people want to be there 24 by 7.

And we've had an opportunity -- we could open those anywhere in the world.

We've been seeking to opening them in the United States at this point, because we think it's the right thing to do.

When you look at our customers, they say they will think better of a company that puts jobs in the US, even if it costs a little more money.

Now, of course, everybody wants a good price, so we have to make sure we continue to use the right kind of labor around the world, which we've been very active in.

Joe, maybe you want to make a comment about the growth of direct and how it kicks in.

Yes, and I'll echo the same things.

We use all our service center capabilities to service multiple channels, so this is not purely related to direct.

We are growing our direct business, are enthusiastic about those prospects and continue to do.

I think we gave you a little bit of information in the Q.

But you can see, that business was growing north of 15% for us in the quarter, and we feel good about it, and we'll continue to keep our marketing and our operational capabilities lined up to facilitate doing that more so.

We want to service customers in the way they want to be serviced and meet their needs and the value proposition that resonate with them, and that will continue to be a focus for us as long as it is for customers.

And Keith, this is Tom Wilson -- I think sometimes -- I want to reiterate, underline and expand on something Joe said.

When you look at -- the key thing is to look at the customer segment and say, what it is they want, and make sure you're delivering it.

So, there is a whole bunch of customers who want a personal touch from somebody, want a relationship, and we obviously seek and do that quite well with our agencies.

There are other people who are more self-directed and want it through direct.

So, we try to deal with customers as to how they want it.

A lot of times people get focused on distribution as -- without focusing on the customer.

We think you've got to focus on the customer first and then figure out what distribution works for them.

Okay, and then Tom, my second question, just more broadly.

The inconsistency in the results is clearly an outlier to your peers.

Can you help us understand why that is, because I'm just having a hard time with that.

Thanks.

Maybe if you can give me a little clarification on inconsistency.

Inconsistency, you have got weather related losses this quarter.

I didn't see that out of TRV or PGR.

The PIF numbers are clearly up and down sequentially when we look at it.

The overall earnings results, pretty inconsistent across the board.

So, we can go on and on offline if you want, but maybe we can start there.

Well, it sounds like you are frustrated.

I'm sorry for that.

What I can tell you is that we give you a combined ratio for the year that's ex-cats and prior reserves releases, which of course are impossible to forecast.

And we've been dead in the middle of that for as long as we've been doing it.

So, I feel good about the 89.2.

As it relates to catastrophe losses, when you are as broad as we are and across the country, it -- you're subject to all those.

So, some of the companies you mentioned have a more narrower focus in terms of where their homeowners businesses is.

Okay, thanks.

Our next question is from Alison Jacobowitz from Bank of America.

Your question, please.

Hi.

Thanks.

I was wondering if you can talk a little bit about the frequency in auto this quarter, it sequentially seems to spike up a little bit, it was 7% in a couple of areas.

And also if it's possible, can you give us some color on the growth?

I know that several states are holding you back.

Can you clarify a little bit as best you can where you are in that process or where you think you are and when that pressure might start to ease up?

Why don't -- Joe, why don't you take both of those.

Relative to the frequency, Alison, we are seeing a bit of an uptick in frequency.

We continue to look at it.

It's generally spread across a broad set of geographies, across a broad set of customer vintages, if you will, tenure that we have with customers and across most ways that we can look at it.

We are seeing a little bit of that spike being increased in claims that are closed without payments, which might be a little bit of a tail impact on some of what we have seen in prior periods.

We made a big shift in our claim system over the past couple of years, which is done basically, but it does impact some of the prior period claim practices.

So, a little bit of that frequency, we think might be some noise out of that.

But even if you take the noise out, there is a bit of an uptick.

We have seen some increases in gas purchases and miles driven, which would be some correlation to that.

I'm not sure where to point where we'd declare it a long-term trend, but we are watching them.

Relative to the growth question, we don't give forward-looking growth guidance or production guidance.

What I will tell you is that we are focused on, over the long-term, growing our business.

We are focused on preserving a strong track record of having very powerful margins, and we'll keep those two items in mind as we march forward.

And I think the comments we have given you is that we've got new business up double digit in states other than California and Florida where we've seen new business decline year-over-year.

We've focused on some specific profitability actions in those geographies, and that will work its way through the system, at least the new business relativity year-over-year.

We've been talking about this for three quarters, so you don't have a year-over-year problem in another quarter or a quarter and a half.

That's just algebra.

In terms of where we project it going forward, I am going to avoid doing that.

Okay.

Thanks.

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

Your question please.

Great, and good morning.

I apologize if I missed this, but the little litigation charge that was in home insurance, what was that?

And maybe you can talk about the A&E charge as well.

I'll give you a quick -- Paul, this is Tom.

I'll give you a quick uptake on the lawsuit and Don, maybe you want to take A&E.

As it relates to the lawsuit, it was a potential class action suit filed in a state court.

You'll remember that they changed -- there is a class action fairness act, which removed class action from state courts to federal courts, because we thought that -- we know that federal courts deal with them in a more balanced approach.

This is one of the ones we had left that was from a state court.

It was down in Texarkana, Arkansas.

It was related to the way in which we calculate the amount paid to fix homeowners claims.

A number of other carriers were before us down in that court had settled their amounts at what we think are amounts higher than that.

This actually would cover 48 states, because we've won this issue in many other states.

It's just in this particular state court, we felt it was better to settle and move on.

And on the A&E Paul, we do an annual analysis of those reserves and we, as in previous years, we did it this year and added about $18 million.

Any reason for that?

No particular reason, no.

No specific reason.

It's not like we got some big claim out there or something we're worried about.

It's just -- as you remember in the environmental thing, I think about 65%, 70% of it's incurred but not reported.

So, of the amount we have up for environment, we don't actually have specific claims.

But you look at the trends, what comes in, what you have to pay out and you make changes.

And in this day and age, you put up when you see it.

I'd like, if you could focus on the Encompass brand and the efforts that -- maybe a little bit more on the efforts you are trying to make to make that more profitable and maybe talk a little bit about the long term viability of that operation.

It has been, I believe, a -- certainly not less profitable than the core business for as long as I can remember.

Paul, let me have Joe take that as to where it is today.

But let me just say from a standpoint, remember we bought that business back in 1999.

We've looked every which way to Sunday, and we've had a good return on that business because we bought it so cheap.

Cheap is good.

So, when we look at it Paul, I would encourage you to think about the Encompass business right now as having two parts in it.

There's a core target that has long been its target of a bundled auto and home targeting a mass affluent customer base, below the real high end that you see in some high value homeowners players, and we do well in that product.

It does -- it's positioned well inside of agencies.

They like the product, they like its performance.

We fit into a well-defined niche there and broadly, we are happy on the performance.

On any given day, any given quarter, we might want it to be a little bit better, whether it's growth or profitability.

Then there's a second part of the business.

A couple of years ago, we tried to expand our targeting to produce more auto business through that brand.

We ended up adding groups of agencies that were more specialists in auto, broadened the product capability to target that mono line auto and found that our approach, both through a combination of distribution and a combination of how we priced and structured the product and managed the underwriting, wasn't effective in that marketplace, and hurt us from a profitability perspective.

What you are seeing right now running through the numbers is the impacts of the unwinding that latter part of the book of business.

Now, as we do that, it has had a little bit of a ripple over effect into the core.

So, that's getting splashed with the clean up, if you will.

As we move through that, we will continue and are continuing to focus on the core niche where Encompass has been effective.

I am very confident that we can be effective in that space, grow that business, make reasonable returns on it and that it's something that is desired by independent agents as distributor and has a good customer proposition.

We just have to finish the cleanup of that auto specialist strategy.

Is this split 50/50, or is it -- how big is one versus the other?

It got as big, at one point, as close to 50/50.

I am going to decline to give you the specifics on exactly where it is right now.

Okay, thank you.

Our next question comes from Cliff Gallant from KBW.

Your question, please.

Good morning.

Two questions.

One, the ad spending, the elevated level that we saw in the quarter, should we expect that going forward?

And then two, during the quarter State Farm had an announcement regarding drywall lawsuits, and it looked like they were trying to move towards some kind of settlement, and I was wondering if you had any update on that issue?

Good morning, Cliff.

In terms of the ad spend, you have seen us increase this quarter because we felt it was worthwhile to take the risk and see what kind of growth we get out of it.

As long as we keep getting growth out of it, we'll keep doing it.

When we think it's not economic, then we won't do it.

As it relates to drywall, we don't really have anything to talk about other than what we said publicly before, which is we don't think there's exposure.

If you are talking about Chinese drywall, we don't think there's exposure.

We think that's a product liability issue, not a homeowner issue.

Thank you.

Our next question is from Meyer Shields from Stifel Nicolaus.

Your question, please.

Thanks.

I want to drill down a little bit into a comment that Joe made about wanting long-term growth in Allstate brand.

I know if we look back about a year, a year-plus, the capital was really constrained, and I think that translated into a focus on maximizing current underwriting profits, probably at the expense of growth.

If I understand you correctly, is that concern now abating so that you can focus more currently on growth?

It's really a capital question, Meyer.

Let me take it.

Which is -- if you have a follow-up as to what you think -- what Joe is doing, we should go there as well.

But as it relates to capital, you are correct in the assumption that we -- I don't know that we felt capital was constrained, everyone's got their own word around that .

But we weren't comfortable with the economic or investment outlook really starting in 2008.

So, at that point, we chose to protect margins at the expense of growth.

You are seeing the consequences of that, both in '09 and 2010 as we try to work through that, because this has long trends in it.

You can't -- because so much of our business is renewal, it's hard to turn that thing on a dime.

But you are correct in sort of what you see today.

Do you have anything more specific on the growth that you want Joe to

I think so.

In the past, you have given ratios of competitor rate increases decreases in auto and how you saw that playing out.

I am wondering whether that is still trending positively.

Can you expand on that a little bit?

Because I am trying to make sure I understand how you are asking the question.

What I am wondering is whether your expectation for the next, I don't know, short-term, call it 12 months, is that your competitive profile will improve due to other companies' rate increases.

That becomes a hard one for us to sit here in this environment and forecast for you both what we are going to do from a pricing perspective and what other folks are going to do from a pricing perspective.

I'd love it if they'd forecast it, because we would find that to be useful.

But from a competitive perspective, I think that's a conversation that is going to be tough for us to have here.

Okay, thanks very much.

Our next question is from Brian Meredith from UBS.

Your question, please.

Yes, good morning.

I guess just quickly here, the underwriting expenses are, in the property casualty area, up about 10% in the quarter, up 12% last quarter.

Is that the ad spend coming through, or is there anything else running through there?

Pension costs, too.

Pension cost.

Okay, how much of the pension cost addition?

I don't think we disclose it, but if you want to follow up with Bob, I'm sure he'd be happy to get that.

Okay, great.

And then just quickly, if I take a look at average written premium per policy the year-over-year growth decelerated in the quarter.

Is that just a function of just getting more competitive out there from a rate perspective at Allstate?

Is there something else that I am missing?

If you look at the -- it's almost a follow-up to the prior conversation, now we are looking through the back window as opposed to the forward one.

Yes, we have talked about it before and we have been a little more focused on being more competitive sometimes.

In some cases, that's been taking rates down.

In other cases, is has been not taking them up a the same rate we had before, and that's the bulk of what is driven through there.

Got you, got you.

And then last one, Tom, you made reference to the customer loyalty being down a little bit in the quarter.

Can you talk about initiatives right now that you have got in place to try to keep that moving up or heading in the other direction?

Brian, they're the same things we've been doing, which is, first it was down a little.

So, you get into, I'd say it was a missed opportunity because everybody else was down too.

We need to move it up because if we move it up, retention will go up.

If retention goes up growth will go up, and that would be good for all of us.

The programs we have in place, just to refresh your memory, we changed the reward system so both our agencies and our employees benefit from higher customer loyalty.

Agencies in that some of their bonus is paid on retention.

Our employees in that the profit sharing plan is now -- we've switched it from profits to customer loyalty so people's 401(k) match is dependant on getting it up.

So, we have the reward side.

On the accountability side, we've continued to increase the accountability for results, and if people don't take good care of our customers, then they can't be part of our team.

We also have is a number of programs underway underneath that to help us improve loyalty.

Everything from calling people, doing protection reviews, calling them when their bill is late to having better and clearer communication.

We've launched some stuff called Insurance Made Simple.

So, there is a whole bunch of things we do along the way which support both at accountability and recognition.

One of the challenges we had this quarter was the benefit of all those programs, rewards, accountability and new initiatives did not offset the impact that reasonably large increases in price had in a couple of the big states.

So, as price goes up, obviously, people get unhappy, and you have to make them even more happy, and we didn't accomplish that.

That said, we didn't make as much progress in the other parts of the country as we need to, so it will stay a big focus for us.

Thank you.

Our next question is from Vinay Misquith from Credit Suisse.

Your question, please.

Hi, good morning.

The first question is on the capital position.

Your stat capital has increased nearly $2 billion since the end of 2008 and your GAAP capital has increased $8 billion.

Just curious about whether the fact that you have not announced a buyback, has that been held back by the S&P negative outlook, and are you waiting for that to be removed before you make some sort of announcement on that front?

Vinay, I'll make a quick comment.

Don may want to make a comment as well.

We're appreciative of the recognition that capital has gone up, and we think it is a big thing and should be driving shareholder value more than it is.

At current book value multiples, we are, in my estimation, a bargain.

But as it relates to capital levels, we run it based on what we think, not what other people think.

So, we set up capital, we look at economic capital, and we think we have plenty of economic capital.

We have -- S&P can have a negative outlook.

I'm not sure why given that we think we have excess capital as to obviously you and other people on this call.

So, their outlook is not keeping us back from doing anything.

I don't need their approval to buyback shares or pay dividend or do anything else.

Fair enough.

So, what is holding you back from buying back stock right now?

Just where we started, which is all things at the right time.

Okay.

The follow-up question is in terms of the actions taken to improve profitability.

I think it's had a negative impact on our retention in California, Georgia, New York and North Carolina, and also in Florida.

Can you give us a sense for what inning are we in terms of rate increases or in terms of these actions taken to improve profitability?

I think Joe answered that, which is we don't look forward.

We increase prices when we think we need to.

There's a number of trends that are -- each of those states is different.

You remember in California, we had to take some big decreases, I think 2008.

And so we are not even back to where we were when we got started with this.

In some of the bigger states that have personal injury protection, you are seeing a number of industry things going up where fraud is way up in places like Florida and New York.

So, it's hard to predict what inning you're in.

I'm never -- I can only tell you that our approach and what Joe and his team do is when they see a problem, they go to fix it.

And we try to keep balance, we try to keep rate increases small as opposed to large and infrequent, and we'll continue to do the same thing in the future.

And on the homeowners side, the trailing 12 month rate increases seem to be only 6%.

Do you think that you would like to take a higher rate increase, given that the combined ratio was 100% this quarter in homeowners?

I've been consistent in saying we need to a better return from that.

Okay, and what's the timeline that you propose to take rates up in that line?

We're not going to go --

We don't give projections on what we are doing in the future.

Okay, alright.

Thank you.

It is useful, Vinay, to remember that the homeowners had the litigation settlement that ran through that number this quarter, so that's a significant number.

Yes, at 4 points on the combined ratio and the combined ratio was 104.7.

So, even if you take that out, that is 100%.

This quarter I don't think it was a really bad quarter in terms of cash.

So, I am a little surprised that it was 100%.

And so I was just wondering whether you plan to take rates up, say, maybe 10% in that line to get it more to the high 80s, low 90s combined ratio.

Well Vinay, we've been very consistent in saying we need a lower combined ratio, higher return in homeowners.

I think actually when I summarized the quarter, I said that that was in -- it wasn't in my disappointing category, it was in my mixed category.

Wasn't the four positives, but we are not there yet.

But it isn't like you can just waive a magic wand and all of a sudden charge people a lot more money, given the regulatory structure and the customer relationships we are trying to manage.

So, we try to do it in a balanced way.

Joe talked earlier about the success we are having with given larger discounts on auto insurance to mono line homeowner customers, that's working quite well for us.

So, we want to do this in a way that accelerates the overall growth of the Company, both in terms of the size of the Company as well as improve returns.

Fair enough.

Thank you.

Is our next question is from Greg Locraft from Morgan Stanley.

Your question, please.

Hi, thanks.

I wanted to cover a couple of things.

Number one, how are you feeling on the pension at this point in time?

It was underfunded by over $1 billion at the end of last year.

We obviously have plenty of cap.

First, how we feel -- we feel good about the pension and that it is an obligation of the Company.

The under -- we put is a lot more money into it this year, and we obviously have plenty of capital to keep the pension whole.

So, it depends what you mean about feel about the pension.

We obviously would like returns to go up on that portfolio, and we've had good returns so far this year.

But we are like everybody else, we still suffer from the downturn in equity values that happened over, really the last three or four years.

Don, you have any other comments you --

No, I think that's --

Okay, great.

And just if you could refresh, how much will you put into the pension this year and then, how are you thinking about funding from a company contribution perspective next year?

You know what?

Let us follow up on that, Greg.

I just don't remember.

Yes, you can -- we fund it when we need it.

There's obviously a tax advantage to putting money in early and letting it roll, but then the downside to it is you lose a little bit of investment income at the Company.

But you are talking about -- our contributions have usually been in the hundreds of millions of dollars.

So, I wouldn't -- it's not a meaningful number in terms of the overall operating income of the Company.

Okay, great.

Second is the debt level of the company.

You guys have done a nice job deleveraging for several quarters now.

How low do you think this could go?

I think your target is low 20s, and it seems like you guys are getting pretty darn close to that right now.

If you do the math on GAAP, that's how it gets to deleveraging.

If you do the math on economics, we've been right where we've always been.

And on GAAP it's 23.5, and we've always said that feels about right.

We obviously don't have a need for extra capital today, so we don't need to go out and borrow it.

Don is always looking at how he wants to optimize our capital structure, both within the existing $6 billion of debt or any -- whether he wants to move other things around.

You have seen us do that over time, everything from issue preferreds to debt and tied to the overall capital of the Company.

But we don't have any plans.

We are not announcing anything today as to what we're doing differently.

I guess I was just wondering, is that 23.5, is there a governor below which you guys would take out more debt in order to hold the ratio flat?

Or do you not -- do you look at it more or less -- you don't look at it as much on a GAAP basis is what you're implying.

That's right.

Okay, okay.

Great.

Last is on the investment income line, that was one of the ones that we were surprised on.

And I'm just wondering how do we think about modeling that going forward?

How much is coming due or maturing, and what does the new reinvestment rate looks like.

Judy is so happy she got question, because she's been sitting here patiently, waiting for someone to jump on it.

Well, we thought maybe Don had just done just done such a good job of explaining it to you, you didn't have any questions (laughter).

Judy?

Yes, so maturities are, I believe disclosed on page 8 of the notes, so you can take a look there and see what we've got coming off over the next several years.

With regard to income, there are many factors affecting investment income.

First, we are in a low rate environment.

Rates are down, as everybody knows, 100 to 150 basis points, 50 basis points in the quarter alone.

We also have our proactive stand on risk mitigation, and we've been doing that for a couple of years.

We think it gives us a lot of flexibility in the portfolio, better positions us going forward.

We have been focus largely on commercial real estate and municipals for the past year or so, and I'd say that those programs are largely complete.

We've also done some duration shortening, or duration management within the portfolio.

And this quarter in particular, we took a hard look at the cash duration in the property and casualty portfolio and made some moves to shorten the cash duration because we felt we were using a derivatives to a great extent more than we needed to in that portfolio and decided to bring down the cash duration, and that impacted income as well.

And then, just normal trading activity in this low rate environment also impacts investment income.

When you look at how to manage it going forward, you talk to any portfolio manager that has fixed income in their portfolio, you have a situation where rates are low, they could stay low for an extended period of time, and then you are looking at less income as a portfolio manager.

Rates could decline further which, the value of the portfolio would go up, but you end up with earning less.

And then if rates rise, the value of the portfolio could fall -- would fall, but you'd earn more income.

And I guess the actions that we are taking put us in a position where we feel that we have the flexibility to be proactive in managing the portfolio and driving shareholder value.

Okay, thanks.

Very thorough.

A follow-up on that is the increase in the expense line that goes into this, and, this is just on the P&C side, is that because of the unwind of derivatives, or -- I didn't fully explain how the lack of using derivatives caused this number to step down so much.

What expense line are you talking -- are you talking about underwriting expense or are you talking about investment expense?

I'm talking about investment expense.

It went up, I think $3 million year-over-year, which was a heck of a jump if you look at the last several quarters in the supplement.

This is Bob.

Why don't you and I talk about that offline and we can get behind those numbers.

Okay, okay.

So, the two -- the number you put up though, is much more indicative of what the future run rate is going to be out of investment income, and then we can model the maturities and reinvestment rate per your guidance?

You can model it.

I would take out the per our guidance (laughter).

As Judy said, what we are trying to do is manage for total return in an environment that could go, flat out go up, go down and would shorten duration.

We are staying on the balls of our feet so that we can move quickly, but -- in harvesting gains.

So again, we're not just riding it down and having the gains and have the gains go away if interest rates go up.

We are trying to protect ourselves if they do.

Okay, great.

Thanks guys.

Our next question is from Josh Shanker from Deutsche Bank.

Your question, please.

Thank you.

Given the pace of frequency trends in auto, I'm wondering if the rate actions you have taken prior are anticipating these frequency increases or where we stand in terms of your current rate outlook related to what frequency is doing?

I'd love to tell you that we can look forward six or nine months and figure out what frequency is going to do, but we don't.

The actions we have taken in the past are functions of what we thought was going on in maybe a very short-term view of where we think frequency might be headed.

My comments before suggested that we are seeing some of these increases in the relatively recent periods.

Parts of them, when we look period over period, we think are a little bit attributable to the claim system changes we made over the past couple of years, and parts of it appear to be more broad and environmental.

And we are going to watch and see what is happening with those trends to see if in fact they are trends or it they're a near term anomaly.

And we will factor that into our pricing approach which will include all the things we've talked about in terms of managing margins and thinking about how we run this business relative to the entire impact of the corporation.

Hello Josh, this is Tom.

On a longer term basis, I think for 20 years, if you look at 20 years, frequency came down as we've got safer cars and better drunk driving laws, older drivers, more cars per household.

A whole bunch of things drove that trend.

If you look over the shorter period of time, it looks much flatter.

So that puts Joe's comments in perspective -- 2010 looks like 2007.

That's good.

Thinking then about the competitive nature of the market with the rate environment where it is, coming into the new year, I'm sure you are doing some budgeting.

Given the seasonality of shopping behavior, and I know you guys have a new ad campaign out there that's running a lot, are you planning on increasing the budget for advertising for first quarter 2011?

That would be a competitive piece of information we wouldn't want to give out.

Okay, well thank you very much.

Our final question today is from Sarah DeWitt from Barclays Capital.

Your question, please.

Hi, good morning.

I wanted to follow up about your appetite for M&A.

Can you elaborate on this and talk about if you have any desire to expand internationally?

Because there have been some reports about Allstate being interested in RBS's PNC business.

Thank you.

Good morning Sarah, this Tom.

I'll come back to what has been our stock answer, that which isn't going to be very specific to what you asked.

Which is we look at everything that comes across the market.

Sometimes we have gone and proactively looked for stuff.

We tend to be relatively conservative in the price we will pay unless -- and try to only buy things where we think we can add lots of value.

So, when we bought the Workplace division a decade ago, we thought we could expand it geographically across the country, we did that.

We thought we could expand it through sales of Allstate agencies, we did that.

We thought we could expand it from small companies to large companies, we did that.

When we bought CNA's business, it had a combined ratio of 117.

And while Joe is not happy with its combined ratio at 100, it's been substantially below 100 since we bought it ,and we've made good money on that.

So, that is the approach we have.

If you -- to answer your question about international versus domestic, much more interested in seizing the opportunity available in the domestic market than international.

But if something was appropriately priced and we thought we could add value, we always look at it.

Great.

Thanks for the answer.

Okay.

Thank you all for taking the time.

We are sticking with our strategy being focusing on the customer, and it is driving all of our activity, both with Joe and his team at Allstate Protection, with Matt and his team at Allstate Financial, and we are being active in risk mitigation and return optimization with Judy and her team.

So, all that productivity has creating more shareholder value, so book value again is up this quarter, and we feel good about that.

We have a great management team.

We'll continue to work successfully to increase the value of your investment.

Thank you, and we'll see you next quarter.

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

This concludes the program.

You may now disconnect.

Have a good day.