Allstate Corp (ALL) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Allstate fourth-quarter 2015 earnings conference call.

(Operator Instructions) As a reminder, today's program is being recorded.

I would now like to introduce your host for today's program, Mr. Pat Macellaro, Vice President of Investor Relations.

Please go ahead.

Thank you, Jonathan.

Good morning and welcome, everyone, to Allstate's fourth-quarter 2015 earnings conference call.

After prepared remarks by Tom Wilson, Steve Shebik and myself, we will have a question-and-answer session.

Yesterday following the close of the market we issued our news release and investor supplement and posted the results presentation we will use this morning in conjunction with our prepared remarks.

All these documents are available on our website at Allstateinvestors.com.

We plan to file our 2015 form 10-K later this month.

As noted on the first slide, our discussion today will contain forward-looking statements regarding Allstate's operations.

Allstate's results may differ materially from these statements, so please refer to our 10-K for 2014, the slides and our most recent news release for information on potential risks.

Also this discussion will contain some non-GAAP measures for which there are reconciliations in our news release and in our investor supplement.

We are recording the call today and a replay will be available following its conclusion.

I will be available to answer any follow-up questions you may have after the call.

And now I'll turn it over to Tom Wilson.

Well, good morning.

Thank you for investing time to keep up on our progress at Allstate.

I'll cover an overview of the results and then Pat and Steve will take you through the details.

Our comments today are more detailed on four topics to make sure we provide you with good transparency.

I will spend some time discussing our rationale for 2016's underlying combined ratio outlook.

Pat will provide more detail on auto profitability plans.

Steve will discuss the asset liability investment decisions including Allstate's financial operating income and the impact that has on operating income.

Then, Steve is also going to provide some perspective on the overall investment portfolio.

That will include both the investments we are in, including limited partnerships and energy.

Also in the room today to answer any questions on any and all topics are Matt Winter, our President; Don Simpkins, who leads our Merging Businesses; Judy Greffin, our Chief Investment Officer; and Sam Pilch, our Corporate Controller.

So let's begin on slide 2. We finished 2015 with a strong fourth quarter that was driven by our repositioned homeowners business, continued progress in executing our auto insurance profit improvement plan and reducing expenses.

The underlying property-liability combined ratio for the fourth quarter was 87.4, which brought the full-year results to 88.7, which was within the original annual outlook range we gave last year at this time.

The recorded combined ratio in the fourth quarter was 92.0, which generated $611 million of underwriting.

The comprehensive program we implemented shortly after a significant increase in auto accident frequency and claim severity includes seeking higher approval for auto insurance prices, making changes to our underwriting standards to slow new business growth and addressing underperforming segments -- it does both of those -- and reducing expenses.

This proactive approach, however, did not offset the impact of the external trend, and underwriting profits from our auto insurance declined significantly in 2015.

Continued strong results from homeowners insurance and moderate catastrophe losses resulted in operating income of $1.60 per diluted common share for the quarter and $5.19 for the full year.

The return on equity on an operating income basis was 11.6% in 2015, down 1% from the prior year.

Common shareholders received $691 million in cash during the fourth quarter and $3.3 billion for the full year, through a combination of common share dividends and share repurchases.

If we move to the chart on the bottom of the slide, revenues were up 1.2% in 2015 and property/liability premiums grew by 4.8%.

Net investment income declined 8.8% compared to the prior year, and that reflects a smaller balance sheet which is due to the sale of Lincoln Benefit in April of 2014 and the continued downsizing of our annuity business; lower interest income, which resulted from shortening the duration of our fixed income portfolio; and a slight decline in income for performance-based investments.

Net income for the year was $2.055 billion, which was $5.05 per diluted common share.

Let's go to slide 3. It shows our full-year operating results for our four property/liability customer segments.

So total policy enforced growth across all brands was 1.3% in 2015, as you can see at the top.

And the recorded combined ratio was 94.9.

The Allstate brand, which is in the lower left, is our largest segment and comprises 90% of premiums written, and it serves customers who prefer a branded product and value local advice and assistance.

Allstate brand total policies in force in 2015 were 1.7% higher than 2014.

Auto insurance, which is on the left-hand side of that box, new business and retention were both impacted by property improvement actions but policy still increased by 2.1% for the year.

Homeowner policies grew over the prior year at a rate of 1.1% and other personal lines grew by 2.7% compared to 2014.

The underlying combined ratio was a strong 87.4 for this the segment at year-end 2015, as you can see in the red box at the bottom.

Esurance, in the lower right, serves customers that prefer a branded product but are comfortable handling their own insurance needs.

Growth was slow throughout 2015 in the segment as our focus shifted to property improvement.

Policies in force were 1.4% higher at the end of 2015 than the prior year and net written premiums grew by 6.6%.

The underlying loss ratio in Esurance improved by 1.2 points in 2015, ending the year at 75.4.

As a result, the underlying combined ratio declined to 108.4, which includes about four4 points due to a number of expansion initiatives.

Encompass, in the upper left, competes for customers that want local advice but are less concerned about their choice of insurance company.

This business decreased in size in 2015.

Its policies in force declined by 8.2% from a year ago due to lower new business and retention, which is largely a result of price increases and underwriting changes.

The net written premium decline of 2.8% for 2015 -- that reflects higher average premiums from increasing rates to improved returns.

The underlying combined ratio was 92.6 for 2015, which was 1.1 points better than the prior year.

Answer Financial in the upper right -- that serves brand-neutral self-service customers and it's essentially an aggregator that does not underwrite insurance risks.

Total nonproprietary written premiums of $581 million in 2015 were 10% higher than the prior year.

So let's go to slide 4. Looking forward to 2016, we expect our annual underlying combined ratio to be in the range of 88 to 90.

That range is comprised of a number of key assumptions.

First, we assume that we continue to improvement in auto insurance profitability across all three brands, given the profit improvement actions we undertook in 2015 and that will continue in 2016.

We do expect modest increases in both auto accident frequency and claim severity, which reflects the broad-based trend we experienced in 2015.

Third, we assume the homeowners underlying combined ratio will increase slightly from last year's level.

And as our profit improvements are realized, as we start to realize the benefit of the lower combined ratio, we will continue to invest to generate long-term value, which will likely increase our expense ratio.

As you know, of course, predicting frequency and loss trends in a rapidly changing external environment is difficult; and as a result we put a range on our outlook every year.

Now, what you also know is that we react quickly to trends, whether they are positive or negative, to advance our business priorities so we are building long-term shareholder value.

So our operating priorities for 2016 are designed to build long-term value.

And as you can see, they are generally the same as 2015.

Serving our customers and generating returns on shareholder capital are our two top priorities and they are central to our plans.

When we do these well, we grow insurance policies in force.

We intentionally slowed auto insurance growth in 2015 to improve auto margins, since new business typically has a higher loss ratio than more tenured business.

New auto insurance volumes in the Allstate brand declined by 24% in the fourth quarter as a result of tighter underwriting, lower advertising and increased pricing.

While these actions are necessary, they are also flexible.

So our appetite for new business will increase as the auto profit improvement efforts translate into a lower combined ratio.

The largest factor in overall growth, however, is the rate at which we retain customers.

The auto retention rate declined in the fourth quarter, in part reflecting higher auto insurance prices.

We are implementing actions to reduce the impact that will have on growth.

But what competitors do in their pricing is also a major driver, and that's not controllable.

So our 2016 growth plans and prospects vary by customer segment.

Growth in the Allstate brand auto insurance will depend on the timing of the successful implementation of auto profitability actions and competitors' pricing actions.

The sooner we see a lower combined ratio, the sooner we will increase new business.

We do have growth plans in place for homeowners and other personal lines policies, given the attractive returns on those products.

We expect Esurance and Allstate Benefits to continue to grow in 2016.

Encompass had a decline in policies in force in 2015 and is not yet in a position to grow.

So we are still committed to growing policies in force across the Company, but it will be more difficult in 2016 than it has been in the past.

Pat will now go through the property/liability results in more detail.

Thanks, Tom.

I'll start with a review of our property/liability results on slide 5. (technical difficulty)Beginning with the chart on the top of this page, property/liability net written premium of $30.9 billion in 2015 grew $1.3 billion or 4.2% over 2014.

The recorded combined ratio for the year of 94.9 increased 1 point versus 2014, driven by an increase in auto losses which was partially offset by lower expenses, strong homeowner underlying margins and catastrophe losses of $1.7 billion, which were 13.7% lower than 2014.

As Tom mentioned earlier, the year-end 2015 underlying combined ratio of 88.7, while 1.5 points higher than 2014, finished within our original annual guidance range, given the strong results in the fourth quarter.

Net investment income for the property/liability segment decreased 4.9% from the prior year, due primarily to lower performance-based investment income.

The property/liability operating income in 2015 was $1.9 billion, which was 8.2% lower than 2014.

The chart on the lower left-hand side of this page shows property/liability net written premium and policy-in-force growth rates.

The red line, representing policy-in-force growth versus the prior year, shows a slowing growth rate of 1.3%, given actions in place across all three underwriting brands to improve auto margins.

Even with these headwinds, we grew policy counts by 449,000 to 34.6 million in 2015 compared to 2014.

The Allstate brand accounted for almost all policy growth in 2015 as Esurance policy growth slowed and Encompass policies were lower than 2014.

These policy growth results exclude 5.6 million Allstate financial policies, which grew by 6.1% in 2015, driven by 11.1% policy growth in Allstate benefits.

Average premium increases to reflect higher costs resulted in the net written premium trends you see shown by the blue line.

The bottom right-hand side of this page shows property/liability recorded and underlying combined ratio results.

The recorded and underlying combined ratios both finished the year strong compared to results earlier in the year, given our actions to improve auto returns.

The underlying property/liability combined ratio in the fourth quarter of 2015 was 87.4, and it was 2.1 points lower than the fourth quarter of 2014.

Slide 6 highlights the margin trends for Allstate brand auto and Allstate brand homeowners.

The chart on the top left of this page provides a view of quarterly recorded and underlying margin performance for Allstate brand auto.

As Tom mentioned earlier, our fourth-quarter results continued to be impacted by elevated frequency and severity, as they have been since the fourth quarter of 2014.

Our efforts to respond to higher cost trends through price, underwriting and expense management resulted in an underlying combined ratio of 97.6 in the fourth quarter of 2015, which was 0.6 point improvement from the fourth quarter a year ago.

On a sequential basis, the underlying combined ratio improved by 0.5 point compared to the third quarter of 2015.

The chart on the top right highlights the trends driving the change in the Allstate brand auto underlying combined ratio.

Annualized average earned premium per policy, shown by the blue line, continue to show upward momentum as rate increases implemented throughout 2015 resulted in a 3.9% increase in the fourth quarter of 2015 compared to the quarter a year ago.

Average underlying losses and expenses per policy in the fourth quarter of 2015 increased 3.2% compared with the fourth quarter of 2014, given the influence of higher frequency and severity, of lower expenses per policy.

The gap between these two points remains positive but it is smaller than it has been historically.

Similar information is shown for Allstate brand homeowners on the bottom of this page.

On the bottom left, you can see that the favorable impact from low catastrophes that we experienced for most of 2015 continued in the fourth quarter, resulting in 71 Allstate brand homeowners recorded combined ratio.

Lower frequency of fire claims in the fourth quarter benefited the underlying homeowners combined ratio, which at 56 was 5 points below the results in the fourth quarter of 2014.

Components of the fourth-quarter homeowners underlying combined ratio are in the chart in the bottom right.

Average earned premium per policy increased to $1,085 or 1.9% over the prior-year quarter.

Underlying losses per policy decreased 6.6% in the quarter compared to the fourth quarter of 2014, resulting in continued favorable underlying gap between the two trends.

Slide 7 provides some context on combined ratio and in topline trends for both Esurance and Encompass.

The chart on the top of this page includes fourth-quarter and annual combined annual combined ratio results for both companies.

Esurance's recorded combined ratio of 107 in the fourth quarter of 2015 was 8.5 points lower than the same period a year ago, given decreased investment in marketing along with a 5-point improvement in the loss ratio, which is reflective of ongoing actions taken in the business to improve auto returns.

Esurance's combined ratio of 110.3 in 2015 improved by 7.4 points compared to 2014.

Encompass's recorded combined ratio of 95.5 in the fourth quarter of 2015 was 2.4 points worse than the prior-year quarter, and was adversely impacted by 2.9 points of higher catastrophe losses compared to the prior-year quarter.

Encompass's combined ratio of 102 in 2015 was 4.1 points better than the full-year result in 2014.

The two charts on the bottom of this page show how growth is being impacted by profit improvement actions in both of the brands.

In Esurance, policy-in-force growth slowed to 1.4% over the prior year and continued to decline sequentially, while net written premiums grew by 5.3% in the fourth quarter of 2015 compared to the same quarter a year ago.

Encompass net written premium declined by 5.5% in the fourth quarter of 2015 compared to the fourth quarter of 2014 as the 8.2% decline in policies in force more than offset higher average premiums from increased rates and underwriting actions.

As with the Allstate brand, we continue to evaluate our results and will adjust profit improvement actions to ensure returns in both of these brands are appropriate.

Slide 8 divides an update on our ongoing plan to improve auto returns.

As we discussed throughout 2015, our auto profit improvement plan is comprised of four parts which are designed to work together to address the higher loss trends we are experiencing.

First, we have sought approval for higher auto rate across the country.

Second, we have implemented underwriting changes to slow new business and address specific underperforming segments business.

Along with underwriting changes, we have also increased our ongoing current classification programs.

Third, we focused on claims operational excellence precision.

And fourth, we have reduced expenses across the organization to quickly impact the combined ratio while the other components took hold.

These actions in total helped us to finish 2015 within our underlying combined ratio guidance range.

Details for the fourth quarter of 2015 are shown on the bottom of this slide.

Approved auto rate increases for all three underwriting brands in the fourth quarter of 2015 are worth $401 million in net written premiums, while the total amount of improved rate increases for 2015 in total were worth $1.1 billion in net written premium, the highest amount of improved auto rate increases in over 10 years.

We also continued to intentionally slow new business and make underwriting changes on isolated underperforming segments of business and geographies across the country to improve our returns.

These underwriting actions in conjunction with our current classification programs and price increases slowed new business and impacted retention.

As Tom mentioned earlier, all of these actions are flexible and they are all driven by local market conditions.

We will continue to adjust them selectively from market to market as auto returns improve.

Maintaining claims operational excellence and precision also continued to be priorities, given cost trends that we and others in the industry are experiencing.

Property/liability expense ratio decreased by 2.8 points in the fourth quarter of 2015 compared to the fourth quarter of 2014 and was 1.2 points slower than 2014 year-end, reflecting expense actions taken across the country.

You can see the impact by underwriting brand in the chart on the lower left.

These actions included reductions in advertising in the Allstate and Esurance brands as well as professional services costs and lower compensation incentives across the Company.

The bottom right-hand chart shows the net written premium amounts generated by the rates we've received approval for over the past three years across all three underwriting brands.

The Allstate brand represents the largest component of these rate increases, accounting for $942 million of the $1.1 billion for the full year of 2015 and $342 million of the $401 million for the fourth quarter of 2015.

Rate and underwriting changes will drive customers to shop their insurance with other carriers, nonrenew their policies or change their level of coverage, which will result in lower levels of premium, in aggregate, than what is shown on this chart.

Allstate agency owners and their staff proactively consult with their customers during the insurance review process to arrive at the best coverage in deductible options for their specific situations and needs.

We feel that having a trusted advisor to help guide customers' understanding of protection needs during a period of rising auto prices across the industry is a key competitive advantage for us.

This analysis only includes rates approved through December 31.

We continue to evaluate and run our business on a local market-by-market basis and continue to adjust our actions going forward, whether it be through price, underwriting, claims excellence or expense management, to ensure appropriate auto returns.

And now I will turn it over to Steve, who will cover Allstate financial investments and capital management.

Thanks, Pat.

Slide 9 provides an overview of Allstate Financial's results for the fourth-quarter and full-year 2015, as highlighted on the top of the slide.

Overall, we have made good progress to narrow Allstate Financial's focus and position the business to support long-term value creation.

In 2015 we continued our efforts to fully integrate the life and retirement business into the Allstate brand customer value proposition and reposition the investment portfolio supporting our immediate annuities.

Premiums and contract charges in 2015 increased 4.2% when excluding the impact of the 2014 results at Lincoln Benefit Life Company, driven by 5.7% growth in Allstate benefits accident and health insurance business as well as a 7.3% increase in traditional life insurance premiums.

Operating income for 2015 of $509 million was 16.1% lower than 2014, driven primarily by higher life insurance claims, the disposition of LDL and lower investment income.

In the fourth quarter, operating income of $98 million was $30 million below the prior-year quarter, driven by a lower fixed-income yield and a decrease in performance-based long-term investment income.

The bottom half of the slide depicts liabilities and investments of our immediate annuity business.

The approximately $12 billion of liabilities pay out over the next 40+ years.

Our investment strategy is to match near-term cash flows with fixed income and commercial mortgages.

However, for longer term liabilities we believe equity investments provide the best risk-adjusted returns.

As such, in the third quarter we sold approximately $2 billion of long-duration fixed income securities to make the portfolio less sensitive to rising interest rates.

Sale proceeds were invested in shorter duration, fixed income and public equity securities, which will lower net investment income in the near term.

Over time we will shift the majority of the proceeds to performance-based investments that we expect to deliver attractive long-term economic returns, although income will be volatile from quarter to quarter.

Moving on to slide 10 and investments, I will start with our portfolio composition at the top of the slide.

We have a diverse $77.8 billion portfolio.

Fixed income represents 74% of the portfolio value with $8.6 billion or 15% [and below] investment grade.

As we have discussed previously, we are increasing and shifting the risk posture of our portfolio to deliver more attractive long-term returns.

We traded capacity for this incremental risk by strengthening our capital position through issuing preferred securities, reducing debt, exposure reduction to catastrophe-prone regions and shrinking our annuity business over the past two to three years.

We are utilizing a portion of that capacity in our investment portfolio to increase idiosyncratic risk to performance-based investing and selectively increasing our high-yield holdings.

Our high-yield portfolio is conservatively positioned, relative to the broader market, weighted meaningfully towards BB and, to a lesser extent, single B issuers.

We have also managed with underweights of certain sectors, including metals and mining and energy.

Our portfolio breakdown by investment approach is at the bottom left.

Within the context of these four approaches, we target asset mix that reflects our risk tolerance and liability profile.

Our market-based core, by far the largest part of the portfolio, delivers predictable earnings aligned to our business needs.

We seek to outperform the public markets, take advantage of volatility through our market-based active strategy.

We have a growing allocation to performance-based investments, both what we term long-term and opportunistic, including private equity and real estate partnerships and direct investments.

The majority of our energy holdings, shown in the middle table, are investment-grade corporate bonds.

We are conservatively positioned versus the broader energy market, preferring midstream and higher quality exploration and production players, which we believe are better equipped to withstand the dislocation to energy prices.

With that said, this is a dynamic environment and the implications of the falling energy prices are being felt across the market.

During the fourth quarter, $47 million of the trading losses of $82 million of the recognized impairments related to energy holdings.

Losses were split between public and private securities.

Details of limited partnership holdings in our performance-based long-term strategy are shown in the table on the right.

Approximately 3/4 of these investments are in private equity, including timber and agriculture, and 1/4 in real estate.

Likewise, approximately 3/4 are accounted for under the equity method of accounting over the term EMA.

Our performance-based long-term strategy had strong results despite a lower fourth quarter, with 2015 being our second-highest income year.

We received significant cash distributions from realizations in this portfolio, which have reduced the amount of undistributed income related to our EMA investments.

Moving on to slide 11, net investment income was $710 million in total for the quarter and $3.2 billion for the full-year 2015.

Investment income and yield by business segment is provided at the top of the slide.

In addition to a multiyear shift in the long-term mix, we continue to proactively manage the portfolio in light of current economic and market conditions.

This includes reducing the duration of our fixed income holdings in both the property/liability and Allstate Financial portfolios with the belief that the markets were not providing sufficient compensation for taking interest rate risk in a low-yield environment.

To the left is property/liability.

We reduced our interest rate risk in this portfolio in 2013, which resulted in a lower yield than the Allstate Financial portfolio.

Yield is now increasing, reflecting our increased allocation to high-yield ons as well as reinvestment into higher interest rates and our continued shift of the portfolio to performance-based long-term investments.

To the right is Allstate Financial.

We took actions in 2015 to make the portfolio less sensitive to rising interest rates, as I covered a bit earlier in talking about the [immediate] annuity business, which is reflected in the lower interest-bearing yield in 2015.

Moving to the bottom half of the slide, at the left is our GAAP total return.

The investment income component of the return has been fairly consistent while the valuation contribution was negative in 2015 on wider credit spreads across the market with the majority attributed in our returns to the investment-grade securities, given their weight in our portfolio.

In the middle is our realized capital gains and losses.

In 2015, we had a net capital gain of $30 million, which included $470 million of net gains on sales including the gain on long-duration fixed income securities we sold from the Allstate Financial portfolio, largely offset by impairments and [intent] write-downs.

The impact of lower valuations can be seen in the decrease in our fixed income unrealized gain in the chart to the right.

Slide 12 provides an overview of our capital position and highlights the cash returns common shareholders received throughout 2015.

Allstate remains in a position of financial strength and strategic flexibility.

Our deployable holding company assets totaled $2.6 billion at December 31, 2015.

Book value per common share was $47.34 as of year-end 2015, down 1.9% from 2014, reflecting lower unrealized net capital gains and losses on fixed income securities.

Excluding this impact, book value per common share was 4.2% in 2015 versus 2014.

We returned $3.3 billion in cash to common shareholders in 2015 through a combination of common dividends and common share repurchases.

We repurchased 9.3 million common shares for $[573] million during the fourth quarter of 2015, which bought the annual total to 42.8 million shares, 10.2% of our beginning-of-year common shares outstanding.

As of December 31 we had $532 million remaining on our current repurchase authorization, which we expect to complete by July 2016.

Now let's open up the call for your questions.

(Operator Instructions) Ryan Tunis, Credit Suisse.

My first question is just on the expense side.

I appreciate there's a good amount of flexibility there, whether it's advertising expenses or just lower incentive comp.

But in the base case that you highlighted in your guidance that assumes some step-up in severity and frequency, how should we think about the Allstate brand expense ratio in 2016 relative to 2015?

I'll make an overall comment and Matt might have some perspective as well.

First, you should expect the expense ratio to go up because we -- this year, to make our goal, we did cut advertising.

I wanted to improve some of the effectiveness of the advertising stuff, anyway, with some new advertising.

And then we took some nice-to-do technology stuff and deferred it and decided not to do it and then cut some other expenses.

(technical difficulty)And if you look at it over the quarters, you can see we increasingly reduced our expenses throughout the year, which was the focus.

That said, there are a number of things we are investing heavily in and want to invest in, in terms of either long-term growth or short-term growth, everything from technology I mentioned to things like telematics.

But Matt, do you want to add anything to that?

I think the only thing I would add, Ryan, is that, as Tom said in his prepared remarks, as we see the combined ratio in each local geography getting to an appropriate point and our loss ratios getting where they need to be and the profit improvement actions fully taking hold and rate burning in, we will want to be able to stimulate growth in selected areas as long as we are earning an appropriate return.

And growth requires some investment.

And so part of the expense ratio next year will -- this year, I'm sorry -- will be influenced by our growth plan and when we are able to turn on growth in certain areas and when we want to invest.

We're focused on long-term value creation, and long-term value creation does require some investment.

But it requires investment with appropriate levels of profitability.

It's flexible.

It will go up.

The degree it goes up will depend on thoughtful analysis of whether or not we are at appropriate profitability, appropriate margin and whether or not we are going to earn an appropriate return on the investment.

Okay, that's helpful.

And then my follow-up is just in the supplement you guys a few quarters ago started breaking out gross versus paid frequency.

And the way I understand it is you incur the losses based on what the gross frequency is, and that's also what I think you guys tend to talk about and what the investment community tends to talk about.

But the paid frequency number has been running significantly below the gross over the past several quarters.

I'm just wondering how we should think about that.

Is there a possibility that you have been overestimating what the frequency is?

Ryan, let me make that -- first, we think our reserves are appropriately established.

So we do that in a bunch of different ways.

We look at both gross and net.

We look at what the original amount is.

We do it by claims, so when a claim comes up we put up some dollar amount for it.

Then, as the adjuster learns more, they keep building that up, and it leads to an [occurred].

And then, obviously, we think that we have to factor in future upward development of that.

So we look at that, as well.

So we look at paid, incurred, incurred but not reported.

And we come up with the number.

Obviously, for things like physical damage claims, where they are really settled out at about 90 days, that tends to run through pretty quickly.

The [bond of] the injury, where it takes about four years before you get 80% paid out, has a little bit longer trend line on it.

And as a result of that longer trend line, you tend to have more process changes along the way because you do things differently every year.

And so that number tends to bounce around a little more.

But I think we are appropriately reserved.

I don't think you should think there is more or less in there than we thought.

It's the right number.

Thanks, I'll stop there.

Josh Shanker, Deutsche Bank.

I had two questions.

Tom, the first one is revisiting last quarter, actually.

We talked about the 4Q auto accident seasonality that did not seem to appear this quarter.

In the end, is it just a dream?

Or is there something really there?

What do you think?

Josh, it's Matt.

I'm going to refer you to a page in the Appendix that we put in there.

If you look at the presentation slide 14, there's a whole bunch of drivers of the combined ratio and a whole bunch of drivers of even frequency.

Some of them are controllable, some of them are uncontrollable.

Some of them we can manage and some we can't.

Even within the ones that are somewhat manageable like new business quality and volume of new business and geographic mix, there's also some things that you just can't predict.

Seasonality and weather, especially, is one of those completely unpredictable pieces of this puzzle.

So when we look at year over year, you can look back.

We have some charts that show fourth-quarter seasonality that tend to spike up.

And then you have last year, where we had almost no catastrophes and benign weather and this year much more normalized catastrophe year but I would say also a more normalized weather environment.

Seasonality is one of those high-level generalities that tends to pan out over multiple years.

But you can have dislocations and aberrations in that on a year-by-year and quarter-by-quarter basis.

So I would not draw trend line conclusions based upon one or two quarters and how they appear versus previous quarters.

And Josh, I don't know if I'm reading into your question.

But it sounded like -- frequency was actually up quite a bit in the fourth quarter.

So I couldn't tell what your underlying assumption is.

But Matt has a slide in there as well on the increase in frequency in the fourth quarter.

I wasn't -- not really -- just to look in the past.

And I always -- I'm anticipating fourth quarter being a tough comp every year.

My other question -- look, I listened to your prepared remarks and I know you're going to invest in the future, and homeowners can change a little bit.

But you did an 88.7% underlying combined ratio, firmwide, for 2015.

And you have a 5.5% rate increase coming through on the auto side, yet you have guided to 88% to 90% underlying for 2016.

It seems to me a very hard thing to believe that there's a world where the underlying combined ratio can be worse in 2016 than it was in 2015.

Are you just being conservative?

Or do you really think that that's the right range, and at 89% with a plus or minus 1 around it?

We think it's the right range.

I think we have been doing this since I became CEO.

I think it's maybe our ninth or 10th year that we've done this.

We've never missed it.

So we do it so that we think it's the right range but that's reasonable.

You get a point swing either way from frequency and severity.

You can get -- as Matt mentioned, you can't predict frequency.

And to be honest, it's really difficult to predict severity within a point.

So that alone gives you a 2-point spread.

There have been some years, Josh, where we have had a 3-point spread.

But that was when we weren't sure how quickly the homeowners business was going to take hole.

And we did quite well.

We got ahead of that and it was faster than we had done in our modeling.

But we do a lot of statistical modeling around this.

We think it's about right.

You are right; you will see a lot of rate come through.

That's the $1.1 billion.

And if loss costs, which is a result of frequency and severity, keep going up, which is what we have in our predictions, we will put more in rate increases.

So -- no, we think it's the right number.

We set it up to get there.

And if you want to assume your case, then that would be in the middle of the range.

We don't get so precise that we do it to a 10th of a point.

I'd like to give just round numbers, and we think 88 to 90 -- we will be in that range.

All right.

Well, good luck.

And I hope it's even better than that.

Amit Kumar, Macquarie.

Congrats on the print.

Maybe two quick follow-up on Josh's question.

First of all, just going back to the discussion on guidance and rate increases, how should we think about future rate increases?

You obviously had meaningful rate increases over the past few quarters.

Are you factoring in that, based on where we stand, a number to diminish or continue to ramp up from here?

It will be reflective of our results in the cost basis.

So if frequency and severity continue to increase, you will continue to see us go into individual states with targeted rate increases.

If it moderates then I think you should expect to see it come down some.

But we don't know for sure.

So I guess related to that is what -- what are you baking in for frequency and severity here?

We have a plan, obviously, that we have frequency and severity.

But when we have moved to do -- when we got away from EPS guidance, which I thought, in our business, didn't make a lot of sense -- we will give you an underlying combined ratio guidance which excludes catastrophes, so things we can pretty much predict.

We think at 88 to 90 what happens with increases in frequency and severity -- we can manage to it with the premium increases we will be able to get next year.

We don't give out the specific subcomponents; that just ends up being -- it helps people do their models but it turns our conversations into one of modeling as opposed to the pace of the business.

We feel good about the business where it is.

We would like to make more money in auto insurance.

Even though the returns are above our cost of capital, we have made much higher returns than that.

Our competitive position and strength enables us to do that, and we are headed down that path.

When we get there will be dependent on what happens with the external environment.

Got it, that's fair enough.

And just on the external factors, I know Josh was asking about this -- the amount of questions you were getting was the benign sort of weather in Q4.

If you were to normalize it, would it be materially different what you are looking at in charts 21 and 22, or would it be modestly different?

Well, let me talk about it.

So, the fourth quarter we came in at -- we were able to get -- within sight of our range at 88.7 for the year.

The good weather really was a result -- it wasn't really good weather, necessarily.

The homeowners business did a little better because we had fewer fire losses, which tend to be big losses.

I don't know whether that's weather or just luck.

We obviously, on the other end of that, which is completely controllable, as Matt pointed out, is expenses.

We did a good job getting expenses down because we wanted to be within the range.

And then the profit improvement actions did start to go through.

But Matt, maybe you can flip to -- maybe, Matt, take them through slide 15, which shows the frequency just because I think everyone is saying it's like benign weather, and we had a big increase in auto frequency in the fourth quarter.

And I don't want you to walk away thinking that it wasn't there.

So Tom referred to slide 15.

What slide 15 does it show what we believe is one of the primary drivers of frequency.

As we have talked about on almost every call, frequency is driven by primarily miles driven but also weather, distracted driving, new business volume, new business quality and underwriting and miles driven.

And so it's driven by employment rate and gas prices.

And we know what has happened to both of those over this last year.

One of the confusing things is I have referred in the past to the fact that the frequency trend is widespread.

And I think some of you have taken that to mean that it is consistent across the country.

It is widespread but it is not consistent across the country.

In fact, it's geographically varied.

And slide 15 is just some data from the Federal Highway Administration that shows how miles driven as of November versus prior year has gone up in each of the different regions.

And you will notice that in the Northeast it only went up 2.9 while in the West it went up 5.5 and South Atlantic 5.1, etc.

So this is one driver, but it's a major driver.

And it does help to explain some of the other questions that you have been raising about why different companies have different experiences.

They have different geographic concentrations of their books of business.

And the miles driven in those areas is different -- it will clearly impact results.

Got it.

Okay, this is very helpful.

Thanks for the answers.

Bob Glasspiegel, Janney Montgomery.

Just an observation, Tom.

When you hit your forecast nine years in a row, I guess it's another way of saying you tend to be conservative with your outlooks because no one is that good to be able to forecast (laughter).

I'm not sure what, Bob, obviously, look, we have a good system.

We have a great team.

They are goal-driven.

They know how to deliver what we said we would deliver.

If you had asked me at last year, when we gave our range of 87 to 89 did I think frequency and severity were going to clip up at above 5 points, I would have said no.

So the point is you really can't forecast frequency in that.

What we can do is tell you, given the strength of our system and the transparency we have, and our management processes in place, we think we can manage to 88 to 90 next year.

And so that's what we've set out to do.

If we do better than that, then that will be because we reacted well and did well.

But we don't set it up so we can be below it.

That's not the goal here because obviously, as you would expect, you want to be balanced, thoughtful and transparent with your shareholders.

You don't want to underpromise and overdeliver because then everybody will think, well, the whole world is falling apart.

Nor do you want to overpromise and underdeliver.

So we try to do it at what we think the system can deliver.

And we think 88 to 90 -- we did not set it up to be too optimistic or set it up to be too conservative.

It's right down the middle.

I hear you.

My question is, I understand all your profit moves and am encouraged by the fourth quarter underlying showing some improvement, which suggests that you are on track.

And I guess I understand what you are doing in Allstate brand and Encompass.

On Esurance, trying to slow the growth dramatically certainly fits within your profit objective and seems like a sound way to go to achieve your short-term plan.

But my question is, are you where you want to be in scale in that business long term?

And what is your overall long-term game plan in Esurance?

How big do you have to be in that business to be a long-term player?

Well, let me make that an overall long-term comment and then Don can give you some specifics.

So Esurance is twice the size from when we bought it four years ago.

And we think it is of scale at $1.6 billion because if you look at normal direct marketing companies it would be 10% of your premiums you would spend in advertising.

And that $160 million, that's enough media weight to make sure people hear you.

If you are half that size, you just don't have enough throw weight in the marketing world.

So I think it's of scale today.

That said, we have good growth plans.

And I don't want you to think that this is a backing off of Esurance growth.

Don can talk about the things we are doing to get into homeowners and motorcycle, Canada, new markets.

So there's plenty of [gross] up there.

We just were managing this year to some objectives that Don had set for the team.

So Don, maybe you want to comment about it?

Yes.

Bob, first, remember, when we acquired Esurance, we did it for the strategic reason of going into the lower right-hand corner with the self-serve, brand-sensitive customer and really focusing the customer value proposition against the Geico and Progressive direct models.

And when we acquired it, what we said we were going to do was run it for economics as opposed to GAAP accounting.

So as you know, in the direct model you expense all your marketing expenses up front.

And as a result, the first year or the first quarter looks particularly bad when you are growing.

But then in later years you tend to make money as the business retains and you don't have to spend the marketing again.

As Tom said, the business is now twice as large as it was when we acquired it a little over four years ago.

It does have meaningful impact on where Allstate reports.

And with twice as much growth we were having some pressure on the loss ratio.

And so what we decided to do this year was slow the growth down, really focus on getting more efficiency out of our model.

That meant both on the marketing side and on the operations side.

And I would tell you I'm absolutely delighted with how they responded and how the business is doing.

You talk about slowing down dramatically -- it's still growing 5% in the fourth quarter and more than that for the year, not as high as it has been.

But given the reduction in marketing, still a good growth rate.

And the underlying combined ratio is down over 8 points from last year in the quarter.

So feeling really good about where they are.

Having said that, I would echo what Tom said.

The business is at scale.

It could run at this size with meaningful growth rates, I think, and certainly do it in an economic way.

But we do want to grow the business in the future as aggressively as we can.

We just want to do it with the balance of profitability and growth.

We felt that was getting a little out of kilter a year, 18 months ago.

We are getting it back in line now, feel good about what they're doing.

The one other thing I'd amplify is, I think Tom mentioned it in his comments, we had 4 points of investment in 2015 that shows up in the combined ratio but you don't get the benefit of those investments in the current year, things like expanding homeowners, which is now in 25 states; renters, which is in 20 states; motorcycles, 11.

Auto continues to expand to 43 states and one, Ontario, in Canada as well.

So we're investing heavily in building our capabilities for the future, holding out features and expanding our footprint.

So we have -- I think the answer to your question is we have very aggressive growth plans for the future.

We are investing heavily in that.

But we want to make sure that we balance that with the economics and the reported results on a current basis.

Thanks for the thoughtful answers.

Kai Pan, Morgan Stanley.

First question, on capital management, it looks like you returned more than you earned in 2015.

I'm just wondering is part of the capital like optimizing capital structure and going forward -- is that going to be sustainable?

So if you look back over the last couple years, we set up our share buyback program really on the basis of [did we put a] capital that we have available.

We sold Lincoln Benefit Life, which freed up some capital and also the proceeds from the sale.

So we moved that up to the parent company, $1.2 billion, in 2013 and 2014.

So in 2015 we used a fair amount of that to increase that buyback program for what might normally have been to the $3 billion level we are talking about.

In addition, as I mentioned in my prepared remarks, we've done a fair amount of work at bringing out risk profile down in the corporation, which once again has freed up some capital.

We do need to grow the business.

So if you look in the future, unless we can continue to change our risk profile, which we would say at the moment -- as I said, we're going to put a little more money into our investment portfolio to back that into the equity type investments -- we will need to put some money aside each year to grow the business.

And we will also have to pay our dividend, obviously.

And what we free up essentially from net income we pay out on a year lag, generally, in our share buyback.

Okay.

So we are looking more probably like payout ratio around 100% levels?

Well, we don't do it that way.

That's, of course, the way the banks do it.

But we do it the way, Steve -- which is so we look at how much capital we need.

Then we say how much did we earn, how much do we have?

And so we don't do it as a percentage of earnings.

Okay, that's great.

And second question for Tom -- it looks -- the change on slide 4 of your operating priorities in 2016, or two things -- number one is better serve our customers through innovation, effective, efficiency.

Could you give some example of that?

And then the sixth item, basically the long-term growth platform, now you mentioned about acquiring.

I just wonder what platform, like [policy current lack] that you would like to grow into, and what's the appetite of your acquisition?

Okay.

So let me answer the last one and ask Matt to answer the first one.

So first, in terms of priorities, they are all important.

So they are not -- like we don't fight over which order they are in.

And so Matt will talk about the customer, which is obviously very important to us, but as important as all the other ones.

We did add -- it was a good catch on your part, Kai -- we added the acquired to the build long-term growth platforms.

Long-term growth platforms are the ones that we are building through things like telematics and what we are doing in roadside and Allstate Benefits and those things.

We think if we need to acquire something to help accelerate those efforts, we would do that.

Secondly, we believe that there's additional capacity in particularly the Allstate agency channel but also some in Esurance to pick up adjacent products and services which are consistent with protecting and preparing people.

Particularly as Matt makes progress on the trusted advisor model in the Allstate agency channel, we think there are other things we can sell.

And we can either decide we wanted to get into the business, do filings, create the product and that kind of stuff if it's unique enough.

Or if somebody has a platform that we can buy and we can bolt it onto ours, we would do that.

So that's the concept behind acquisitions.

We didn't put it in there because we have some specific target or anything we want to talk about.

Matt, do you want to go through the customer piece?

Sure, Kai.

So you correctly pointed out that it's customer-based.

So it's all about customer-centricity and using innovation, effectiveness and efficiency not just to manage financials and manage margins but to better serve our customers.

And there's three primary tracks of work going on under that category.

The first, as Tom just mentioned, is Trusted Advisor.

Trusted Advisor is all the work we have underway to help our agency owners and their staff and our exclusive financial specialists better serve our customers through personalized, customized, tailored solutions geographically based that are advice-based, not product-pushed, that are solutions as opposed to transactions and based on long-term value relationships.

And so we have a lot of work underway there.

And that goes to both the effectiveness of our agency system as a distribution model and the efficiency with which we put through product.

The second major line of work that we have underway is -- we refer to it as our continuous improvement.

Others refer to it as lean engineering.

And we have installed continuous improvement in a good portion of the Company already.

It's a set of management principles and practices that empower front-line employees, get them involved in root cause problem-solving, create flow of information, create an environment where they are engaged in their work.

And we have seen dramatic increases in productivity and efficiency of those operations that we have installed continuous improvement.

We've also seen a greater customer satisfaction and employee engagement in those areas.

The third, and this is on really the innovation side, the track of work we have underway -- we refer to it as integrated digital enterprise.

But you've also heard me refer to it as a set of projects that take data, predictive analytics and emerging technologies and combine those capabilities to better serve customers.

And that includes a range of things that both use internal sources of data as well as external sources of data to provide more predictive guidance to our agency owners in serving their customers that help them better serve those customers, tell them what the next logical product for them might be, and to use those emerging technologies to deliver that in a way that's more accepted by the customer, more intuitive to the customer and is more respectful of the customer's time and energy.

And so you will continue to see a lot of focus there.

As Tom referred to in his opening remarks, as he explained why the expense ratio may float up a little bit, we will continue to invest in all these core initiatives because they are all about long-term value creation.

If we are able to better serve our customers through innovation, effectiveness and efficiency, we will create a more valuable organization.

And we are all about that.

So I thank you for asking the question.

Alison Jacobowitz, Bank of America Merrill Lynch.

It's actually Jay Cohen, as you can probably tell by the voice.

Two questions -- one is you are obviously taking action, as you talked at length about, to improve the auto profitability.

And you suggested that certainly the effect will depend partly on what your competitors do.

The question is, what are your competitors doing?

What are you seeing out there?

And then, secondly, relative to miles driven, arguably one of the reasons is lower fuel prices.

Would you suspect that oil going from $100 down to $40 has a bigger effect in oil going from $40 to $30?

In other words the effect, one might suggest, would be declining over time.

Those are two really good questions.

First of all, what we are seeing on the part of our competitors, some of our competitors, is a significant rate action.

And the filings that we are reviewing as we make our filings, we see competitor rate filings as well.

Some of them are quite significant, some of them are more moderate.

Most of it depends upon -- if you look back three or four years at level of rates, they started this period.

And so those who had a greater gap to cover in order to deal with the frequency and severity pressure are taking greater rate.

So we expect that to generate some increased turmoil in the environment.

And it will certainly generate shopping behavior in the industry.

And shopping behavior can be a positive or a negative, depending on how you approach it and where you are positioned.

It's all part of competition.

So we believe we are well-positioned.

We believe we are prepared for it.

We believe we are monitoring their actions.

But we are mostly focused on what we need to do to earn appropriate returns and serve our customers.

So I would say our primary focus is always on managing our own business with an eye towards what the competitors are doing as opposed to trying to react to competitors all the time, which I find can just drive you crazy.

On your second question, it's a great point.

There is a point of diminishing impact with gas prices on miles driven.

We've always said that we thought the unemployment rate and economic activity had even a greater impact than the gas prices because economic activity impacts employment driving.

And gas prices typically impact only discretionary driving activities because, if you have to go to work you have to go to work.

And you are going to pay $3 a gallon or you are going to pay $1.90 a gallon.

If you are thinking about a vacation this summer and you are deciding whether to stay home or drive down to Florida, if gas is at $1.60 it's probably going to influence you differently than if gas was at $3.50 a gallon.

There is a point at which, though, it's just plain cheap and it's no longer a question.

And I think we're probably at that point.

So I think you are correct in that from what we look at we think the biggest influence of the drop in gas prices has already occurred and it's unlikely that that will drive much further increase in miles driven.

But that being said, we also don't know what economic activity is going to look like and what all the other influences on frequency will look like.

So thank you all.

I'm going to leave you with a couple thoughts.

Allstate has an extremely strong operating platform, first, that enables us to react quickly to whatever appears in the world.

Secondly, we proactively manage our risk and return on a consolidated basis, whether that's catastrophes, auto margins, investment returns or our capital structure.

We look at it in total.

And thirdly, we are focused on long-term value.

We pay attention to current earnings because it's a step along the way, but we will not give up long-term value creation for short-term earnings because we believe that's what shareholders want, which is creating economic long-term cash value.

Thank you very much.

We'll talk to you next quarter.

Thank you, ladies and gentlemen, for your participation in today's conference.

This does conclude the program.

You may now disconnect.

Good day.