Good day, ladies and gentlemen, welcome to the Allstate second quarter 2017 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. If anyone should require assistance during the program, please press star then zero on your touchtone telephone. As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Mr. John Griek, Head of Investor Relations. Please go ahead, sir.
Thank you, Jonathan. Good morning, welcome everyone to Allstate's second quarter 2017 earnings conference call. After prepared remarks by our Chairman and CEO, Tom Wilson, Chief Financial Officer, Steve Shebik, and me, we will have a question-and-answer session. Also here are Matt Winter, our president, Don Civgin, the President of Emerging Businesses, John Dugenske, our Chief Investment Officer, Mary Jane Fortin, President of Allstate Financial, Eric Ferren, our Corporate Controller. Yesterday, following the close of the market, we issued our news release investor supplement, filed our 10-Q for the second quarter, posted the results presentation we will use this morning in conjunction with our prepared remarks. These documents are available on our website at allstateinvestors.com. As noted on the first slide, our discussion today will contain forward-looking statements about Allstate's operations.
Allstate's results may differ materially from these statements, please refer to our 10-K for 2016, 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 or our investor supplement. We are recording this call, a replay will be available following its conclusion. As always, I will be available to answer any follow-up questions you may have after the call. Now I'll turn it over to Tom.
Well, good morning. Thank you, as always, for taking your time and investing with us to keep you, to understand the progress we're making at Allstate. Let's begin on slide two. Allstate delivered strong financial results in the second quarter. Net income was $550 million, or $1.49 per share in the second quarter of 2017. That is in comparison to $242 million last year. It really reflects improved auto insurance margins and strong investment results from our performance-based strategy. Operating income per share was $1.38 in the quarter. The improvement in auto insurance profitability is a result of us rapidly reacting to higher loss costs beginning in 2015, it was aided by declining frequency in the first half of 2017.
Investment income on our $81 billion portfolio also increased from the prior year as stable earnings from the quarter, market-based fixed income portfolio was supplemented with higher results from the performance-based portfolio. Operating income return on equity was 13.5%, as you can see at the bottom of the table, a significant improvement over last year. Go to slide three, which shows our operating priorities for 2017. We made excellent progress on the five operating priorities, not all of this has yet impacted the reported financial results. The first goal is to better serve customers, we measure customer satisfaction by a Net Promoter Score, it increased for most of our businesses. Although this has not yet led to higher policy retention, we do expect higher customer satisfaction to translate into higher growth, particularly as insurance auto price increases moderate.
Allstate manages shareholder capital to deliver attractive returns, which requires us to achieve target economic returns on capital. As you can see from our results, we are excelling in this priority. Auto insurance margins have improved, reflecting the broad-based profit improvement plans initiated over two years ago. Profitability also benefited from lower frequency of accidents, reflecting both our profit improvement plan and overall flattening in the market. The recorded auto insurance combined ratio for all brands was 96.6 for the quarter and 95.8 for the Allstate brand. Auto insurance combined ratios for the first six months of the year was 94.1 or 6.5 points below the prior year. That led to over $700 million in underwriting profit difference between these first two quarters and the first two quarters of last year.
The homeowners' insurance line was also profitable in the quarter, led by Allstate brands, which had a combined ratio of 97.2, despite $650 million of catastrophe losses. The property liability was 97.2, the underlying combined ratio was 85.5 in the second quarter. Through the first half of the year, our underlying combined ratio was 85.1. Assuming current loss trends continue, we expect to end 2017 at or below the low end of our annual outlook range of 87-89. Allstate Financial operating income increased to $153 million as a strategy to increase performance-based investments for the annuity business generated good results. Long-term value creation also requires growth in the customer base. The acquisition of SquareTrade in January has added over 31 million policies, Steve will cover our key priorities for SquareTrade in a few minutes.
Allstate Benefits continues its 17-year track record of growth, policies in force exceed four million. The Allstate brand is now accelerating the Trusted Advisor initiative to raise growth by delivering a better value proposition to the local advice and branded product customer segment. A large component of operating income is results from investment income, despite the continuation of historically low interest rates, we've done quite well there as well. The portfolio is proactively managed and is primarily a high-quality fixed-income portfolio, which generates predictable earnings with modest risk. The value of the market-based portfolios increased this quarter due to a reduction in corporate bond yields and higher equity values. The performance-based portfolio had a great quarter with strong growth in private equity and real estate earnings. We focused on delivering current results while investing for long-term growth.
In addition to the Trusted Advisor initiative, we have growth plans for Allstate Benefits, SquareTrade, Allstate Roadside, and Esurance. We are also investing in building connected car platform, Arity, which has continued to enhance its capabilities in telematics, data analytics, and customer service. Slide four provides an overview of our capital strength and financial flexibility. As you can see from the box at the top, we have delivered excellent returns, increased book value, maintained a conservative financial position, while increasing shareholders' ownership in the company by reducing the number of outstanding shares. We returned $903 million to shareholders through the first six months of the year. This includes repurchasing 7.9 million shares of our common stock, or 2.1% of those outstanding at the beginning of the year. Yesterday, we authorized a new $2 billion share repurchase program that will begin following the completion of our current $1.5 billion program.
Our intention is to fund this new program through a combination of deployable capital, operating cash flow, and a potential issuance of preferred shares. Let me turn it back to John.
Thanks, Tom. Slide five shows property liability results by customer segment and brand. Starting with the table at the top, net written premium was $8.3 billion, which was a 3% increase from the prior year, and the recorded combined ratio of 97.2% was 3.6 points better than the prior year quarter. When we exclude catastrophes and prior year reserve re-estimates, the underlying combined ratio for the second quarter was 85.5%, 3.1 points better than the prior year quarter. The underlying combined ratio for the second quarter includes 0.6 points or $52 million of restructuring expenses, primarily related to the expansion of QuickFoto Claim, our virtual estimating platform. This expansion resulted in improved efficiencies and the closure of a number of claim drive-in offices. As you know, our strategy is to provide different customer value propositions for the four consumer segments of the property liability market.
The Allstate brand, in the lower left, competes with the local advice and branded segment, where the most prominent competitors are State Farm, Nationwide, and Farmers. Obviously, GEICO and Progressive target these customers as well, but do not offer the same value proposition provided by our 10,400 Allstate agencies. This segment comprises 90% of our total premiums written. The underlying combined ratio is 84.4%, with the favorable prior year comparison being driven by improving loss trends in auto insurance, which had a 92.8% underlying combined ratio, five points below the prior year. Net written premium was 2.3% higher in the second quarter of 2017 compared to the prior year quarter due to a 3.3% increase in auto. Esurance, in the lower right, serves customers who prefer a branded product but are comfortable handling their own insurance needs.
GEICO and Progressive Direct have a larger share of this segment than their overall market share. We continue to focus on improving the auto loss ratio, raising customer satisfaction, and rapidly growing homeowners policies in force. The combination of these initiatives will support long-term growth. The underlying combined ratio for auto insurance improved slightly and was below 100 for the second consecutive quarter. The homeowners business continues to grow rapidly with underlying profitability that reflects startup costs. The underlying combined ratio of 125 in the second quarter of 2017 was significantly better than the prior year quarter as homeowners' marketing spend was reduced. Encompass, in the upper left, competes for customers who want local advice, are less concerned about a branded experience, and are served by independent agencies.
We are making good progress in improving underlying margins, the business has gotten smaller as we exit unprofitable markets and raise prices. As we achieve rate adequacy, we will initiate growth plans on a targeted basis in this segment. Let's go to slide six to cover the results for Allstate brand auto insurance in more details. Starting with the top left graph, the recorded combined ratio for the second quarter was 95.8, which was 5.4 points below the prior year quarter and benefited from increased average earned premium, lower frequency, and favorable prior year reserve re-estimates, primarily related to injury coverages. The underlying combined ratio of 92.8 in the second quarter of 2017 improved by five points compared to the second quarter of 2016, driven by a 5.7 point improvement in the underlying loss ratio.
The chart on the top right shows the results of the broad-based profit improvement plan initiated in 2015. Annualized average premium, shown by the blue line, increased 5.6% to $999 compared to the prior year, while underlying loss and expense, shown by the red line, was nearly flat. This resulted in a favorable gap of $72 per policy compared to the mid-teens in the second quarter of 2015. We continue to selectively file rate increases to keep pace with loss trends, the overall magnitude of rates taken will moderate if the gap between the red and blue line is maintained. Gross frequency trends for bodily injury and property damage coverages are shown on the bottom chart. Frequency continued to show improvement across both coverages in the second quarter of 2017, and favorable trends were geographically widespread.
The lower frequency in 2017 reflects good weather in the first quarter, the benefits of the auto insurance profit improvement plan, and moderating frequency trends across the industry. Slide seven shows the underlying drivers of policies in force for Allstate branded auto insurance. As you can see from the graph at the top, overall policy counts have flattened out on a sequential quarter basis. This reflects an increase in new issued applications and a steady renewal ratio. We are beginning to accelerate the components of the Trusted Advisor initiative while expanding Allstate branded distribution, with the objective of increasing policies in force. This should be supported by fewer required price increases now that auto margins have improved. Slide eight shows similar information for Allstate branded homeowners, which has had consistent profitability and is also being positioned for growth. Now I'll turn it over to Steve.
Thanks, John. Let's go to slide nine in our investment results. Overall investment results have been strong this year, reflecting favorable market conditions and the asset allocation decision to increase performance-based investments, which reflects a 10-year history of increasing commitments and building our capabilities. Today, we utilize third-party managers, co-investments, create beachhead partnerships, and our own direct investing, and have created a broad portfolio of diversified investments. Total return in the upper left graph was 1.8% for the quarter, as our strategic positioning, coupled with favorable market conditions, drove strong results across our diversified portfolio. Investment income, shown in the blue, has consistently contributed approximately 1% of return per quarter, with stable earnings from our market-based portfolio of primarily investment-grade fixed income investments. Total return varies based on the portfolio value at the end of each quarter, as reflected by the valuation component shown in gray.
As you can see, the value of the portfolio increased in the second quarter, primarily due to lower corporate bond yields and higher equity prices. The property liability bond portfolio, which totals $32 billion, is concentrated in three- to five-year maturities. If interest rates rise, bond valuations will be negatively impacted. Net investment income will increase over time. Net investment income in total, and for the market-based and performance-based portfolios, is shown in the upper right graph. Net investment income for the second quarter was $897 million, $135 million higher than the second quarter of 2016. This increase was driven primarily by performance-based investment income of $263 million. While performance-based income is variable from quarter to quarter, long-term returns for Allstate have been attractive, as shown by the bottom two graphs.
The quarterly impact of performance-based net income has averaged $155 million over the last 10 quarters and is largely driven by private equity and real estate investments. The table beneath the chart on the bottom left shows the increase in carrying value of performance-based portfolio over time. The performance-based portfolio has generated attractive long-term economic returns, as shown on the bottom right. Internal rates of return are generally over 10%. The recent downturn in the 10-year measure reflects high valuations just prior to the global financial crisis of 2008 and 2009. Turning to slide 10, Allstate Financial had a substantial increase in profitability as a result of the performance-based investment results. Premiums and contract charges totaled $591 million in the second quarter, an increase of 4.8% compared to the prior year quarter. Operating income of $153 million increased by 27.5% over the prior year quarter.
Life insurance net income of $60 million and operating income of $63 million were both $1 million below prior year, as higher contract benefits and expenses were partially offset by higher premium and net investment income. Allstate Benefits net and operating income were both $25 million in the second quarter of 2017, with operating income $4 million below the prior year quarter, as higher revenue was more than offset by increased contract benefits and investments in growth. Premiums and contract charges increased 7.2% compared to the prior year quarter, primarily related to growth in Hospital Indemnity, Critical Illness, Short-Term Disability, and accident products. Annuities operating income of $65 million in the quarter was an increase of $38 million compared to the prior year, reflecting the continued benefit of our performance-based investment strategy.
You'll remember, we increased the amount of performance-based assets in this business to match the long duration of liabilities. This should generate increased shareholder value, but does require us to utilize more capital in the business and lowers interest income, both of which depress short-term returns on capital. Slide 11 provides detail on SquareTrade. Last quarter, we indicated additional disclosure should be provided regarding this recently acquired business. SquareTrade has three primary objectives. First, to increase and broaden Allstate's customer relationships. This will be accomplished through the existing model of selling through store-based and online retailers, leveraging Allstate's other market-facing businesses, and entering new markets, either from a product or geographic perspective. Second, SquareTrade is growing rapidly by utilizing innovative customer service approaches to reinvent a traditional product offering, and it will continue to utilize this capability to enhance its competitive position.
Third, as all of our businesses seek to do, SquareTrade will also earn attractive returns on capital. We evaluate this by looking at long-term cash flows. For high-growth businesses such as SquareTrade, we use shorter-term measures, such as operating profit, to ensure we are on pace to meet our long-term objectives, but are willing to continue investing in growth even if it reduces near-term profitability. Moving to second quarter results, as shown on the bottom half of the page, SquareTrade had solid growth primarily through the U.S. retail channel, with policies in force increasing by 1.4 million from the first quarter to a total of 31.3 million, as shown in the graph in the bottom left. Over the last 12 months, policies in force have grown by 28%.
Premiums written in the second quarter of $85 million reflect the magnitude of product sales, while earned premium of $70 million reflects the recognition of that premium over the approximate three-year average duration of coverage. Underwriting loss totaled $22 million in the second quarter, reflecting $23 million of amortization of purchased intangible assets related to the acquisition. Operating income, which excludes the amortization of purchased intangible assets, was positive in the second quarter, totaling $1 million. We also included a new non-GAAP measure this quarter, adjusted operating income, to provide a run rate view of the business. This factor excludes purchase accounting adjustments made to recognize the acquired assets and liabilities at their fair value. During the second quarter, we executed a 100% quota share reinsurance agreement with our largest third-party insurer. As a result, we reduced the premium paid to that third-party insurer, which will increase underwriting income.
Additionally, Allstate assumed approximately $200 million in funds held in trust for potential future claim payments. Investment income on these funds will be earned by SquareTrade. In conjunction with this agreement, claims and claims expense benefited by a $6 million pre-tax favorable adjustment for loss experience. Slide 12 provides an overview of a new reporting structure. We'll expand our financial reporting segments from four to seven. We plan to adopt the new reporting structure in the fourth quarter. The new structure will provide enhanced transparency and allow for an evaluation of our businesses grouped by like attributes. Allstate Protection will continue to include the traditional property liability businesses that address the four segments of the consumer property liability market, Allstate, Esurance, Encompass, and Answer Financial. A new service business segment will include operations that have a larger portion of earnings from services, but generally have less underwriting risk.
This is likely to include SquareTrade, Arity, Allstate Roadside, Allstate Dealer Services. Allstate Financial will be split into 3 segments. As you know, we have substantially reduced the breadth and size of Allstate Financial over the last decade. Allstate Life sells life insurance to Allstate agencies in support of the Trusted Advisor strategy to broaden customer relationships. This business earns a low double-digit return. Allstate Benefits is a high growth and mid to high teens return business, so breaking its results out will highlight its value creation. Allstate Financial does not sell proprietary annuities given our view on economic returns, so the annuities is really a closed block of business. Returns are low in part, reflecting current low interest rates. In addition, as we discussed, the decision to maximize shareholder value by increasing allocation to performance-based investments has had an additional negative impact on near-term return on capital.
This new segmentation will have an impact on goodwill impairment testing and the aggregation of Allstate financial reserves for sufficiency testing. More information is available in the Form 10-Q, and we will provide additional detail later this year. I'll ask Jonathan to open the line for your questions.
Certainly. Ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. We also ask that you please limit yourself to one question and one follow-up. You may get back into the queue as time allows. Our first question comes from the line of Greg Peters from Raymond James. Your question please.
Good morning. Thanks for the call. I just wanted to circle back. I've asked this of you before, but now that you've had 2 quarters in a row where your underlying combined ratio is certainly trending better than expected, I'm curious about your view of competitive positioning in the marketplace, especially when I think we've seen some anecdotal stories or situations where some of your peers have started to cut some pricing.
Greg, this time I'll start, and then Matt can jump in. First, we do think we were out early, and taking the price increases that were necessary in auto insurance, and that has put us in a position to not have to, assuming these trends continue, we don't think we'll have to raise prices as much, which obviously helps because price is a large component of that which we compete on. It's not the only thing we compete on, however, there's a wide variety of ways in which we compete with other people. The other part is it largely depends what other companies do. It's impossible for us to predict what they'll do. Some of the large mutuals which have significant underwriting losses may choose to stay there, and then there really won't be any competitive window for us to grab more share from those specific competitors.
Some of our other competitors choose to subsidize various states, run losses there by having lower prices or higher margins in other states
I would say we prefer to be on this end of the equation, having improved our profitability so we're in a balanced position to grow. I don't think you can automatically assume that because other people didn't follow us, that they will follow us, or that this is sort of open to buy and it's easy to take business away. Matt, you may have some more specific comments.
Sure. Thanks, Greg. It's Matt. First, it all varies based upon geography, we'll start there. On a countrywide basis, as I said last quarter, we feel good that we've essentially caught up the loss trends and are now in a more reactive mode where we're monitoring loss trends and keeping pace with them. That, of course, has some variability state by state. There are some states where we still have indications, and we'll still need to take some rate. There are others where we're doing quite well, and things have stabilized. Overall, we feel real good about our competitive position. In our business with our distribution model, one of the most important things for them is stability.
As we're stable, as we maintain more normalized adjustments to rate and more inflationary rate adjustments, as we're able to build multi-month and multi-year marketing plans and give them predictability, they're more willing to invest. They're able to do long-term business plans. We see increased quote activity and increased closing rates. As a result, increased new business production. We actually feel quite good about our competitive position. It's interesting that you point to rate reductions that you've seen. We still see lots of our competitors with very large indications that are not yet taking all of their indications in some states. In others, they're still taking double-digit rates. We're seeing it all over the board while we are, for the most part, very stable and taking modest rate increases, which we believe is very good for our business model.
Thanks for that color. As a follow-up, with frequency, both BI and property being favorable for you in the last two quarters, I believe, is there anything going on in the environment that might lead us to believe that that's going to continue?
Oh, boy, if I could predict the future, Greg, I'd be a very happy man, and Tom would be happier too. What we've seen is a moderation in frequency the first half of this year. As we closed out last year, it was really unclear what frequency would look like. We were, as you know, monitoring miles driven, monitoring the unemployment rate, monitoring gas prices, and monitoring all those things that fed into miles driven, which fed into, in addition to distracted driving, fed into accident frequency. We've seen some moderation there, which has been good for our business these first two quarters. We have no way really of projecting what it's going to look like for the remainder of the year. We feel, as I said, good about the fact that it appears not to be making step function changes.
That is, it appears to be moving in a more normalized basis up and down, normal variability with weather and things like that, which is much easier for us to react to and monitor and take appropriate rates for.
Great. Thank you for the answers.
Thank you. Our next question comes from the line of Sarah DeWitt from J.P. Morgan. Your question, please.
Hi, good morning and congrats on a good quarter. As you begin to transition to growth, should we expect the underlying combined ratio to stay around these levels, or should we start to see it rise a bit given, I don't know, maybe a new business penalty or less price action?
Sarah, thank you for the question and good morning. When we manage overall profitability, we obviously look at the underlying combined ratio, it's lower than we expected this year, obviously. We also look at the reported combined ratio and factor in caps and everything else, we kind of like where we're at. Could it drift up? Sure. Frequency and severity typically bounce around by more than 1% a year, so it could move around. If you said, do we have an objective to further reduce it from here, the answer would be no. Might it go lower? It all depends what happens in the market. We really try to prioritize and balance between maintaining the combined ratio and growth. Obviously, when 2015 frequency and severity went up faster than we had factored into our pricing, we had to prioritize profitability over growth.
I would say we're back to a more normal position today. Matt, anything you want to add?
Yeah, let me just add, this is Matt. Let me add just two items. Sarah, you mentioned a new business penalty and whether or not as we begin growing, whether or not that could influence the combined ratio. Certainly, the new business penalty is a fact of life that as you grow fast, the newer business that's not yet tenured does tend to have a higher loss ratio than the more tenured business. One of the things, however, that mitigates against that is that in our reaction to the frequency spike in the last two years, we took very segmented rate actions, and we took the segmented rate actions against those worst performing segments of the book. As a result, the quality of our book increased. That led to more defections from the worst performing segments. It also led to us adding fewer new customers from those lower performing segments.
We believe that the new business penalty will be dampened as we add on, assuming that we maintain the same high quality we've been seeing lately. I don't expect that to be a significant drag. The other thing I'd point out is that there's been some commentary about whether or not this will cause us to dramatically increase marketing spend to stimulate growth, really, the marketing spend is not the primary driver on the growth right now, as we've discussed many times. Retention is actually a bigger influence for us than the new business on our total items in force. We are just as focused on trying to improve our retention within those bounds of what we can control, since a lot of it is uncontrollable, since it's based upon competitor actions.
For those things that we can influence, such as customer satisfaction and customer engagement and stability of pricing, we're just as focused on the retention component as we are on new business.
Great. Thank you. That was helpful. Secondly, I was wondering if you'd talk a little bit about your QuickFoto Claim and other claims initiatives and how we should think about the potential for savings there, as well as if there should be further restructuring costs. I think your LAE ratio is running around 11 points, but would it be fair to say maybe over time you could shave a couple points off of that?
Sure. It's Matt again. Let me just start high first. We've talked about Integrated Digital Enterprise and emerging technologies. One of those areas that we are deploying it initially and in quite some force is the claims area. We believe it's an area primed for it because there is some inefficiency in the way the model operated. In the past, there was a lot of windshield time. There was a lot of dead time, unproductive time as adjusters drove around, driving to cars, driving to body shops for both initial estimates and supplements. We looked at that and realized that emerging technologies, data and analytics could rectify that and take some of the inefficiency out of the system. We began the digitization of the claims process. Last year, we launched a new immediate payment method, which we call QuickCard Pay.
QuickCard Pay is the fastest claim payment method in the P&C industry. We make payments directly to debit cards within seconds. We've also been assessing roof damage from hail events utilizing drones. We've been doing that quite successfully for the last several quarters. In the last quarter, we opened two digital operating centers. They handle auto claims on a countrywide basis by estimating through photos. Approximately half right now of all drivable vehicles are currently being inspected through our QuickFoto method of settlement. That has led to the shutdown of many of our driving claim centers. It has also led to a reduced need for field adjusters since we took a lot of that inefficiency out of the system. We now have our adjusters looking at enhanced photos, digital photos in the computers without having to drive to and from the sites.
We've also begun utilizing video chat technology to review supplemental damage with auto body shops. It's something we call Virtual Assist. The combination of all of those things has led to a dramatically more productive and more efficient claim system. We've taken a cycle that used to take five to seven days in order to get eyes on a vehicle and get an estimate out. We've done that now in hours. We are literally doing that in under 24 hours. For supplements, instead of having to schedule an adjuster to come back out to a body shop and look at supplemental damage, we now use the video chat technology same day. We move it along. Everybody's happier. The customer gets their car back sooner, the body shop gets the car off their lift sooner, and they take another car in.
We are reducing rental car time and improving customer satisfaction. We do believe the combination of these leads to a more efficient system. It leads to obvious cost savings as we take inefficiency out of the system, and it leads to greater customer satisfaction.
Sarah, this is Tom. I think might have to go back and look at the LAE. Your number seemed high to me. I'm not sure how you were slicing it out, but you can get that from Jonathan. Let me pick up on Matt's Virtual Assist. That's really great technology, and we're making it available to other insurance companies. Basically, as Matt mentioned, it's FaceTime that combines with your claim system. What enables you to do is not to have somebody drive out to a body shop to do a supplement, and you can do it remotely.
It's available through Arity, so if insurance companies want to use it, this is where we can use our market-leading movement here, because we think we're ahead of other people in doing this, because you don't have to go out and train a bunch of body shops how to use this technology. We've already trained body shops how to deploy it. We're making that available to other insurance companies. That's my commercial for Arity.
Okay. Can you quantify the savings you've seen from these initiatives at all?
Here's what I would say, we're not going to quantify the exact savings. Obviously, when we take a charge of $52 million, not all of it was related to the claim speed. Some was related to some restructuring in the legal department. We obviously expect to earn that back in a relatively short period of time. That's not five years. That's not five days either, but it's pretty substantial savings on an absolute dollar basis. When you look at it on a percentage basis, it's obviously much smaller.
Great. Thank you.
We break all that number. We break out the restructuring piece by component in the Q.
Thank you. Our next question comes from the line of Jay Gelb from Barclays. Your question please.
Thanks very much. The Allstate brand underlying combined ratio in auto clearly improved year-over-year, although it was higher quarter-over-quarter. I'm just wondering if there's some seasonality that would explain that or if there's some other cause.
I wouldn't make anything of it, Jay. It bounces around. You remember the first quarter, January and February were much lower. It's really better look at it versus the prior year quarter because of weather patterns.
All right. I thought there was some seasonality there. Okay. On bigger picture, has Allstate given thought to purchasing increased catastrophe reinsurance protection on sort of working layer catastrophes? It seems that over the past, or the company's on track over the past two years to have around eight points of catastrophe losses. As reinsurance rates keep dropping, I'm wondering if there might be an opportunity there for increased risk transfer.
I'll make some general comments, then Steve may want to jump in. First, we look at reinsurance broadly, continuously, and have helped actually develop markets, whether that be cat bonds or larger, longer term aggregates where we go out 3+ years, which were never available before. We're always active in the market, and that's because we're obviously one of the biggest buyers in the market, so people respond to our requests. It comes in a couple different flavors. I think what you're suggesting is, have we looked at using reinsurance to moderate the annual impact of what I'll call non-large modeled events, so hail, windstorm, and stuff, having lower level of protection. We feel we can handle that volatility in our P&L.
If you look at the homeowners business, each of the rolling last 12 months, we've made over $1 billion a year. It gets expensive when you look there. You go to the higher-end levels, the sort of one in 100-year events, it has obviously the benefit of not having to have that volatility if in fact that event happens. It also is a capital relief tool. We don't mind paying a little higher price for that because to the extent we can earn a higher return on our equity than the reinsurers need to because of their portfolio diversification on our specific piece, we use it for that purpose. I would say we're always looking at different ways to do it.
We're always trying to moderate the amount of capital we have to put up and maximize the return we get on that capital. Steve, anything you want to add?
I think you did a pretty good job, Tom. The only couple of things I might add, we do look not only at buying more, but how we structure-
Yes
the reinsurance. We look at it annually. It's kind of an annual buy for Allstate in the early part of the year and for Florida kind of mid part of the year. If you look particularly this year, we did buy a $200 million cover in the Southeast, Florida and the Southeast for auto, which kind of filled in a hole we thought we had in terms of bringing the retention down a bit for that area. We continue to look not only how you structure, but there's holes we think might be if a storm were to hit, we'd focus on that. As Tom said, really it looks at economics. Generally what we've seen over the last handful of years is it hasn't been economic for us at that time to buy more or to structure differently.
We're entering into what we consider our normal type period in the fall here where we look at it. We'll look at it again, given you are correct, reinsurance rates have continued to move down.
Much appreciated. Thanks.
Thank you. Our next question comes from the line of Elyse Greenspan from Wells Fargo. Your question, please.
Hi. Good morning. As you guys talk about looking to grow in auto and some of your comments you also did mention in home, can you just remind us about the bundling within your book, those that purchase both auto and home coverages, and how you expect as you look to improve the retention in auto, how you expect that to play out in home?
Matt will answer for the Allstate brand. Don will make a comment on Esurance, because I think in one of the analyst write-ups last night, there was a comment about Esurance. Does that make sense, Matt?
Sure. Elyse Greenspan, it's Matt. Let me talk about the Allstate brand. The last couple of years have hurt our bundling capabilities. We had bundled primarily with auto and another product, auto and home, auto and life, auto and consumer household products. With all the disruption in the auto business, it has influenced and impacted the potential growth of the other businesses. We watch the home area specifically, and we know that home is lagging auto, not only because of the 12-month policy in home, but the different renewal periods. As a result, you tend to see a lag in the growth. When auto picks up, it tends to be a quarter or two before home picks up. We're still seeing some of the influence from that disruption in home, even though auto has begun to stabilize and turn the other way.
Our expectation is fully that as this works its way through the system. I remind you that a lot of rate was taken just over 12 months ago, so it has now worked its way through the system. As things stabilize and we hope retention stabilizes and potentially improves, we expect to see our capacity for bundling to improve. We like that, obviously. Number one, we want to serve customers holistically. We think it's 100% consistent with our Trusted Advisor strategy, but it also helps leverage a single acquisition cost across multiple product lines, leading to a more efficient system and a more efficient use of marketing funds. You should expect to see a continued emphasis on the part of the Allstate brand to increase the bundling, increase the number of products sold per household, and increasingly meet the needs of our customers.
Don, you want to talk about Esurance?
Yeah. First, much of what Matt said about the Allstate brand also applies to the Esurance brand and actually to other brands as well as you see across the industry, people at different companies have made the attempt to bundle for their customers. Recall when we acquired Esurance six years ago, it was a monoline company, so they sold only auto insurance. At the time, we knew that there was an opportunity for us to use homeowners to get a different kind of relationship with the customer, and in fact, even a different type of customer. By the way, we obviously know how to do homeowners as a corporation, we were able to leverage the skills we had at Allstate as we built out the Esurance capabilities. Esurance now has homeowners in 31 states.
Bundling is very important to us for the same reason as Matt talked about for Allstate. Our attach rates are going up dramatically as we roll the product out and make it available to customers. It will offer us an opportunity to increase retention, build a different customer relationship, and really build the business. Now, I want to temper those comments. There's only $20 million in net written premium here in the Second Quarter. You have 69,000 policies. It's still a relatively small percentage of the book. There is still volatility in that number. A few large losses will swing that loss ratio up dramatically as it did in the Second Quarter. We've done it for strategic reasons. It's delivering everything we expect, and I think it's a big opportunity for us to continue growing Esurance.
Okay, great. In terms of capital return, you mentioned the new $2 billion buyback program and being financed with capital at hand and your earnings. How do you view M&A right now? I know you just completed the SquareTrade deal, any kind of high-level thoughts how you think M&A is still part of the equation as you think about capital return here?
Well, of course, the first thing we do is look at managing overall capital. We'd like to invest in our existing businesses to the extent we can with just organic growth that obviously leverages our skill capabilities for higher returns. We do look at acquisitions, as you mentioned, we bought SquareTrade to broaden our product portfolio, broaden the distribution we have, and give us additional products to be able to sell through the Trusted Advisor initiative or through Esurance. What we do after that is say, "Okay, well, if we don't have additional use of the money, we should return it to shareholders and help increase their relative ownership in the company." In the last three years, we've bought back 15% of the shares outstanding. Your value should go up by 15% just because we're returning capital to shareholders.
Over five years, it's a little over 25%. I would expect that same pattern to continue. If we see something interesting, we'll buy it, and we paid a lot of money for SquareTrade, but we believe we can grow it just as we did Esurance and Allstate Benefits.
Okay, great. Thank you very much.
Thank you. Our next question comes on the line of Kai Pan from Morgan Stanley. Your question, please.
Thank you, and good morning. First question to follow up on the digital claim processing technology. I just wonder, how do you measure the accuracy using photos to set up the initial loss reserve versus using adjusters in person?
Hi, it's Matt. That's a good question. Obviously, when you initiate a massive change in a process such as this, quality is one of the most critical things. We did a lot of testing along the way. We still have testing, and we do both secondary reviews as well as reviews in person. We do selectively have people doing on-site reviews. As I said, it's only about 50% of the drivable cars right now. We have a baseline to look at. The reality is the quality has been exceptional. Supplements are slightly higher, but rather an insignificant amount. The overall quality is quite good. We are continuing to develop our ability to enhance the digital photos and get better visibility into the damage.
Obviously, as our adjusters get more familiar with how to use these photos and what angles to request and how to change the lighting on it, we're able to pick up more and more information. We're using some technology to actually help us learn from that and compare photos from similar autos and similar types of accidents to help us baseline. Overall, the quality has been quite good, actually slightly better than we expected. The productivity and efficiency savings have been tremendous.
Kai, on the reserves, remember, these are relatively short tail, so within 90 days, you know what it costs to fix a car. It cycles its way, so we think we're good there.
Okay, that's great. By the way, how much do you spend on these sort of R&D investments? It's a part of your expense ratio, right?
Yeah. I won't give you a number or a percentage. I will just tell you that we always look at these things and we invest heavily in research and development, whether that be the things we talked about here or Arity or other things, and we believe we can handle it with the overall P&L. We do not resource constrain that. Capabilities and ability to execute might constrain us, but it is not a money constraint.
My second question is on your change of reporting structure. Is there any change in the underlying operating structure, and how big do you think the service business will becoming a sort of meaningful percentage of the overall business of the company?
Well, Kai, the operating structure what we did really was try to align this the way we allocate capital and the way we think about our businesses and to give you increased transparency. We don't have a specific goal on percentage of revenue or profit we want from any of those various businesses. Let me give you an example. If you go to Allstate Financial, even though we showed people many of the underlying numbers, when Mary Jane manages that overall business, people would look at the overall ROE and say, "Oh, it's like 6% or 7% or 8%," depending on the quarter. The fact is that Allstate Benefits has great ROEs. Allstate Life has good ROEs, and it's dragged down by annuities business. We felt like we just needed to show people in a different way.
Even though some of this information you could parse out and accumulate together by looking at the Q or the K or the investor supplement, this really increases transparency by bundling it together for you in a way that aligns with the way we think about and manage the business.
Thank you very much.
Thank you. Our next question comes from the line of Joshua Shanker from Deutsche Bank. Your question, please.
Good morning, Allstate. I'm going to apologize in advance because this is going to get in the weeds a little bit, but between Sarah and Kai's question, I'm still having trouble understanding the expenses and technology versus what's in the expense ratio and what's not. Can we talk a little about why the $52 million maybe shows up in the expense ratio? Typically, you guys have $10 million or so of expenses that are kind of other that show up. How should we think about it going forward? Normally, just to understand, you guys are always investing in the future. Why does this show up in the expense ratio and other stuff in the past has not?
Let me be clear. It's not about technology expenses. This is about the cost for severance for people who are no longer be required. That's over 500 people. We have 937 drive-ins. Now, a lot of those, over time, we've structured to have month-to-month leases because we knew we were headed here. We still have some charges to take from shutting things down, getting leasehold improvements out. That's not really related to the investment in it at all. It's really related to the shutting down of other stuff. Why does this show up in underlying combined ratios question Matt and I have harangued Steve with for the last several weeks. Restructuring charges have always been in there.
I think you should expect to continue to see them in there even though they perhaps are not as continuing as we would think in terms of underlying. I don't think you should expect us to take a $52 million charge every quarter. That said, to the extent we need to take the charge or any charge really, as you know, we manage this place on cash flow and economic returns, and if it rattles through the P&L.
Okay. That's perfect. I'm on the same page now. The limited partnerships, I'm not going to get a great answer out of it, but they were phenomenal this quarter. Were there any specific gains taken that were unusual, or it was just a great quarter for mark-to-markets? How should we think about this going forward?
John will give you that perspective.
Yeah. Thanks, Josh. This is John. It was a combination of factors. One, we have been building up the book of business, so you'd expect that the return on that book of business would get larger. Two, favorable markets did influence it. When you look at our performance-based assets, they do have a correlation of about 70% to public markets, so that was a factor. Three, to answer your question specifically, there were a few idiosyncratic properties that performed quite well, and credit to the team that sifts through many opportunities, narrows them down to the ones that make most sense to the firm and invest in those.
All right. Well, if you need some more co-investment, let me know. I'll sign.
As long as you have good returns. We're in.
Thank you.
Jonathan, we have time for one more question.
Certainly. Our final question comes from the line of Robert Klasky from Janney. Your question please.
Squeezing me in. One numbers question on your net investment income page on 51. I'm going in the weeds, I apologize. Your fixed income yields are actually up year-over-year, despite the fact you've shortened maturities. How have you been able to keep the yield on fixed incomes going up in a sort of low interest rate world with shorter maturities?
Yeah. Hi, this is John again. As you would imagine, the combination of events can cause changes in yields. Not only where you're placed on the yield curve, but also what investments you buy in the market. Part of that is in response to increased holdings in securities like high yield and other higher yielding securities. We also did, and it should be noted, while it was a small move, in the first quarter of this year, we did extend the duration of the portfolio by about a quarter of a year, and that impacted yields by about 20 basis points.
Got you. One other quickie. The preferred that you say you're going to issue to help on the buyback, what's the motivation there? What roughly yield and magnitude are we talking?
We are looking at it as part of the potential funding for our buyback.
Right.
I think currently right now, the market seems fairly attractive. It just kind of goes on cycles. We will look at that as part of that financing. Obviously, we don't have to do it because we have plenty of capital and cash. When opportunities that we think are attractive are available, we want to take advantage of them.
Rough idea of the size and yield that you'd be paying? Ballpark?
Well, the yield should be as low as possible from our standpoint.
Right.
You saw a deal went out earlier this week a couple of ticks over 5%. When you can issue perpetual equity that has a guaranteed 5% return and you can use that to buy back common, we think that's a good trade on behalf of shareholders. As you know, we've done $1.75 billion of it over the last, Steve, two or three years.
Four years.
Four years. We like the results of that. There's more to. We wouldn't obviously do this for $100 million. It's not worth all the overall effort, so we haven't sized it, but there's plenty of opportunity for us to issue given our brand name, our credit capacity, and our ability to pay them.
Thank you.
Let me close by again, thank you all for participating. Overall, we made excellent progress on our five operating priorities. Most importantly, better serving the customers, achieving economic returns on capital, and proactively managing our investments. We also are beginning to focus more on growing the customer base and are always looking at building long-term growth platforms, whether that's investing in Integrated Digital Enterprise or new initiatives like SquareTrade and Arity. Looking forward, we're just going to stay focused on our 2017 priorities and be precise in the way we execute our business, balancing both short and long-term initiatives. Thank you all, and we will see 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.