Good day, ladies and gentlemen. Welcome to The Allstate Corporation fourth quarter 2013 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 conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Steven Siewert, Chief Financial Officer. Sir, you may begin.
Thank you, Matt. Good morning, everyone. Thanks for joining us today for Allstate's fourth quarter 2013 earnings conference call. After prepared remarks by Tom Wilson and myself, we will have a question and answer session. Yesterday, following the close of the market, we issued our press release and investor supplement, plus a slide presentation to be used in conjunction with our prepared remarks. These are all available on our website. We plan to file our 2013 Form 10-K on Wednesday, February 19th. As noted on the first slide, our discussion today may contain forward-looking statements regarding Allstate's operations. Allstate's results may differ materially from these statements. Please refer to our 10-K for 2012, our 10-Q for the third quarter of 2013, the slides, and our most recent press release for information on potential risks.
This discussion will contain some non-GAAP measures for which there are reconciliations in our press release and on our website. We are recording this call. A replay will be available following its conclusion. I, along with our Treasurer, Mario Rizzo, and Pat Macellaro from Investor Relations, will be available to answer any follow-up questions you may have after the call. Let me turn it over to Tom Wilson.
Good morning. Thank you for investing your time and money in Allstate. I'll start by covering our 2013 results as they relate to our strategy and our operating priorities for both 2013 and 2014. Steve will go through the business unit results and talk about capital management. With us today for the Q&A period are Matt Winter, who, of course, leads Allstate Personal Lines; Don Civgin, who's responsible for Allstate Financial and Esurance; Cathy Mabe, who leads Allstate business-to-business operations; Judy Greffin, our Chief Investment Officer; and Sam Pilch, our Corporate Controller. Let's begin on slide two. Our strong 2013 results demonstrate success in executing what is a broad and comprehensive approach to creating shareholder value.
That includes, obviously, strong operating income, a balancing risk and return, aggressive capital management, you see accelerating growth as well this quarter, which are all resulting from achieving our operating priorities for the year. Overall, 2013 provides a very solid foundation as we continue to aggressively implement our strategy, which is to differentiate the value propositions between customer segments. Starting at the top, revenues increased 3.6% to $34.5 billion in 2013, which reflects 1.5% growth in policies in force with contributions from all the brands. Net income of $2.3 billion declined slightly from 2012, primarily due to the $521 million after-tax loss from the pending sale of Lincoln Benefit Life and the impact from repurchasing debt. Operating income of $2.7 billion for the year was 24% higher than 2012, primarily due to lower catastrophe losses.
Operating income per diluted share increased 30% to $5.68 per share as a result of higher operating income and the impact of the share repurchases. Book value per common share also increased over the prior year, both including and excluding fixed income unrealized gains or losses. Operating return on equity was 14.5% for the latest 12 months. If you go to slide three, on the top, we show our five operating priorities for 2013. On the bottom, we show the four distinct consumer segments we serve through our competitively differentiated strategy, along with their respective growth and profitability. The three brands where we underwrite risk, Allstate, Encompass, and Esurance, all grew net written premium and policies in force in 2013 compared with 2012. We achieved all five of the 2013 operating priorities.
Starting in the lower left, for the Allstate brand, that of course, serves customers who prefer local advice, assistance, and want a branded experience. Our policies grew in 2013 by 0.4% from the prior year, as Allstate brand auto policies in force increased 1.5% versus a year ago and 0.6% versus the last quarter, which reflects both improved retention and continued strong new business growth. This growth is a result of, one, the retention, but also we've expanded the Allstate agency exclusive agency distribution. We have effective marketing and less restrictive risk targets. We've made substantial progress in improving returns in homeowners. As a result, the decline in homeowners policies was down to 2.2% from year-end 2012 and flat versus the third quarter.
The continued rollout of our Allstate House and Home product across the country will support our future multi-policy household focus. Overall, Allstate brand profitability improved in 2013 with a combined ratio of 89.9% and an underlying combined ratio of 85.8% due to auto profitability, good underlying homeowner margins, and lower catastrophe losses. Esurance brand, which serves a self-directed, brand-sensitive customer, is in the lower right, generated significant premium and policy growth in 2013. Premiums written increased by 27.9%, and policies in force increased by 26.7% compared to 2012. The combined ratio finished 2013 at 117.5%, reflecting continued high levels of marketing spend. You'll remember, that's where we expense all of our advertising right up front. Investments expanding both geographically and from a product perspective, continued expensing of acquisition and tangibles, and the impact of higher loss ratios on new business.
Esurance continues to adjust its pricing and underwriting to ensure the growth we're experiencing generates long-term profitability. These actions caused growth to decelerate a little bit in the third and fourth quarters, and we expect growth to decline somewhat in 2014. The Encompass brand in the upper-left quadrant serves customers through independent agents that provide a choice of brands. Our unique package policy represents about 80% of Encompass' total premium. This brand also grew with policies up 6.5% compared to 2012. The combined ratio for 2013 was 95.9, an improvement of 10.5 points from the prior year, which was driven by a significant decrease in catastrophes and improved underlying performance in the homeowners line. The auto insurance margins in this brand still need to be improved. Now let's move to slide four. We had a great year. Now it's time to move forward.
2013's operating priorities are compared to the five operating priorities for 2014 to highlight the evolution we're going through, which is from focusing on strengthening the core business to positioning for sustainable growth. The operating priority in 2014 on growth is in units rather than premium, as the importance of market share growth is now greater than raising average prices on homeowners insurance. Secondly, we want to maintain the underlying combined ratio in 2014. This combines the second and third priorities from 2013 and reflects the significant improvements made in the underlying margin in homeowners. Proactively managing investment risk and return remains a priority, although the focus will shift.
Now that the interest rate risk has been lowered in the property liability portfolio, the investment focus will shift from public fixed income corporate securities to other high-yielding assets, typically in the private market where returns are not as linked to overall market performance. The 2014 priority to modernize the operating model is a broader and more sustainable approach to the 2013 priority of reducing the cost structure. We'll continue to take a broad look at improving the way we do business, which means starting with the customer. We're pursuing continuous improvement, simplifying our processes, and streamlining our technology to deliver faster, better, and more cost-efficient service. This will lead to improved customer satisfaction and fund further investments in growing our business. To continue increasing shareholder value, focus is being increased in building long-term growth platforms.
We'll continue to look at ways to become an even more integral part of our customers' lives. The evolution, of course, of the connected customer and telematics, and there's a number of structural and technological changes that offer good growth opportunities for us. Finally, in keeping with our practice to provide you an outlook for our property liability underlying combined ratio for the next year, that's 2014, we set a range of 87%-89%, which is one point lower than last year's range. Now let me turn it back to Steve.
Thanks, Tom. I'll start by reviewing the 2013 financial highlights on slide five. Starting at the top, Property & Liability had earned premium of $27.6 billion in 2013, which grew 3.3% from 2012 and recorded a combined ratio of 92. The underlying combined ratio for the year was 87.3, essentially flat to prior year and better than our full-year outlook range. Catastrophe losses were $1.25 billion, $1.1 billion below 2012, and our lowest year of catastrophe losses since 2006. Net investment income for the Property & Liability segment grew 3.7% from the prior year, reflecting very strong limited partnership performance. Operating income was $2.47 billion for the year, 35% higher than 2012. The combined ratios on a recorded underlying basis for each brand are shown on the right-hand side.
As discussed by Tom, the Allstate brand continued to generate solid profitability as the positive effects of rate changes and low catastrophe losses more than offset modest inflationary increases in loss costs. The Encompass recorded combined ratio also improved from 2012 through lower catastrophes and improved homeowners margins. The Esurance combined ratio of 117.5 for 2013 improved 2.4 points from the prior year. It remains elevated, as Tom noted earlier. Allstate Financial, on the bottom left, had a 5% increase in premiums and contract charges in 2013, reflecting a 5.5% increase in underlying products, including a 10% increase in Allstate Benefits. Operating income of $588 million was an 11.2% improvement over 2012 due primarily to an increase in investment margin, lower expenses, profitable growth in Allstate Benefits, partially offset by a reduction in spread-based business and a lower benefit spread in our conventional life insurance.
Net income of $95 million for 2013 was significantly lower than 2012 due to the loss on the pending sale of Lincoln Benefit Life. On slide six, we show net written premium and policies in force in total and by brand. The red line shows that total policies in force began growing in the second quarter of 2013. For protection in total in the upper left chart, overall policies grew 1.5% from last year and 0.5% from the third quarter. Each brand achieved growth in both net written premium and policies in the fourth quarter and the full year. Moving to the upper right chart, Allstate brand policies ended the year 0.4% higher than both 2012 and the preceding quarter. The Allstate brand grew net written premium 3% in 2013, driven by higher average premiums and favorable trends in both retention and new business.
Allstate brand auto net written premium increased 2.2% from prior year, while policies rose 1.5% from 2012. Allstate brand homeowners net written premium grew 3.8% compared to 2012, while the unit volume decline continued slow, with fourth quarter 2013 homeowners policies flat to third quarter 2013. On the bottom two charts, you can see growth trends for Encompass and Esurance. Remember, the absolute dollar scales are much smaller than the top two graphs. Both brands grew net written premium and policies compared to 2012. Moving to slide seven, the chart on the left-hand side show the earned premium and underlying loss trend for Allstate brand auto and home, while the charts on the right show the combined ratio trends. We have continued to maintain overall margins in the Allstate brand.
For Allstate brand auto, you can see that earned premium and losses, which are somewhat volatile, tend to move in tandem over time as we closely manage rates to keep pace with loss developments. In the last three quarters, losses per policy have increased faster than earned premiums, leading to a slight deterioration in margin. Essentially, after experiencing very favorable loss results at the end of 2012 and the first quarter of 2013, moderate increases in loss cost have exceeded the increase in earned rates. Despite these increases, the underlying combined ratio for auto is still within targeted range and generates extremely attractive returns on capital. For Allstate brand homeowners, shown on the bottom half of slide, underwriting loss cost per policy is slightly higher in 2013 than 2012, while earned premium per policy continues to rise. This improved the underlying combined ratio by 2.4 points for 2013 to 62.7.
The recorded combined ratio for the year was 77.9, 10.1 points better than the prior year, reflecting the improved underlying margin and lower catastrophes. The combined ratio trends are shown in the lower right-hand chart. You can see our underlying 12-month average continues to decline, but at a slower rate as we approach price adequacy. Our 2013 investment results, depicted on slide eight, reflect actions we have taken to reduce interest rate risk in the Property-Liability portfolio, maintain alignment with Allstate Financial's changing liability profile, and actively managing our equity investments. As shown in the graph on the top of the slide, investment income before expenses was $1.08 billion in the fourth quarter, and the total portfolio yield was 4.8%. Investment income for the quarter was higher than the first three quarters of 2013, but was slightly below the fourth quarter of 2012.
We reported lower income from the interest-bearing portfolio due to lower reinvestment yields and a smaller asset base driven by the decline in Allstate Financial spread-based liabilities. The equity portfolio continued to benefit from strong limited partnership earnings, which increased by $92 million in the quarter compared to the fourth quarter of 2012 and partially offset the income decline in the interest-bearing portfolio. The equity component of our portfolio continues to grow. We expect to earn attractive but more variable returns over time in this component. Moving to the total portfolio return in the bottom left, our total return for the fourth quarter was 1.1%. Net investment income was the primary driver. Total return for the year was 1.8% as higher equity valuations were offset by lower fixed income valuations as Treasury rates rose during the year.
The level of unrealized gains in the portfolio fell from $5.5 billion at year-end 2012 to $2.7 billion at year-end 2013, as shown in the lower right. The fixed income valuation decline, resulting from the significant increase in Treasury rates, was the primary driver of the $2.9 billion decline in unrealized gains for the year. Our rate risk reduction actions positioned the Property-Liability portfolio to be less sensitive to rising interest rates and pull forward future income through realization of gains and the sale of longer-term securities, but lowers future operating income. Slide nine depicts the trends in the Property-Liability in Allstate Financial portfolios, each of which comprise approximately half of the total portfolio.
For Property-Liability in the top left, there is a declining earned yield trend on our interest-bearing portfolio as seen by the gray line, reflecting the interest rate risk reduction activity during the year and reinvestment in lower-yielding, shorter duration bonds. The impact of our actions is further illustrated in the scheduled maturity graph at the upper right, where the two declining red bars at the longer maturities show that only 10% of our portfolio is due after seven years, versus 32% at the end of last year. While we continue to evaluate our overall investment portfolio risk exposure, we currently intend to maintain the shorter maturity profile of our Property-Liability portfolio. At the bottom of the page, you can see that Allstate Financial's net investment income has been more stable.
Over the past few years, Allstate Financial's investment cash flows have been used largely to fund liability outflows. The portfolio yield has not been impacted significantly by the low yields of new investments. Future investment income will decline as liability outflows outpace new business and the sale of Lincoln Benefit Life is completed. The last column in the table provides a pro forma view of investment results exclusive of LBL actual results. The interest-bearing portfolio yield remains essentially unchanged, but investment income is $112 million lower, excluding the LBL-related assets. The chart on the bottom right shows the ongoing decline in the Allstate Financial portfolio as we continue to reduce spread-based liabilities. Slide 10 shows the progress we have made in improving operating income return on equity from an inadequate return of 8.6% in 2010.
We communicated in 2011 our focus on five key drivers to increase operating income return on equity to 13% by year-end 2014, as shown on top of the page. The underlying homeowners combined ratio, which represented over two-thirds of the expected improvement opportunity, has improved steadily from 72.9 in 2010 to 62.7 for 2013, and 60.7 for the fourth quarter of 2013. Auto profitability has remained stable and a combined ratio of roughly 95%, continuing to generate very attractive returns. When we established our goal in mid-2011, the expectation for the investment portfolio yield in the Allstate Financial ROE was the interest rate to rise over time. This obviously hasn't materialized as risk-free rates today are lower than they were in 2011. We have also proactively reduced rate risk in the Property-Liability portfolio, which has been a right economic decision even though it reduces operating income.
We continue on our track record of proactive management of capital, providing strong cash returns to shareholders through dividends and share repurchases. Since 2011, Allstate Financial has returned over $1 billion in capital. The 2013 14.5% return on equity reflects favorable catastrophe losses. Normalizing catastrophe losses and adjusting for non-recurring charges such as the pension settlement charges, discontinued line reserve strengthening, and restructuring charges, as well as excluding Esurance results since we did not own Esurance at the time we established the goal, still leaves an operating income ROE above 13%. Slide 11 shows our capital position at December 31 compared to last year. We are in a stronger capital position reflecting excellent earnings, the debt refinancing, changes in employee benefits, and the replacement of higher cost debt with capital that is longer term and has more flexibility, such as perpetual preferred stock.
In the fourth quarter, we returned $565 million to shareholders to bring the total to $2.2 billion for the year. We repurchased 1.8% of our outstanding common stock in the quarter, or 8.4 million shares, bringing the total repurchase for the year to 7.8%. As of year-end, we had $139 million remaining on our share repurchase authorization. As you know, we typically review our capital plans in the first quarter following completion of our year-end reporting. We estimate year-end statutory surplus to be a total of $18.2 billion, with $15.2 billion estimated for the Property-Liability companies. During 2013, Allstate Financial companies returned $774 million of capital, including $500 million this quarter. Holding company deployable assets were $2.6 billion at year-end. If you scan down the slide, you can see our strong capital position at the beginning of the year is even stronger today.
Overall, in 2013, we made good progress in the execution of our customer-focused strategy and achieved all of our priorities. We are well positioned to aggressively implement our differentiated strategy while delivering strong returns to our shareholders. Now, let's open up the call for questions.
Thank you, sir. Ladies and gentlemen, if you'd like to ask a question at this time, please press star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, to ask a question, please press star then one on your touchtone telephone. Our first question is from Bob Glasspiegel from Janney Montgomery Scott. Your question please.
Good morning. It seems like you have achieved your homeowners goal in the low 60s. Where do you stand on your overall homeowners strategy going forward?
Bob, this time I'll make a comment, then Matt can talk about what he's doing to turn the line on homeowners. I know you've been after us several times wanting to declare victory on homeowners. We feel really good about where it is now. If you look at the underlying combined ratio, it's in a good place. It's taken us four-plus years to get there, and we're now positioned to be able to leverage it as a competitive advantage. Matt can give you some sense of how he's going to do that.
Hey, Bob.
Good morning.
Good morning. I've mentioned previously that we kind of have a four-pronged approach to the way we're looking at the homeowners business and our strategy going forward. The first was the rate adequacy component, which as you and Tom have been talking about and as you've been mentioning on previous calls, we have made substantial progress on, and we feel really good about our rate adequacy right now. Although as things develop and change, we'll develop and change, but that's only one component of our strategy. The second component was to update and upgrade some of our product availability, which we did with House and Home, which you know we've rolled out to a substantial part of the market.
We launched it in about 27 states so far, which is about three-quarters of our new business apps, and we'll continue to roll that out into some additional states this year. The third component of the strategy, though, was to reassess our probable maximal loss and do what we call PML optimization and figure out if there are ways to use that PML capacity in a more optimized way that enables us to grow households and enables us to get benefits of diversification. We've done a lot of work with our PML. We've done a lot of work through reinsurance, and we've done a lot of work on a very localized basis to ensure that we're able to take on some additional homeowners capacity without really raising our overall risk load. The fourth component of it, of the strategy, is just general geographic diversification.
We know that the more we're able to grow in certain areas of the heartland, where we have non-correlated risk to some of the coastal areas, it gives us overall homeowners capacity. There's a lot of work underway to increase that geographic diversification, grow in some areas of the country where we have not historically grown, and therefore enable us to grow additionally in some of the regions where our capacity is constrained. All four of those prongs are enabled by our brokerage strategy, our Advantage strategy, which allows us not to hurt the customer as we do all those things. We always ensure we have a homeowner's product offering for our customers and for our agency owners to offer to customers while we're changing things, assessing risks, adjusting PML.
We've done a lot of work with our Advantage agency and Northeast agencies to ensure we have homeowner product availability throughout the country.
Thoughtful answer. Your third prong, in an environment where reinsurance costs are going down, are you taking the savings to the bottom line or using it to grow?
Yes.
A little bit of both?
I don't mean to be flip, First of all, reinsurance prices change over time. It's hard to rely on what the arbitrage may be over the long term. You have to be thoughtful and, I think, disciplined in how we choose to use that and how we choose to think about that, in either reinvesting it or taking to the bottom line. I think we're taking a fairly balanced approach. We may be reinvesting some of that savings and using some of it to enable us to enter areas where we haven't been able to enter before.
Hey, Bob, it's Tom. Remember two things as well, you don't just take change in reinsurance pricing and pop it into the combined ratio, which is we have a stacked program, it rolls out over three years. Reinsurance factors into our pricing. On a long-term basis, to the extent reinsurance costs went down, we'd be able to offer our customers more value. We would make that up by growing better, but it's not sort of just an expense that comes or goes.
Thank you.
Our next question is from Michael Nannizzi of Goldman Sachs. Your question, please.
Thank you. Tom, do you guys have an estimate or an idea of what the potential January losses may be for 2000, for the first quarter?
Mike, we do not, no.
Okay.
Of course, you know we do provide, we'll do our normal monthly CAT estimate, which is, I'm not sure.
The third Thursday.
Third Thursday of the month. That'll be coming up.
Got it. Okay. One question, how much of the increase in the year-over-year expense ratio was due to the incentive comp?
On the year-over-year basis, I'd say less than half a point in total. Incentive comp's like everybody, like not just management agency bonuses. There's a lot of people who are incented to drive growth and profitability in the company. There was a little bit of a bump. It was more than that in the fourth quarter, though, because we had some catch up, because there was a pretty good strong run for the finish line.
Got it. Okay. Is there any way to control for that piece, or?
I'm sorry?
Just trying to understand. Is there any way to kind of think about what it might've been excluding that piece, just to try and think about what the forward might look like?
I think, the best way to look at the underlying profitability, just look at the loss ratio piece. The expense ratio will move around depending how much we're advertising in a quarter and those kinds of things. We do expect the expense ratio to come down over time, though.
Got it. Clearly taking rate in homeowners, it seems to be slowing. I don't know if that's the right interpretation. Do you think you can continue to see PIF trends move in the right direction, as you continue to push for rate and maybe see some margin expansion there? Thanks.
Mike, I'm sorry. This is Matt. Were you referring just to homeowners there on rates?
Yeah. If you can comment on auto as well, but I was mostly talking about homeowners, yeah.
Okay. Well, if you look at page 17 of the sup, you can see that the impact of rate changes on premiums written over the last several quarters broken out by auto and home. As I said in my earlier comment to Bob, we have neared rate adequacy. Remember, as we roll out Allstate House and Home, for the vast majority of states, that goes in rate adequate right away. That has helped us jump to a rate adequate position early. We operate on a localized rate-taking basis. We watch loss trends as they emerge on a local basis, and we react on a local basis. Looking at it on a system-wide perspective is hard to do and I think a little misleading. When we see issues arising in a loss cost
In a region or in a state, we react quickly in a region or in a state, we'll take rate as needed. We've done a lot of work. We know the importance of customer experience and momentum. A lot of work was done over the last several years to factor in customer experience and momentum into the decisions we make about when we take rate, how we take rate, and how fast we take rate. We'll continue to balance that to optimize the overall return, the overall customer experience, our growth capabilities, and our ability to retain our existing customers.
Great. Thank you.
Our next question is from John Hall from Wells Fargo. Your question, please.
Thanks. Good morning.
Hi, John.
Hey there, Tom. Yeah, I was just wondering if you would just talk a little bit about the profit runway for Esurance, sort of the timeline, and then whether that's purely a top-line phenomenon or whether there's an element of overspending that's going on in Esurance. Just sort of tail on to that, whether you have any success metrics that you could share around your post-Super Bowl Esurance ad.
Okay. I'll answer that, and then Don can help me out as well since this works directly with him. First, impressive report quickly. Fast turnaround. I was like, you must have had that thing all filled out and just dropped the numbers, and I have to say, I was quite impressed.
Thank you.
As it relates to Esurance, let me go up to the strategy. Don can get into sort of the runway and the profitability. When we bought it, we thought we were a better owner because we could do a number of things. One, we could reposition the brand specifically targeted towards that self-directed customer. We did that. The first phase of that was to not have it be used to appeal to both segments, which was people when you want them and technology when you don't. That's obviously trying to appeal to both ends of that spectrum which they needed to do because of their size, and we did not. We repositioned it really around that self-serve customer, and Don can talk about the work they're doing in marketing there. That was the first thing, reposition brand.
Secondly, to strengthen the brand by endorsing it with Allstate. In fact, we've done that by having it be endorsed but not confusing with the Allstate brand. We also thought we were better at claims and preferred pricing. It was based on those assumptions that we said we could get in and invest more aggressively to drive growth in the business. We substantially increased the marketing spend, even though that has a negative impact on the overall combined ratio because we can handle it given the size and scope of our company. The result of that is you see we have great top-line growth over the last couple of years of that business. Now, of course, all good plans always have something that you got to adjust to. The loss ratio is a little higher than we would like.
Don and Gary Tolman and his team are working to get that. He can give you some insights on both what are we doing with the current marketing program and what are we doing to get loss costs in line. I'm okay. As long as the loss cost is in line, I'm okay continuing to invest in growth of the business, even if it brings their specific component combined ratio above what we would like on a long-term basis.
All right. John, let me maybe just fill in a couple of things on both the profitability trajectory, and then the marketing. As Tom said in the opening comments, you have to look at both the GAAP profitability and then what we look at, which is economics. Because we expense all the marketing expenses up front, particularly in a business that's growing, and Esurance is obviously growing very rapidly, the GAAP combined ratio is going to be elevated during the points at which you're growing the way we are. We would prefer to not just look at GAAP, but also look at economics, which is the way we run the business. We look at the lifetime combined ratio that the business they're writing today is generating. I'll talk about the loss ratio in a second.
By and large, we're comfortable that the business that Esurance is writing right now is profitable over its lifetime. You won't see it in the GAAP accounting because of the expensing of all of the advertising expenses up front. On the loss ratio, I think Tom's right. We're all a little disappointed with the loss ratio this year. We've been on it. We understand where it's coming from. Where we can, we've worked with Allstate to share data and make sure that we're on top of it. I think Gary and his team have done a really nice job of working to make sure that through both pricing, which you'll see in the supplement, you will see the rates being taken, and underwriting actions, that that will come back in line. We're already beginning to see the loss ratio come back in line.
I would expect to see improvement in the loss ratio in 2014 compared to where we were in 2013. I think so long as the business continues to justify the advertising spend, you will see an elevated combined ratio on a GAAP basis. Just one word of caution. You saw in the third and fourth quarter the top line slow down a little bit for Esurance as a result of some of the rates that have already been taken. I expect to see continued pressure in 2014. The way they're taking rates and moving underwriting, 2014 will be difficult to maintain the trajectory on the top line that they had in 2013. Let me move to marketing for a second. After we made the acquisition I think Gary and his team did a really nice job of fashioning a new campaign that was designed.
It was called the Insurance for the Modern World campaign. It was designed to make sure that everybody understood what their customer value proposition was. If you go back to our four square, that advertising campaign was designed to make sure people understood that Esurance was in the lower right hand, and not competing, against Allstate. That campaign was terrifically productive, extremely strong response rates, you can see from what it did to our top line, it worked extremely well. The Esurance ad after the Super Bowl was a little bit of a shift in that, instead of telling people we're in the lower right hand, we're now going to tell people how good we are at the lower right hand. That was the way to kick off that shift in the campaign.
We're extremely happy, not only with the impressions we got, I mean, if you read any of the social media reviews, it was extremely effective in generating Twitter activity, not only after the Super Bowl, but up until last night, when the announcement was made in the Jimmy Kimmel Show, on the winner. I think it's worked extremely well. What I like in particular is that the credit the team's getting for the campaign is extremely consistent with what the brand stands for, which is clever, modern, and doing things different than it's been done in the past. Feeling very good about the marketing campaign. We're investing in it. We'll see how it works. I think we're delighted with the way the ad after the Super Bowl has worked for us.
Was there an immediate response in terms of call volume?
Yes. Well, you have to separate that from call volume to quote volume. Quote volume was up substantially after the Super Bowl ad. Call volume was off the charts.
Great. Thank you very much.
A lot of that was obviously to learn about the contest and so forth. The response was extremely good.
We spent a lot of money. People should call.
Fair enough. Thank you.
Our next question is from Michael Zaremski from Credit Suisse. Your question, please.
Thanks. Good morning. On capital management for 2014, any outlook there in 2013, you guys, if I do the math on share buybacks, and the dividend over operating earnings, you guys returned in excess. How should we think about 2014?
Well, good morning, Mike. You should think about it as one of our core values for our investors is generating good cash returns for them. We started to talk about cash returns a little differently this quarter. We talk about the combination of dividends and share repurchases and what does that look like as a percentage of one's market capitalization. The concept behind that is if you own the entire company, at the beginning of the year, and you own the entire company at the end of the year, how much cash would you have gotten in between? Sometimes I think the share repurchase numbers get lost in the fact that you could choose to maintain your relative ownership interest as a shareholder by selling pro rata into the share repurchase program and getting that cash. That cash looked like about 9% last year.
It looks similar to that the prior couple of years. That is still our goal. As Steve said, we evaluate that in the first quarter. We're not prepared to make an announcement on what we're doing in dividends or share repurchases on this call, but you shouldn't expect a huge change in our philosophy in terms of driving shareholder return and providing cash to them.
Okay. That's interesting. Next and lastly, a follow-up to one of the previous questions. If we look at slide seven, auto loss costs seem to be exceeding earned premium for the last few quarters. Should we be expecting another tough comp in 1Q given what's been going on in January and maybe if last year 1Q was a tough comp as well in uncat weather? Thanks.
I don't really want to get into quarterly forecasts on it. I can tell you that our general philosophy is one Matt said, which is manage it locally, but also there's the be paranoid about it. The reason you maintain good returns is you stay focused on it. Matt can talk about what they've been doing in the last half of last year to reflect the trends you just mentioned.
Thanks, Tom. Mike, I'd rather focus on, as Tom said, how we manage this. When you look at slide seven and you look at the chart, I'd just remind you that this is a % year-over-year underlying margin trend. What we just saw is a comparison to what was an extremely favorable fourth quarter 2012. That notwithstanding, we do have some clear pressure emerging. You see slight uptick. We think it's still within our expected norm and our historical norms on the severity side on BI and PD. It is just kind of volatility that's normal and somewhat expected. That being said, what we see on a system-wide basis is different than what we see
On a localized basis. If you go back to slide page 17 of the sup, you'll see the number of states we took rate in during the second half of the year on auto. It's significantly higher than what we took in the first half of the year. We saw some trends emerging in some particular states. As such, we took necessary rate to ensure we got out in front of those and caught up quickly and minimized any lag between the earned premium and the increase in loss cost. We also took some underwriting actions, and we accelerated some correct class work in the second half of the year, that I anticipate will have a positive impact as we begin this year.
Thank you.
Our next question is from Dan Johnson of Citadel. Your question, please.
Great. Thank you very much. Wanted to talk about a segment that's actually sizable enough to talk about that's on the other Personal Lines, the underwriting improvement there was, I'd say, just about as meaningful as it was in the auto business in terms of year-over-year contribution. What's the outlook for that continuing? Now that Don's not there, who's running the business? I got one other follow-up after that.
Okay. Dan, well, good morning. As you point out, yeah, we are doing better in what we would call consumer household stuff, which includes a variety of other Property-Liability products. The business' profitability has improved. We'd like to see it grow a little faster, to be honest. Its growth was moderate. When we look at the potential market share or the market share we have in those spaces, whether that be motorcycle or RV or both, and we look at our overall market share in auto and home by state, we have some room to grow there. We'd like to. We're working on having a more household focus. Cathy Mabe is the person who runs that part of that business. Or, sorry. I'm sorry. We moved it over to Matt. I'm sorry.
I was thinking Cathy, Matt said, "No, I got Cathy." Cathy Mabe took over for Don. All the Encompass stuff, we've rearranged some stuff called business to business, I'll come back to that in a second. Don left, Cathy took his role. We reshifted that role somewhat. We have a fairly large set of businesses that are good at business to business, but they weren't really run together as business to business. For example, we have our worksite business, which serves the 2.7 million customers through the worksite. We also have a commercial insurance business, small businesses. There's a bunch of things that are really business to business, we felt like we weren't delivering as good and clean a value proposition to those businesses as we could have. We put those together and reoriented that right as Don was leaving.
As part of that, we took the consumer household business, we moved it into Matt's organization so that it's more integrated on the household focus from both pricing, technology standpoint, a whole bunch of reasons that'll help us grow faster.
Yeah. Well, that was actually my next question as to now that we've got it to very respectable profitability, can we grow it? Maybe I just ask it slightly different. Are we sort of at profitability, where we hope to be, and then the focus needs to be from growth? Is there still other things on the profitability front that you think can be done? That's it. Thanks.
Hey, Dan, it's Matt. On the profitability side, again, when you see it's rolled up to all the lines together, and we still have some additional work to do on a few of the smaller lines there to ensure that their profitability is sustainable. Remember, some of the profitability improvement we saw in this last quarter was driven primarily by low CATs. We don't want to declare victory too soon there. The way we're approaching these lines as we move them over from what was emerging businesses into Personal Lines is I consolidated things with wheels with the auto line into the vehicle line management, and I consolidated landlord, renters, and condo and manufactured homes into our homeowners business. They're being managed more holistically by what is now vehicle and home or vehicle and property line management.
I expect that over time, as we ensure that we have profitability on each of the subcomponents of those coho lines, that we will, consistent with our CVP, begin growing the overall portfolio. Remember, our overall approach with the Allstate agency now is to say yes more often to customers, have more products available to serve their customers, and enable those agency owners to be more holistic risk advisors to their customers and have a variety of products at their disposal. As we continue to embed that CVP into the agency system, we think that the ability to sell some of the consumer household products will improve. Our breadth and depth of customer penetration will improve as
As a result, we will get better at packaging them together, porting data between the lines, making it more intuitive for a licensed sales professional to switch from a standard auto sale to a renter or a condo sale and port data over. We're excited about the opportunity. We think the integration into the rest of the Personal Lines business, the auto and home business, will be a long-term strategic benefit to us.
Hey, Dan.
Very good. Thanks very much for that.
Hey, Dan, this is Tom. I want to add one thing to that because I think you're on an important point from a strategy standpoint. This is really a shift from a product and policies in force strategy to a household strategy focus. Our metrics don't quite follow it. We show you policies in force by product and that kind of stuff, and it's really in line with a customer focus. Some of our competitors only have one line, right? We have to compete heads up with them. We're more interested in selling everything we can sell to you. If you thought of us as a retail store, we don't just want to sell shirts. We want to sell shirts, pants, shoes, socks, whatever you need, we want to give to you because we think that speaks to that customer segment.
Matt talked about it there. We're also doing the same thing in Esurance. Esurance, we've rolled out renters in 16 states, motorcycle in three states, and homeowners in one. You should expect to see, we think that gives us a competitive Advantage in that space because we'll be able to leverage our relationships and marketing dollars over a broader swath of products and services, have greater retention from people because we sell more things. It is about shifting to that consumer-customer focus. This is, of course, one part of it.
Very good. Again, thanks very much.
Our next question is from Josh Stirling from the Sanford Bernstein. Your question please.
Hi. Hey, good morning. Thanks for taking the call and congratulations. Good quarter and couple of hard years, and now we can all talk about growth. Wanted to talk briefly. We oftentimes don't talk about your agents. You obviously have a lot of them. They're sort of central to the story, but I think they get lost a bit. Three or four years ago, you guys made a whole bunch of changes, lots of new blood in the organization, some consolidations, new agency behavior in management strategies and compensation.
You're obviously starting to see some core growth in the channel, and I'm curious if what you've learned from the various initiatives you pulled and if some of the growth that we're seeing is kind of you guys getting some traction from, for example, the new blood and new hires and things like that, or whether the growth is something that's just a bit more cyclical as opposed to structural, that we can look at.
Well, Josh, thank you. As you were talking about it, I was saying, okay, well, this is my 8th year as CEO. The last one was a lot more fun than the first 6. We've made a lot of progress. As it relates to our agent channels, they're never lost. They're a key component of that which we do and very vital to us. As we've talked about before, when we had to refix homeowners, lean a little heavier on auto, we decided to, at the same time, go in and strengthen the agency distribution force through a whole bunch of things. Matt can talk about what he's doing there. I would say that I am very proud of the work that our team has done to improve the relationships with them, help them be more successful. That is part of what's driving growth.
It isn't just about selling more homes and not taking as much rate. That is, of course, part of it, but it's also about getting the system positioned. We had that kind of period of time for a couple of years where we had to kind of regroup, build our foundation, and they've taken it to a new level. Matt, maybe you want to talk about how you feel about agencies, what they're investing in, and how it's driving growth.
Thanks for the question, Josh. I love getting questions about agency owner distribution. It's, I think, one of our core strengths as a company and one of our competitive advantages. We did a lot of work on reengaging the agency system. As you mentioned, we had a tough transitional period. We had to do some hard work as a company to change and improve the productivity and efficiency of the agencies. Some of that involved compensation changes to shift towards more variable compensation to spur and incent growth and give them a reason to take a leap of faith and invest in their agencies, even though at that time they were declining in size. We have managed through that new compensation program to completely bend the line because they did take that leap of faith. They invested in their agencies. They hired licensed sales professionals. They increased their marketing.
They invested in technology. They totally reengaged, and as a result, they are now growing items in force, and their agencies are more valuable. Our system is more valuable, and we're thriving together. That brought together a bunch of work. It brought together technology work, marketing work, compensation work, workflow reengineering to make the products more intuitive to sell, a lot of great product work. That has yielded 2 tangible results. I think on the last call we mentioned that the agency relationship survey, which is a survey that measures their level of satisfaction and confidence in the system, is at an all-time high. If you see on page 11 of the supplement, you'll see more detail in the 10-K when it's released.
We're growing the number of agencies. That trend was going down for several years, and now it's increasing because we're adding points of distribution. They, in fact, are adding additional licensed sales professionals.
Our EA retention is significantly higher. The previous couple of years, we experienced retention rates that were at about 80%. In 2013, our EA retention was 92%. That means fewer of them are leaving the system. There's less disruption to our customers. It builds on itself. All of these things, the momentum on the growth side, the momentum on new business side, and retention, along with what I call sustainability metrics, which are the number of agencies and the productivity and efficiency in those agencies, should all work together to improve the overall growth of the system. The short answer to your question is, I think it's very structural. I don't think it's cyclical, and I don't think it's a short-term thing.
That's really helpful, Matt. Thank you. Just one other sort of question. Long term, if you guys think about sort of five years, we're trying to think about what the Allstate of the future looks like. Homeowners is arguably maybe that's cyclical, maybe that's structural. It's a much more profitable business today. You guys have shrunk your footprint by something approaching, gosh, maybe 30% in terms of PIF, since 2005. The question is, if you think bullishly, how big could you get that business over some extended period of time? Then second, at Esurance, you're still sort of getting your legs, but your investments thus far, it's been kind of modest in terms of ad spend. Obviously that's turning the corner. If you look forward five years, how material a part of this business do you think it may be? Thank you.
How material of-
Would Esurance be as a function of the total Allstate franchise?
Well, I'd like them all to grow as fast as they could grow. I'd take the same percentage in higher growth in total, or I'll take higher percentages on either. I think if you want to go really five years, I would start to think more about just telematics, connected customer, the way in which we interact with our customers. We have a different approach to telematics. We're still developing it is, but telematics, of course, is our Drivewise and DriveSense. It does one thing, which is give better pricing, gives you the ability to do better pricing because you have more data about individual customers. Our offering, though, also is trying to enhance the customer value proposition.
We haven't sorted out exactly what that means yet, but if we were to look over five years, I think you would find that the types of services, information, and relationship we have with our customers will be stronger, and more valuable to them, and should enable us to grow. I think you're really, the next couple of years, you should see them to grow in what is economical and as we think we have the skills, capabilities, and performance to grow. I don't really want to talk about just homeowners or the other pieces.
Okay. Thanks, Tom. Good luck.
Thank you.
Our next question is from Adam Klauber of William Blair. Your question, please.
Thanks. Good morning. Just to follow up on the standard auto loss ratio. Looked like it did tick up a bit in the fourth quarter, as you mentioned. Is some of that just sort of an accident year true-up, just looking at the trends developed, and you saw it and sort of caught up? Number 2, you mentioned you're seeing modest pressure and severity. Also looks like frequency is maybe normalizing. Could you talk about what you're seeing on the frequency side also?
Yeah. As I said, the tick up that you're referring to, we just consider kind of some normal volatility. There is some embedded pressure on the severity side. I think frequency is relatively stable, and is performing well within the historical ranges. There was a little PD tick, but remember that 2012 was actually below the historical range. We looked at that, and there's nothing to be worried about. We looked at the new to renewal ratios because as we're growing, we would expect some pressure on our frequency there, but actually it hasn't emerged yet. The faster we grow, that becomes somewhat inevitable, but we're monitoring it closely, and we'll stay out in front of it. Again, on the severity side, it's slightly elevated. You look at the two-year average growth, though, on PD paid severity, and it's fairly moderate.
I think it's I know what you're trying to do. Everybody's trying to see whether or not a trend is emerging, and so you have to look at the last two quarters or year-over-year. We have to do that and balance it with what it looks like over a two-year period, understanding that there's some volatility in there. Again, you're seeing it on a systemic basis, and we're trying to look at it on a very localized basis. We're able, I think, on a very localized basis, to distinguish better between what is just normal volatility and what's an emerging trend. We jump on anything that looks like it's an emerging trend, and we wait out what looks like normal volatility.
Okay, that's helpful. One follow-up on the overall expense structure. The business historically ran closer to 25%, and clearly been edging up more in the 26% now. Is the reality, is it just more of an expensive business today than it was five, 10 years ago?
It's changed. I would say that you're absolutely correct in the percentages, but there's more money being spent today in marketing than there has been in the past. We are spending less money in certain categories, and in many categories, we cut costs to invest in other things. If I look at total technology spend, we're spending a lot more money in technology, in simplifying, cutting expense out, which should lead to both improved customer experience and lower costs in the future. It bounces around. We're always about, though, trying to reduce cost. This is a relatively thin margin business. It's low involvement business from a customer standpoint, so they don't like to pay for something if they don't have to. We try to look at everything, say, "Will our customers pay for it?" I think we don't have a magic goal.
I think the answer is how do you deliver the most value to customers, and split your money up? If we have to spend half a point in expenses, and we think that it gives us ability to charge another % in average price, we'll do that. We're not going to manage just the expense ratio as a way to grow the business. It's all about what the customer wants. It shifts around a little bit. A lot more money in marketing these days. Then the mix changes with Esurance in there, and you got to kind of break it out between Esurance. Really, the four segments should stand on their own as it relates to expenses, because that's what you're paying to deliver the service to that specific customer.
Thanks a lot.
Our next question is from Brian Meredith of UBS. Your question, please.
Hey, good morning, Tom.
Morning, Brian.
Hey. I wonder, could you give us an update on Drivewise and how that's doing, and any plans for 2014 to push that product, maybe more ad spend or something?
Yeah, I will, Brian. Matt, I think this is our last call. I didn't realize we were getting good questions, we went a little bit over time, I apologize to those of you who have other things to do. Yes, we have two offerings in the marketplace, Drivewise and DriveSense. The first is the Allstate brand, the second is the Esurance brand. In the Allstate brand, we're over 300,000 units on the street today. We stay connected in our offering versus some other offerings where they take it back. Not everybody does. There are three components to that which we're trying to do. One is better pricing. It's every bit as powerful, I believe, as credit was when we got started. Second, it will be about enhancing the customer value proposition.
Third is how do we use that data to help our customers do even more, and pay less? There's three components to it. We have what we call V1.0 out in the marketplace today, which is the product I just mentioned that's in the cars. We are working on some other alternatives this year that we'll be investing a substantial amount of money in this year to test, and decide how we want to take and grow that product. We call those affectionately 2.0, 3.0. Then we have a team that's working on innovating there. We're connected with all the OE in terms of what they do. I think we'll probably end up with a different strategy for the OE market than the aftermarket. Of course, aftermarket is where most of our customers are.
That will start to roll out, and we'll talk about it as we go through the year. It is important to us, and we're spending lots of money on it.
Great. Thanks. One other just quick one. Can you talk about what potential impact ACA may have on your supplemental health business as we kind of look forward here and voluntary products go onto those exchanges?
It's a relatively small impact on the business. There are some product things we have to change, but it's not a meaningful item for us, in that business or obviously for the whole company. Thank you all. Last year, you saw us begin to shift from improving returns to accelerating our strategy, which is, of course, to grow by providing differentiated value propositions to the four customer segments. We really are now positioned for growth. We got a good, solid strategy. We got brands, we got the business capabilities. We're executing well. We have the financial resources, and as importantly, we have a great team between our management team here and our agency owners. We are positioned to both grow and continue to provide cash returns to our shareholders. Thank you all, and we'll talk to you next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect.