Good day, ladies and gentlemen. Welcome to The Allstate Corporation third quarter 2012 earnings conference call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. If anyone should require assistance during the conference, please press star then zero. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Robert Block, Senior Vice President, Investor Relations. Sir, you may begin.
Thanks, Matt. Good morning, everyone. Thanks for joining us today for Allstate's third quarter earnings conference call. First, Tom Wilson, Steven Shebik, and I will provide some color on our results for the quarter. Then we'll go into a question and answer period. Also on the call are Don Civgin, Head of Allstate Financial and Insurance, Judy Griffin, our Chief Investment Officer, Samuel H. Pilch, Comptroller, and Matthew E. Winter, Head of Auto, Home, and Agencies. Don Bailey, who leads the emerging businesses, will not be able to join us today since he's on the East Coast as a result of Superstorm Sandy. Last night, we issued our press release and investor supplement. We filed our 10-Q for the third quarter. We also posted a slide presentation to be used in conjunction with our prepared remarks. These are all available on our website.
Beginning with slide one, this discussion may contain forward-looking statements regarding Allstate's operations. Actual results may differ materially from these statements. Please refer to our 10-K for 2011, our 10-Q for the third quarter of 2012, 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. I will be available after this call to answer any follow-up questions you may have. Now I'll turn it over to Tom for his perspective on our performance.
Well, good morning. We appreciate you spending time with us today. Before we discuss results, let me say a few words about Hurricane Sandy, which I know personally affected many of you. First, I hope you're all getting your lives back together. As you know, this was a massive storm, affected most of the eastern half of the country. If you look on slide two, you can see the breadth of that. Put in comparison to other events, this is at least twice the breadth of Hurricane Katrina. The good news is that the wind speeds were substantially lower than Katrina and more like last year's Hurricane Irene. In fact, wind speeds were about two-thirds of Katrina. As you know, the damage is exponential as that speed goes up. While it's of course too early to call ultimate damages, several modelers have put out insured loss estimates.
EQECAT is at $5 billion-$10 billion, AIR is at $7 billion-$15 billion, with economic losses at twice that amount. If the storm's damage is over $8 billion in insured losses, that'll make it the fifth largest hurricane in U.S. history. Of course, a lot of the damage at this point would appear to be caused by flooding that is covered by your auto insurance. As you know, the federal government provides flood insurance, and it's typically not covered by people's homeowners insurance. Of course, in these times of trouble, that's when our company, Allstaters, do great work on behalf of our customers. We have 1,100 catastrophe claim adjusters out in the field as we speak, another 500 at our service centers. We have 24 mobile claim centers. We're reaching out to customers. We're doing advertising. We're walking the neighborhoods.
We are very proud of the fact that we are either among the first, if not the first, to be there for our customers. It's sort of a point of pride for us. We're out there helping them find a place to live, get food, clothing, assess their losses. Allstaters really do an amazing job of providing for the needs of our customers, being empathetic and supportive at this time. As you know, customer focus is central to our strategy. In fact, we just got the J.D. Power auto claim satisfaction results this week, and our overall satisfaction on auto claims increased significantly. We're now in the high satisfaction tier above the industry average and several other well-known insurance brands. We all want to know, of course, how much this storm will ultimately cost us, and it's obviously too early to estimate the impact of that storm.
However, the catastrophe is not expected to have a material impact on our overall financial condition. Obviously, at this time, our focus is on our customers, not our monetary losses. Ultimately, of course, we do provide an estimate for cat losses in a month if it surpasses $150 million. We typically do that by the third Thursday of the following month. Because this event occurred at the end of a month, and it involves such extensive damage, we may not have enough information to develop a credible estimate by November 15th because the way that Thursday falls, it's really 15 days after the end of the month. As soon as we have an estimate, we'll put one out. Let's move on to discuss the results for the quarter.
I'll focus my remarks on our performance relative to our 2012 priorities, and then Bob and Steve will cover the quarterly results in greater detail. Moving to slide three. Our strategy, of course, is to provide unique products to each of the four customer segments in the marketplace, which you can see on the top there, and it is working. The Allstate brand serves those customers who prefer to purchase competitively priced, branded products and want local advice and counsel. In this business, we've introduced several new differentiated products, including claim satisfaction guarantees, Drivewise, Good Hands Roadside, and House and Home. In the third quarter, premium and unit growth continued to be impacted negatively by our efforts to improve homeowner returns broadly across the country, our actions to improve profitability in a few large auto states, which, as you know, we started last year.
We did see positive premium growth in total for the Allstate brand as homeowners, emerging businesses, and standard auto outside of New York and Florida all contributed to that increase. Additionally, Allstate Financial's New issued life policies sold through the Allstate agencies to the customers in this segment increased as well. Of course, we continue to look for ways to improve the growth trajectory for standard auto, one of our core lines, identifying market opportunities to expand homeowners in emerging businesses, and then support our agencies so that they can grow their business profitably. The self-directed segment that prefers a branded experience that's served by Esurance, that's the lower right. Since they were acquired last October, Esurance has exceeded our growth expectations with policies in force increasing 22% since the beginning of this year.
The GAAP combined ratio remains elevated, as one would expect, given the amount of new business we're writing and the way the accounting works for direct businesses. We are closely watching the loss ratio since maintaining auto profitability is one of our core priorities. Progress is also evident in the advice in brand neutral customer segment, that's up top, served by Encompass. The growth and profit trends for that brand are also positive. If you move to slide four, let's review our financial performance for the third quarter. On a consolidated basis, we generated $723 million in net income on improved underlying margins and lower catastrophe losses while growing premiums. Operating income of $717 million converts to $1.46 per diluted share. That's our best quarterly result in five years. Book value per share grew to $42.64 per share. That's 22.4% better than the third quarter of 2011.
Lastly, we produced a return on equity of 13.6% and 15% on a net income and operating income basis, respectively. That is on a trailing 12-month basis. I recognize we set a goal of 13% operating income return by 2014. Keep in mind that while we made good progress on improving the profitability of the business, the weather's been fairly good over the last 12 months, there's more work to be done before we feel like we've achieved that goal. We also established four priorities for 2012, we're on pace to achieve all of them. Maintaining auto margins is critical. The underlying combined ratio in the quarter was 93.7. That's an improvement from the third quarter of 2011. The homeowners' underlying combined ratio improved seven points. As rates continue to work into the P&L, weather remained relatively benign, and the benefit of our underwriting actions.
This is a result of five years of hard work to reposition this business. Annuity returns remained relatively flat, the reduction in contract holder funds was lower, due primarily to the low interest rate environment. Going forward, we'll continue to look for opportunities to accelerate that reduction. Property liability insurance premiums grew 5% from the third quarter of 2011, largely due to the acquisition of Esurance. Both the Allstate brand and Encompass produced positive premium growth rates in the quarter. In that customer segment served by the Allstate agencies, however, auto and homeowner policies declined. Reversing this trend is a key priority for Matt's team. Don Civgin's team has done a nice job of repositioning Encompass and growing the roadside business with a new product, Good Hands Roadside now has over three-quarters of a million members.
We actually changed the disclosure in the investor supplement to see the policies in force in a slightly different way this quarter. The Allstate Financial team, led by Don Civgin, is growing life sales through Allstate agencies and the benefits business. Judy's team continues to proactively manage the investment portfolio, which led to solid total return performance of 2.4% in the quarter and 6.3% through September. Net investment income of $940 million, declined 5.4% from last year's third quarter. That's primarily due to reduced Allstate Financial liabilities, lower yields, which of course, you're all familiar with. Limited partnership results were down a little bit this quarter as well. The portfolio net unrealized gain increased in value during the quarter to $5.7 billion at the end of September.
From a capital utilization perspective, we repurchased $153 million of our stock. That's at a slower rate than in the previous quarter. As we said, in the third quarter, as we move through cat season, we tend to slow that program down a little bit. We feel good about the results for the year, also recognize there's a lot more work to be done. Let's hear from Bob and Steve.
Thanks, Tom. Let's take a closer look at the details for property liability and Allstate Financial for the third quarter. Beginning with property liability on slide five, we show both the top line and combined ratio results. Overall written premium grew 5% from third quarter 2011 to $7.06 billion, primarily due to the acquisition of Esurance. The growth rate increased from the second quarter of 2012 as both the Allstate and Encompass brands also contributed to the positive result. Looking at the results by line, Allstate brand standard auto declined by two-tenths of a percent from third quarter 2011. It was similar to the second quarter of 2012. Excluding New York and Florida, the two states where we have implemented significant profit improvements over the last 18-24 months, Allstate brand standard auto grew by 1.4%.
New issued applications of 460,000 remain slightly below the prior year. We're at the average level produced over the last six quarters, which ranged from 451,000-472,000. The retention ratio remained at 89.0%, down a tenth from the third quarter 2011. Policies in force declined sequentially as the level of new business was not sufficient to offset the renewal losses. Allstate brand homeowners' net written premium of $1.69 billion increased 3.2% compared to the third quarter of 2011. The favorable impact of rate changes on average premium more than offset the decline in units. We continue to see great changes in order to achieve our stated return goals. In addition, we are rolling out our new product, House and Home, now in 17 states, including five states that rolled out in the month of October.
Encompass continued to show positive results in both premiums and units, with increases over prior year of 5.3% and 3.8%, respectively. Esurance contributed $282 million in premiums written during the third quarter and increased units sequentially to 962,000, a 22.4% gain since the beginning of the year. On the bottom half of the slide, we provide the combined ratio results for property and liability and by brand on a recorded and underlying basis. The recorded combined ratio for property and liability was 90.2, significantly better than the prior year due primarily to lower catastrophe losses and an improvement in the underlying combined ratio. Year-to-date September, the underlying combined ratio was 87.4 or 1.5 points better than prior year and below the bottom of the outlook range we provided at the beginning of 2012 of 88 to 91.
If we match the underlying combined ratio we recorded in the fourth quarter of last year of 90.7, it would put us in the lower end of that range. This is not a prediction or a forecast, just creating some context for why we didn't adjust the range at this time. During the third quarter, we completed our annual comprehensive review of the discontinued lines and coverages reserves. We made some minor adjustments to the reserves for an impact of $42 million. The recorded combined ratio results by brand indicate significant improvement for both the Allstate and Encompass brands, due primarily to reduced catastrophe losses. The underlying combined ratio also improved for the Allstate brand and Encompass. For Esurance, the recorded and underlying combined ratios remain elevated. On slide six, we provide charts detailing loss trends, rate changes, and combined ratio for Allstate brand standard auto.
As shown in the upper left-hand corner, after increasing over prior year in the second quarter, gross frequencies for both bodily injury and property damage declined 1.2% from the third quarter 2011. In the upper right-hand charts, the calendar year paid severity results for property damage showed a little acceleration from second quarter increase in 3.9%. Bodily injury calendar year paid severity rose to a 6.8% increase over the third quarter of 2011. Bodily injury severity tends to be volatile from period to period, and the mix of state and report years contributes to it. Over a two-year period, the increase is in line with inflationary factors. There's some pressure on the most recent report years, primarily in New York and Florida. The overall loss trends remain well within our pricing actions.
In the lower left-hand chart, we provide the approved rate changes for the last four years. For the last four quarters, we've averaged about 3% in standard auto rate changes. In the lower right-hand chart, displays the combined ratio trends since the beginning of 2010. Over the last few years, the combined ratios remain very consistent in the mid-90s range. Slide seven looks at the underlying combined ratio trend on the top of the page and the underlying margin components on the bottom of the page for standard auto. In the top chart, you see that we've averaged an underlying combined ratio of 95.1 over the last four quarters.
On the bottom of the page, you can observe that the average earned premium, which is the red line, has remained above the average losses line, shown in blue, meaning that the margins are getting a little better each quarter. Maintaining auto margins remains a top priority for us. On slide eight, we provide similar statistics for homeowners. In the upper left, we have approved rate changes for the last five years, and over the last four quarters, we've received approvals for almost 7% rate increases on a countrywide basis. We will continue to seek needed rate changes in order to hit our return objectives for this line of insurance. In the upper right, loss cost trends excluding catastrophe losses are displayed. For the third quarter, frequency decreased 11.4%, while paid severity increased 5.8%.
These results led to a reduction in the underlying combined ratio of 7.1 points, as shown in the lower left. We continue to believe that about half of the improvement in the underlying results is sustainable and half are the results of the milder weather. Slide nine provides a better look at the underlying loss trends for homeowners. The top chart gives the underlying combined ratio, and one can observe the improvement we've achieved in the last several quarters. On the bottom, we display the trends for the average earned premium and average losses over time. The trend for the average earned premium in red reflects the favorable impact of rates increasing steadily since 2010. The trend for losses in blue is far below the prior years and gives rise to our hesitation to take full credit for the margin improvement we've enjoyed this year.
Improving homeowners' returns is a priority for 2012, and we have been successful thus far through the first nine months. Turning to Allstate Financial, where we continue to shift the focus to underwriting products and away from spread-based ones. The results reflect successful execution of this strategy. Total premiums and contract charges of $563 million increased 2% in total and 3.6% for underwritten products. Allstate Agency Life's unit sales contributed to this result, increasing 6.9% over the third quarter 2011. Consistent with the strategy of reducing spread-based products, contract or holder funds were reduced by $722 million from the second quarter and $2.2 billion from year-end 2011. Given the low interest rate environment, we've not made as much progress in reducing annuity liabilities as we would've liked, and we continue to explore a variety of options to execute this strategy.
Net income for Allstate Financial was $131 million for the third quarter, down $61 million from the third quarter 2011. The primary reasons for this reduction were realized capital losses in 2012 versus realized capital gains in 2011, along with lower operating income results. Last year, we executed a sales program designed to harvest gains, accounting for much of the difference. Operating income was $97 million for the quarter. During this quarter, we completed our comprehensive review of assumptions for deferred policy acquisitions, or DAC, deferred sales inducement costs, and secondary guarantee liability balances. This resulted in a $27 million pre-tax charge to income. In 2011, we conducted this review in the first quarter of the year, resulting in a $6 million pre-tax charge to income.
Looking at the operating returns by line, life insurance declined 2.2 points to 9% from year-end 2011 due to worse mortality experience in the last several quarters and the impact of the annual DAC unlock study. Accident and health continued to produce solid returns at 16.6% as of September 2012. I'll turn it over to Steve.
Thanks, Bob. We continue to proactively balance portfolio yield and return objectives in this challenging low interest rate environment, delivering strong investment results with a total portfolio return on a GAAP accounting basis of 2.4% for the quarter and 6.3% to the first nine months of the year. On slide 11, you can see longer term trends in the composition of our portfolio. We ended the third quarter at $93 billion in amortized cost and a fair value of $99 billion, reflecting improved valuations, which along with portfolio income and improved underwriting cash flows from our property liability business, more than offset the ongoing reduction from Allstate Financial's spread-based business. The chart on the left-hand side of the slide helps illustrate the results of our proactive steps to enhance the profile of our portfolio from a risk and return perspective.
Note that the drop in the portfolio's amortized cost resulted primarily from our planned reductions in Allstate Financial's liabilities. As we headed into the financial crisis, we proactively reduced financial sector and real estate related exposures while increasing the liquidity of the overall portfolio. Coming out of the crisis, we have favored the strong fundamentals and stability of credit, including high yield over public equities. During the most recent quarter, we opportunistically reduced risk by selling $722 million of structured securities, realizing a loss of $119 million. The securities increased in value over the course of the year, justifying the sale into a strong market. Collectively, these actions have resulted in a strong, well-positioned portfolio. We have been proactively managing interest rate risk by optimizing our fixed income portfolio's position on the yield curve, focusing on intermediate term securities.
This will reduce reinvestment risk and lessen the sensitivity of our portfolio's value to increases in interest rates. On the right-hand side of the slide, you can see the results of these actions in the scheduled maturity profiles as a shift away from the due after 10 years category. We are contemplating reducing our interest rate risk in the property liability portfolio further by selling additional long-dated securities and reinvesting shorter on the yield curve. We expect gains to be realized in the sales and the portfolio yield to decline as these sales and reinvestment are executed over the next several quarters. We turn to slide 12, highlights our portfolio income and yield trends. For the third quarter of 2012, net investment income was $940 million, and total portfolio yield was 44.3%, below both the prior quarter and third quarter of 2011.
You may recall that we prospectively changed our classification of equity method limited partnership results to net investment income from realized capital gains at the beginning of the year, which brought us in line with the reporting practices of other peers. Although investment income on limited partnerships of $22 million is below the prior year quarter, this income is $177 million higher on a year-to-date basis. The increase reflects the change in classification as well as an improvement of $50 million in limited partnership performance. Excluding limited partnership results, the portfolio yield was comparable to last quarter and the third quarter of 2011. On slide 13, you can see that we realized losses of $72 million in the third quarter of 2012 compared to a realized gain of $264 million in the third quarter of 2011.
Our portfolio management actions and other trading activities generated approximately $24 million in net trading losses, including the $119 million loss in the sale of structured securities I mentioned earlier. Impairment and intent write-downs are $46 million and continue to trend significantly lower than prior year periods. Derivative results in the current year reflect reduced usage as we are managing more of our rate risk in the cash market through portfolio positioning on the yield curve. In the third quarter of 2011, interest rate derivative valuation losses reflect a significant decrease in rates in that period. We finished the quarter in a strong capital position, as shown on slide 14. Shareholders' equity of $20.8 billion increased $2.5 billion from year-end 2011. Statutory surplus rose to $17 billion, and deployable assets at the holding company level reached $2.3 billion at the end of the third quarter.
We continue to buy back our stock, purchasing $153 million during the quarter. That leaves $166 million as of quarter end on our current $1 billion buyback authorization. Our book value per share came in at $42.64 on the strength of our operating performance, improved portfolio valuation, and active capital management. Let's go to the question and answer session.
Matt, if you could start the Q&A, please.
Thank you, sir. Ladies and gentlemen, if you'd like to ask a question at this time, please press * then 1 on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the # key. Again, to ask a question, please press * then 1. Our first question is from Josh Shanker of Sanford Bernstein. Your question, please.
Hi, good morning. Thank you for taking the time. Obviously, it's a real priority for you guys to be out in the field. We all appreciate you not pushing back earnings. The question I would ask would recognize that you can't comment on an actual estimate, of course, it'd be way too premature. You are getting reports of first notice of loss. You're out there in the field talking to customers. You have some sense of the volume of this storm. I'd love to get a sense of, from these operating metrics, where you are, say, in perspective relation to Hurricane Irene last year. Then similarly, you probably are starting to get a sense of the mix and composition of the claims that you're actually going to have to adjust. I'd love to get a sense, especially when we think about severity going forward.
Is this going to be driven by lots of large total limit losses, or are you going to see more modest, far many, but maybe more than previously, but many more smaller losses that are damaged ancillary structures and things like that?
Hey, Josh, this is Tom. You're correct in saying it's way too early. Even on loss counts, it's a little difficult because sometimes people have cell phones, they can get access to it, sometimes they don't. I can tell you we're very busy. We also do flood adjusting for the federal government. We're a Write Your Own Flood. We're one of the bigger handlers of that program as well. We take all of those claims in. Anybody calls us, a customer, we go out and see them. It's really too early to tell on either the volume, the mix, or the severity. What I can tell you is when we do our estimate, we'll try to give you as much information as we can at that point in time.
I can tell you that from a risk management standpoint, we are down in policy counts in all of the affected areas by a reasonably substantial amount. If you're interested in that, Matt can give you some more details on it. The actions we've taken over the last 5 years in places like New York, New Jersey, all up along the East Coast, have reduced the policy counts we have there in the 10%-30% range. That will obviously impact what our losses are relative to what they would have been. What you really want to know is what are they going to be? I can't give you any more clarity than that.
I certainly understand. The investors, I think, at this point are obviously dealing with modeling firm estimates. I think you guys are sophisticated users of the models, and you've got a lot of your own data and your own perspective over time. I'm wondering what sort of, to use the phrase, known unknowns, model errors, and historic biases that you think that historically perhaps we've seen that you guys might be watching for as you handicap the estimates themselves. One topic of conversation I think people are curious about is whether this has the possibility of being something like Hurricane Ike, which ended up going further inland and ended up driving surprising levels of losses with what would have been perceived to be modest wind further inland than typically models would have suggested at the time. Thanks so much.
Josh, maybe I can give you a comment on the models. Then a suggestion maybe on how I can help you sort out what you're trying to get to, which is what's the impact on it. We do obviously have our own models. We buy all the models from everybody else, and we have our own policy data actually loaded into that. We have a wide range. Matt and his team have done a number of scenarios, hey, it's a really wide range. The number could be low, could be higher. What I think you could do to give yourself some comfort as to how big it could be would be go to the website and put in gross losses into the reinsurance section. It's got the interactive model, which will tell you what the net ought to be.
You can see that at certain levels, our reinsurance programs kick in, which caps our exposure.
Okay, thanks. Good luck.
Oh, Bob tells me it's not interactive. Sorry.
Yeah.
I guess the interactive part will be you'll have to bring that. I thought we were a little more sophisticated than that, Josh, sorry. Bob can help you if you need help.
We can help, yes.
It's often interactive.
Our next question is from Ian Gutterman of Adage Capital. Your question, please.
Hi, Ian Gutterman so soon. I guess first, Tom, when I look at the auto results, obviously very good. I think you said it was a 93.7%, I think, accident year. If I add on its normal cats of a couple of points, that's high ninety-fives, which again is a solid result. I'm wondering, can that get better? Can we get that in the past, we've obviously seen low nineties, but even a 94%, 95%, is that possible given rates are starting to improve? Is 96% kind of the best you can do in the current rate environment?
First, I just wanted to give one point of clarification. The information we provide is calendar year, not accident year.
The underlying is what I mean.
I think it's the underlying is what I mean.
The underlying is that.
The underlying is ex-cat, so I took the underlying and added two points of normal cats to it.
Okay. The way we look at the auto business is it generates really good returns for us. Return on capital at that level, we've shown some slides before, depending what you want to assume in terms of capital levels, is in the 20% range, plus or minus. That's a really attractive return on capital. We'd like to grow that business at those kind of returns. I would rather see us grow it, maintain auto profitability than squeeze a few extra dollars out of margin.
Got it. That actually led into my follow-up, which is I was going to ask how is the outlook for that? I believe there was an internal memo that hit one of the newswires that suggested you're broadening your targets, and maybe the tone of that seemed to be a little bit more optimistic about growth going forward. Certainly with some of your big competitors having to chase rate to improve their profitability back to where it used to be, it would seem maybe you're in a little bit of a sweet spot here.
Let me maybe provide an overview on growth in total, and then Matt and Don can give you some more detailed perspectives on both the Allstate brand, Esurance, and Allstate Financial, because I think you have to think about it in total if you think about our strategy. Of course, our strategy focused on those four segments have competitively differentiated products in those segments targeted to those customers. The largest segment, as you point out, is the advice and brand-focused one that's served by the Allstate agencies. The overall policies in force are down there, which is largely as a result of the homeowners actions we've taken, which was intentional on our part to improve returns in that business. Along with that, standard auto is down a little bit, partly due to the homeowners, partly due to N.Y. and Florida.
Matt can talk about what his opportunities are there to grow. I think the biggest opportunity is to improve customer retention, because his new business levels are kind of running about where you would expect them to be. We have expanded the disclosure, as I mentioned earlier. You can see Good Hands Roadside, which serves that segment largely is up substantially, but we don't count it as a policy since they don't pay us until they actually use it. The advice and brand neutral segment that's served by Encompass, the independent agencies, is up slightly. We need to recapture some lost market share there. Esurance is that self-serve branded segment we're growing at a rate as fast as we're comfortable with. Then Allstate Financial is growing the life policies sold to that lower left-hand segment and our benefits business.
Matt, do you want to make some comments more specifically to standard auto? I guess you were after standard auto, so we can zoom in there if you want.
Sure. It's Matt. I'll comment a little bit first on some of the drivers. Tom mentioned our two primary drivers that have impacted growth have been our homeowners' return improvement actions, and some of the auto profitability issues in New York and Florida. I'll take it up one higher level, and I'll say that I think our fundamental approach to the marketplace is to be very proactive and very disciplined. Sometimes that creates a first-mover disadvantage on us, where we're first to take action, where we see a need to do risk mitigation. We're first to take rate where we see emerging environmental and economic trends. We're first to take proactive action that actually can sometimes impact our growth prospects.
I think you know that we have about 16 states where we're either closed for homeowners' new business or have significant new business restrictions in them. I think Sandy is a good indication of why we did that, and it will prove to have been a good move for us to reduce our exposure in some of these coastal areas. All of those actions, whether they're profitability actions in New York and Florida on auto, or these homeowner actions, have an impact on our ability to grow. As Tom said, you can't take all these profitability actions. You can't do the nonrenewals. You can't do re-inspections. You can't tighten underwriting without some impact on our retention. That is really what we see as our prime opportunity for growth at this point, because we think we were early in most of these actions, and we were proactive.
As a result, I think we're further along in that timeline, and we are at the point of stabilization, and we are at the point where we are beginning to see pockets of growth. You mentioned broadening the target. We have several growth initiatives out there, including broadening the targets and price optimization work, some additional work to analyze our ability to grow even faster in selected areas. We have those pockets of growth emerging. We have about 20 states right now that had positive year-over-year PIF growth in standard auto. Our hope is over 2013 and 2014, we will dramatically improve that number without losing any of our discipline on the profitability side. Our first-mover disadvantage, I think at some point, will work into a first-mover advantage where we will emerge out of this cycle faster than some of our peers.
We'll be able to take some of the growth opportunities that are presented to us, which I think are many at this point.
Great. Thank you. It sounds like you'd be disappointed if we don't see growth in standard auto for 2013.
I don't remember saying that exactly. You'll draw your own conclusion.
Very good. Thank you.
Hey, Ian, good morning. It's Don. Let me just give you a quick update on Esurance. As Tom said, of course, we acquired Esurance so that we could grow in that self-directed segment in a profitable way. That's been the goal is to grow market share profitably.
Since the acquisition, we've done a number of things. We've linked the brands together, so it's Esurance and Allstate company, which has played well. We've clarified their position in the market through their features and their technology. We've developed a new ad campaign. We've thrown a lot of weight behind the new ad campaign intentionally. Here's how I would characterize where we are today. I think we're very happy with the results we're seeing. The response rate with new quotes is up dramatically. The conversion rate is up, the retention rate's up. You can see it, over 22% improvement in policies since just the beginning of this year. That's a big number. What you're also seeing, though, is a high combined ratio. Part of that is intentional.
The accounting model is such that we have to expense that advertising in the quarter we take it, even though the value of the policy continues to linger on through retention. We are watching the GAAP combined ratio, but I'll be honest, we're more interested in the economic combined ratio. If we're convinced that we're writing good business that will be profitable over its life, and we are, then we're comfortable tolerating the GAAP loss ratio being over 100 for some period of time. We also have a little bit of an elevated loss ratio in the third quarter. Gary and his team are watching it closely. We're working together to make sure that we have all our resources between Allstate and Esurance on the job. I'm confident that number will get back in line.
All in all, I tell you the growth prospects for Esurance are going so far very well, and I think we're very optimistic about the future.
Great. Thanks. Very thorough comments, guys. Appreciate it.
Our next question is from Bob Glasspiegel of Langen McAlenney . Your question, please.
Good morning, everyone. I need a little bit of help on your reinsurance slideshow, given that I can't plug the stuff into a spreadsheet. You give an example of a hurricane going through New Jersey, which seems to have its own cover, and there's two different covers, which I don't quite understand how they interact. I think you talk about a $700 million type loss working its way down to $200 million net. Maybe if you could just give, if the number was $10 billion in the three states, simply what the gross and the net numbers would play out. That would be helpful.
Bob, I can give you a call back later. We can walk through the steps. The contracts in New Jersey all work together.
Okay.
I'll give you rough numbers, but it's about $150 million retention.
Yes.
It's 95% reinsured up to the top of the contract. We can walk through it.
That's New Jersey.
That's New Jersey property losses only. That does not include auto.
Right. Then, of course, as I said, auto flood is covered, and this hit 21 states. It's a big storm. We can help you sort it through.
If you had a $10 billion sort of loss in the other two states, what would the net number be?
First, I assume you're talking about $10 billion as the industry level.
Right.
Versus us. Just to get me on the right page.
Let's say you had 10%-12% of that, so $1 billion gross. What would the net be?
I think it's highly dependent on the mix of which states and what type of losses. If you want, and you come up with two or three different scenarios, Bob can show you how those would work through the reinsurance program, and you can come up with an estimate on it.
Okay. I think others might be interested in those well. On Encompass, it looks like a mini breakout from what's been a troubled line for a long time. You're growing premiums and the underlying underwriting is improving. Am I overreacting to this quarter, or do you think you got the horse running the right way around the track?
I guess I would agree. I think first, this business is a good business for us to be in serving that customer segment. Second, as you know, that business is probably down $700 million or so in premium over the last three or four years. It's got some room to come back. Some of that, of course, was intentional because we're in places we didn't want to be from a cap management standpoint, but there is room to grow that business. Three, we do have new leadership there. Don Civgin's got a new leader in place there. We like the results that he and the team are now driving. I would hope to be able to see it continue to grow. I'm not sure what breakout is. We all have different assessments of breakout.
I think if you look at what's going on in that customer segment and the companies who serve that segment largely through independent agencies, I think we're well positioned to grow, yes.
I was referring to the underlying profitability, underlying combined ratio.
Oh, the breakout in the profitability.
Right.
Sorry, I thought you meant breakout in growth. Profitability has gotten better. I like the trends. I'd like to see the combined ratio come down a little, but I'd like to see the business grow as well. I don't think we're going to. We've had that business. Shortly after we bought it, we took the combined ratio down from 117 down into the low 90s. I don't expect it to get into the low 90s.
At this point in the cycle, given where the competitors are. I think it can be better than it is today, and I think the business can grow at the same time.
Thank you.
Our next question is from Brian Meredith of UBS. Your question, please.
Yeah. Good morning, everybody. Just two quick questions here for you. The first one, looking at the slide on the underlying margin trends on the standard auto business, looking at your underlying loss trends and what's going on there. I'm just curious, maybe you can talk about kind of the difference between the paid loss trend and what you're showing here, the incurred loss trend, because the paid loss trend appears like the last couple of quarters it's been above where your average earned premium per policy has been.
Brian, it's Matt. You have all the issues that come up with paid loss trend. I guess BI paid severity is a good example of that. You look at BI paid severity, and it looks fairly dramatic, but as Bob said in his opening comments, about half of that increase can be accounted for as the change in the mix of claims settled by report year and a shift in the state mix, the other half is consistent with the medical CPI. We do have, I guess, some distortion that's always present when you look at the paid versus incurred. I think if you look, I'm assuming you're referring to the bottom chart on page seven of the presentation, the underlying margin trend.
I think if you look at that consistent pattern over the last several quarters with the nice trend line between earned premium and the losses, I think our goal is to manage that, our goal is to look at the loss trends in aggregate. I think it's somewhat dangerous to focus on the attribution analysis of each component. We have a term Tom and I throw around a lot here is false precision, we can get trapped in our own map. We look at it, we do the attribution analysis, we try to understand each of the drivers, whether they're medical inflation or whether they're report year or shift in state mix.
We look at the aggregate loss trends and the aggregate premium trends, we look at our rates that we're taking, our attempt is to manage some of those levers so that each of those on one quarter, one is going to go up, the other's going to go down. It's like pushing on a balloon. Our job is to manage the overall size of the balloon and how much air is in there and the pressure being exerted on it. I think history will show that our team is exceptionally good at managing that. They manage each of the components. They manage loss trends very carefully while maintaining a good customer experience and good customer treatment. They're very proactive in looking at emerging economic and environmental trends and taking rate where it's appropriate and warranted and mandated and justified.
I wouldn't get too caught up in the paid volatility. I'd get a little more focused on the underlying trends, that's why we tried to show them to you in the slide presentation.
Yep, very helpful. That was great.
Brian, it's Bob.
Yeah.
Just a couple of things to keep in mind. Remember, while you're looking at the paid severity trends, you also have to look at the frequency trends.
Frequencies are down, the fact that bodily injury and property damage together make up about 45% of the standard auto losses. There are other coverages that are in there, collision, comp, uninsured motorist, and everything where the trends are good as well. You're looking at two of the big covers, but there's still other pieces to that puzzle. Also the fact that I think you can tell from our reporting on reserves, our reserves are reasonable, and they're accurate.
Yeah. Absolutely. Just one quick one on the life insurance business, if possible. Your investment spreads really kind of improved this quarter. Wonder if there is anything unusual going on there.
Our investment spreads, Brian, did get a lot better. I think you see several things going on. Some of it is what you'd expect. We continue to work on crediting rates, and that's being offset somewhat by the lower yields in the portfolio and the continuing lower asset levels. The investment spread, the biggest impact is the option valuation from the Equity-indexed annuities. I think if you look at apples to apples, you're going to have to take that out. You get back to what I said, which is the crediting rates offset by yields and the asset levels.
Great. Thank you very much.
Our next question is from Michael Zaremski of Credit Suisse. Your question, please.
Hey, thanks. In regards to Hurricane Sandy, it looks like insurance regulators in at least a few impacted states are saying the storm won't technically be classified as a hurricane, therefore, hurricane deductibles won't apply. I was curious how the difference between a hurricane versus tropical storm classification impact Allstate.
First if you're interested in the science of it, a hurricane gets its energy from the water. The winter storm or northeaster gets its energy from the temperature differential in the air. That's why it's been classified that way. The tropical cyclone deductible probably will not be triggered up in the Northeast.
We're prepared for that, and that's what's fair and accurate for our customers. It may or may not. I'm not sure where we are down in the far southern states. There may be a few states where, but the damage is much less severe down there than where the hurricane turned in.
Would you say the kind of estimates that a lot of the reputable firms are putting out there take into consideration that the higher deductibles won't be triggered?
I don't know for that. I don't know, Mike. Not everybody has a tropical cyclone deductible. I don't know how good their models are on that. It's, of course, very complicated because even when you have it in the marketplace, not every policy has it on it. I would say to the extent it is not triggered, industry losses would obviously be higher than when it is triggered because that's a higher deductible than you would have on a normal all-peril policy. I don't think it would substantially alter the numbers, which are such big, wide swaths anyway now. The ranges are billions of dollars, so I don't think it would impact it much.
Okay. In regards to, Tom, the 13% ROE target on a normalized catastrophe load basis, obviously. Where will most of the increase come from now, given that you guys seem to be getting close to the goal within Homeowners, not looking to increase auto profitability. I guess I do recall at the Investor Day, you talked about unlocking capital within the life insurance segment. Maybe you can update us on that. Thank you.
Okay. First, my entire team is raising their hands saying they're going to deliver it. First, I think I would say, we're above that target for the last 12 months. I think that is reflective of where we would hope it would come from, which is maintaining auto margins, improving returns in the Homeowner business, and getting returns up in the life business. Of course, there were two things that happened this quarter, which we wouldn't expect to happen every quarter. One is low CAT, and the other is the change in the investment spread we just talked about. We still have work to do to fill up the profits ahead of that. Homeowners, we feel very good about where it's at. Matt and his team are working hard on it. We've been at this for a while, as you know.
We're definitely in a much better position. We're doing a good job on auto profitability. We do have a little bit of a headwind in the life business with low interest rates, which starts to drift over into the property casualty business. We're going to work to manage our way through that, and still achieve our goal, but there's a little bit of a headwind there. To the extent we can reduce the size of the annuity business faster, we will seek to try to do that. It was down about almost $4 billion over the last year. I think it's like $3.8 billion, but it was only down about $700 million in the last quarter. You can see that rate of decline is down a little bit. That's because low interest rates and people don't want to surrender their policies.
Don and his team are hard at work trying to figure out other ways we can reduce the size of the annuity business, not the life business. The life business is getting good returns for us, the life insurance business. To the extent we can reduce that business, that of course frees up capital and we get a higher return out of that as well. We have a little more work to do on all fronts, but we're feeling good about where we're at.
I guess this is as a final follow-up then. Within Allstate Financial, should we be looking at the statutory capital? Because that amount of capital has kind of been staying the same over the last year. The annuity portfolio's been running off, traditional life has been growing. Should that number be expected to drift downwards if the current run rates continue?
As Steve pointed out, the size of that portfolio is down about $20 billion or so in the last three or four years. As that size of that portfolio comes down, I would hope we could have dividends out of that business, which would be the statutory capital, yes.
Thank you.
Our next question is from Matthew Heimermann of JPMorgan. Your question please.
Hi, good morning, everybody. Couple of questions. One, just on Homeowners. I was just trying to get a better sense of what the underlying improvement was. On my math, kind of adjusting for the non-CAT weather that you've quantified in previous quarters. It looks like year-to-date, we've got about 470 basis points of improvement, which is a little faster than I think the run rate you all have talked about in the past. I'm just curious if you could remind us, I think the difference is there was some adverse weather in 2011. Just remind me if I'm thinking about kind of the puts and takes, right?
Matt, it's Matt. I'm trying to understand your question a little bit. Are you asking about what component is sustainable and what component is based upon the lower than normal CAT quarter?
You've quantified the lower than normal CAT. If I look just at loss ratio, I'm getting year-to-date improvement nine months over nine months of about 470 basis points. I think historically when you've talked about, that seems high to me relative to what you've talked about kind of your expectations of core margin improvement. One I guess, comment on whether or not that perception is correct about how 470 might compare to your run rate expectation. Then secondly, if it is in fact a little bit faster, is that attributable to the fact that 2011, I think in one Q in particular, had some unfavorable weather that might be making that look a little bit better? I'm just asking because I want to make sure that as I think about next year, I'm not botching anything up.
That is true. We had some unfavorable weather that exacerbates the year-over-year view. I think the other way of looking at this is that this is a fairly volatile business, and trying to do it over year-over-year while we're declining in selected areas on the coast is a little distorted because we're changing the mix of the housing, we're changing the risk profile of the homeowners business as an overall block. Trying to compare year-over-year as if it's a stagnant, steady mix is a little distorted. I think we're changing the risk profile of the business a little. House and Home, as you know, it was 12 states in the third quarter, as I think Tom mentioned, another five in October, so 17 states. That has a different risk profile, and we underwrite roofs differently.
We assess the risk differently using some tools that we're used to using on the auto business. While we are seeing normal year-over-year improvements where you could back out some of the things, we're also seeing a changing homeowners business, which I think is going to continue to improve. I would say that the quality of what is there is higher than it was even a year ago. I think a lot of what you're seeing that you can't get to mathematically is a result of that change in quality of the business.
Okay. As we play that forward into next year, is that something we should expect to continue to help a little bit on the margin as we go into next year? Now is the impact going to be less dramatic?
It'll be less dramatic. As we put in House and Home, we tried to put it in in the highest leverage areas first. We clearly wanted to maximize the early impact of the shift. A lot of our efforts on non-renewal and reduction of homeowners in the coastal areas and high-risk areas is well into the latter part of the timeline. I would not straight line it. I think you'll see a continued improvement as a result of those two efforts, but not at the same pace as we've currently experienced it.
Okay. That's helpful. Sorry that took so long for me to ask the question in a way that made sense.
No. I'm sorry I was struggling with where you were going with it. I wanted to make sure I was answering what you were truly asking.
Yeah, no, that was helpful. I guess just one on Sandy, this just goes to I'm going to bring up Katrina, not because I think that should be the baseline we think about the loss, but because there were a lot of adjusting issues, because surge is really a big potential loss driver here, whether it's insured or uninsured or government insured is a different question. Katrina, right, there was some regulatory push to cover flood losses with wind, and there was a lot of gray as to in some cases, that was because there was a lot of gray and there weren't houses left to actually adjust.
I'm curious when you think about Sandy based on, I know it's early, but how is the gray area in this loss, wind versus flood on the personal line side contrast with kind of your experience with Katrina? Is that something that gives you a lot of pause, recognizing that normally when you get big events, the ties usually go to the policyholders, but I'm just curious more whether or not there'll be as much gray.
Let me give you a quick answer because I want to make sure we get a couple other questions in here. Of course, it's too hard to tell. I haven't been on the ground out there, so it's hard for me to see. I will tell you that as it relates to Hurricane Katrina, we did very well on wind versus flood. We were proactive about our approach to that. Of course, the issue there was a house on the coast, big hurricane comes, house is gone. Was it the wave and then the wind came, or was it the wind and then the wave came? Trying to sort that out. That doesn't appear to be the situation here, but it's way too early to tell what the issues will be.
I will tell you that we have a history, though, of doing what's right for our customers and giving them what they pay for.
Right. Thanks for that. Yep. Sorry, didn't mean to cut you off if there was more.
That's all right. We'll go to the next question.
Next question from Adam Klauber of William Blair. Your question, please.
Morning, everyone. How aggressively do you plan on rolling out Drivewise next year? Is your intent to use that to augment growth, augment profitability, or both?
Well, we don't disclose which states we're going to do it in, Adam, I will tell you, we like what we see
The customer uptake is a little higher than we thought it would be initially. We think we have a slightly different offering than other people because the device stays in the car as opposed to coming out of the car, which gives us the ability to have a different customer relationship, which says that it should work on both of the elements you've talked about.
Okay. Thank you. One follow-up question. It appears that you'll make more money this year than you have in probably four or five years. How is that going to reflect when you think about the buyback for next year?
Well, obviously, I can't comment on what we'll make this year because we're still trying to sort through Sandy.
Sure.
I'd like that to be the case, obviously. Let me maybe just go up to capital. We are obviously well capitalized. Today we have plenty of capital, any which measure you want to put it at. We also generate substantial capital, and we have access to capital in the marketplace. We have three sources of funds from which we could buy back shares or use our capital to grow the business. Obviously, our preferred option is to grow the business, particularly in the auto business where we're getting very high returns. Occasionally, we make what I would call modest acquisitions, whether it be Esurance or Encompass or the benefits business we bought. We've gotten good returns on those, but those tend not to be a big portion of our utilization of capital.
Of course, as you know, about 80% of the capital we return to shareholders through dividends or share repurchases. That has been our history for a long time. When you look at dividends, we of course make the decision, the board makes the decision every quarter. Right now, when you look at our dividend rates, whether that be payout or yield, they look a little low relative to where our stock price is and earnings are. We'll consider that in the beginning of the year as to what we should do with the dividend. Then on share repurchases, we're not obviously done with the current program.
When we are, we'll look at all the sources of capital we have, either the capital on our balance sheet today, our capital generation potential, or ability to access capital, because as you know, there's some pretty attractive markets today in what are equity-like securities, to use that to restructure and lower our cost of capital. That's the way we think about it. When we get done with this one, which we're pretty close on, we'll be thinking our way through that.
Thanks a lot.
Our next question is from Michael Nannizzi of Goldman Sachs. Your question, please.
Thanks. Most of my questions have been answered. One question I just have, when you look at insured losses that will come out of Sandy, how much of that ends up getting absorbed, do you think will end up getting absorbed by the National Flood Insurance Program?
That really hard to tell, Mike. It's almost impossible to tell right now. I will tell you, if you want to go way up, the National Flood Insurance Program ends up being a net drain on the U.S. government. If it was your business, you would seek to restructure that business, charge accurate prices relative to where people's houses were. You'd try to expand the coverages so you weren't only insuring those houses that get flooded two and three times. There's, I think, and Congress has struggled with that over time. The net losses will probably end up being bigger than they would need to be if you ran it as a private business rather than as a political entity.
Got it. Great.
I can't give you any estimate for the exact number. I have no idea.
Great. Then just maybe one on Allstate Financial. It seems like, clearly moving towards a more underwritten profile as opposed to spread business. What is your kind of expectation for that business longer term? It doesn't seem like other than the life product now, doesn't seem like there's a lot of operational synergy or overlap with your kind of captive agent platform. Just trying to understand kind of where do you see that business moving as you execute your transitional strategy there?
Okay. Well, we look at it a couple of ways, Mike. First, we look at it strategically as it relates to our customers, we look at it to say, where do we get a decent return? Strategically, as it relates to those personal touch loyalists down in the lower left-hand quarter, who want advice and a relationship and want branded products, they want to buy all things, more things from one person rather than multiple people because they don't just feel like having 15 different relationships. Life insurance and retirement products obviously fit into that category. We do well there. The life sales, I think, are up down 6% or 7% this year so far. We like what we have there in terms of bundling that together. That's good for the customer. That said, that doesn't mean we need to make everything we sell.
We sold the VA business in 2006. Our fixed annuity business today, we use a lot of outsourced products. We have some proprietary products still in that channel, but we use outsourced products. On the annuity business, if we don't like the returns we're getting, I will just sell an outsourced product with someone who has a different return objective on it. On the life insurance business itself, just life insurance policies, we're getting pretty good returns on our capital, well above our cost of capital there. We've done that. We try to separate into two things. What do we need to do for our customers? What do we need to do for our shareholders? We manage our way through that.
That's why we're taking the size of that annuity business down, is we don't need to have shareholder capital employed in that to execute our strategy.
Great. Thank you very much.
Our final question today is from Randy Binner of FBR. Your question, please.
Hey, thanks for squeezing me in. This is another Allstate Financial question. I appreciate all the commentary on trying to kind of redeploy capital out of particularly the annuity business into what you perceive to be higher, kind of better risk-adjusted returns in really the other protection businesses. I guess just as I think about modeling, to the extent you're successful in kind of getting folks to give up those annuities and then you're able to free up capital from the annuity business, that takes time, and then reallocate it. I'm just trying to think if there's going to be kind of a donut hole or a lag in the earnings that you generate as you kind of transfer that capital around. I guess I'd be kind of interested in your thoughts on that approach, kind of how that affects 2013 earnings.
I'm not sure if I've heard this in the commentary, are you thinking about kind of more aggressively trying to go after annuity holders and maybe giving them lump sum payouts or other incentives to surrender?
On the last part of your question, the answer would be yes, we're actively looking at that. On the 2013 earnings capital generated from accomplishing that, I would say it's not likely to have a meaningful impact on overall earnings. If you could do the math for every $100 million of earnings, Allstate Financial, even if you redeploy it into something, some of that business we could redeploy it and get a higher return than what it's getting today, even in investing. It would not be meaningful to force.
I guess it happens gradually enough over time that there isn't a big block of capital that go. It needs to get upstream, then reallocated, and then earned against. It's more of a gradual process because I guess in our model, it seems like as you move capital out, there's a little bit of a lag, but it sounds like it's more of a gradual process from your perspective.
I would say, I'm sure there's a lag. In terms of the overall scope and projections of the company, if you were to change auto frequency by half a point, it would have a bigger impact than this would. You're right. I would just say, as it relates to Allstate Financial, we're approaching it as a do it smart, do it when you can. Don't look for sort of a simple, easy solution where you just change it all. You got to kind of do it by line. Don's got the annuity business broken into a whole bunch of different segments. Some he cares more about than others. Those that are the biggest in the hole he's working harder on than those that are earning a positive or above cost of capital return. It's highly segmented, this strategy.
All right. That's helpful. Thanks.
Let me close and just say first, thank you. We had a good quarter. We're on track for all of our four priorities. Those of you who are still in the queue, Bob is available today working all day. Feel free to reach out, or he'll reach out to you. As it relates to Sandy, we're working hard to do what our customers pay us for. We'll provide additional perspective on loss estimates when we can give you a more informed perspective. Thank you very much, 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. Good day.