Good day, ladies and gentlemen, and welcome to The Allstate Corporation third quarter 2011 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. Robert Block, Senior Vice President, Investor Relations. Sir, you may begin.
Thanks, Matt. Good morning, everyone, and thank you for joining us today for Allstate's third quarter earnings conference call. Tom Wilson, Don Civgin, and I will make some brief remarks to provide more color on our results for the quarter. We will then hold a question and answer session, and we ask that you limit yourself to one question and one follow-up so that we can hear from as many folks as time permits. Joining us for the Q&A session are Judy Greffin, our Chief Investment Officer; Mark LaNeve, Senior Executive Vice President, Agency Operations, and Chief Marketing Officer; Sam Pilch, our Controller; and Matthew Winter, Senior Executive Vice President, Insurance Operations, and President and Chief Executive Officer of Allstate Financial. Late yesterday afternoon, we issued our press release and investor supplement, as well as filed our 10-Q for the third quarter 2011.
We also posted a slide presentation, which will be used in conjunction with the prepared remarks. All of these materials are available on our website. Our discussion today may contain forward-looking statements regarding Allstate's operations. Actual results may differ materially from those statements. Please refer to our 10-K for 2010, our 10-Q for the third quarter, and our press release for information on potential risks. The discussion may also contain some non-GAAP measures for which there are reconciliations in our press release and on our website. After our call concludes, Christine Ieuter and I will be available for any follow-up questions you may have. Let's begin with Tom Wilson. Tom?
Good morning. I'd like to begin our conversation by reviewing our strategy and operating commitments for 2011. I'll compare this to our third quarter results and discuss our 2012 priorities. Bob and Don will then go through the underlying drivers of our results. If you begin on slide two, we're in the business of selling protection products to consumers based on their preference for price, service, and delivery channel. It's a long-term strategy designed to evolve with the changing marketplace. Our board and management are fully aligned behind the strategy and goal of generating an operating return on equity of 13% by 2014. To do that, we're focused on three near-term priorities. First, we must maintain margins in the auto insurance business at industry-leading levels. Secondly, we must improve returns in homeowners and Allstate Financial. Thirdly, we must aggressively manage our capital.
On a longer-term basis, we'll reposition our products and distribution platforms to meet the changing needs of customers. Near and long term, of course, we continually manage our most powerful asset. That's the Allstate brand, and it gives us unparalleled access and opportunity within our core businesses and to each of the company's core constituencies. Let me review our progress in the third quarter on slide three. We strengthened the breadth of the Allstate brand standard auto insurance profitability by improving combined ratios in N.Y. and Florida. Both of those states continue to have loss ratios that are higher than the countrywide average, though the results have improved significantly relative to 2010, reducing the pressure on countrywide results. The rest of the country continues to have strong results.
The overall combined ratio for Allstate brand standard auto insurance was 94.2 for the quarter and 95.8 for the first nine months of the year. The Allstate brand homeowners combined ratio was 131.9 for the quarter, of which 55.8 was due to catastrophe losses. To improve returns, we continued to increase prices and downsize this business, with average premiums are up 5%, and then there's a 4% reduction in items in force versus a year ago. The underlying combined ratio was 72.3 for the nine months, which was a 0.9 improvement from the prior year. For the quarter, it was 1.7 points better than the prior year. Overall, the property liability underlying combined ratio was 88.9 for the first nine months, which is at the favorable end of our committed range of 88-91 for the year.
Allstate Financial had a solid quarter, with operating income of $134 million, a 24% increase from the third quarter of 2010. The returns from Allstate Financial were improved over the prior year as a result of higher investment income and lower crediting rates. The fixed deferred annuity business declined by $4 billion in contract or holder balances since the year-end of 2010, as surrenders continue to outpace new sales. Proactive management of the investment portfolio gave us three great results. We maintained yields, we realized substantial capital gains, and we increased the absolute level of unrealized gains in the portfolio from the end of last year. Our capital management program includes an active outsourcing program for products such as homeowners and annuities. In the homeowners business, we've reduced our items in force by 1.2 million or 15% over the last four years, in part by offering coverage from other carriers.
Today, we broker homeowner premiums in many markets, the vast majority of which is Florida and other hurricane-exposed areas. As you know, of course, we are a substantial user of reinsurance, which enables us to shift risk to third parties and recover most of the cost through higher prices from customers. Allstate Financial uses similar strategies. Of course, we sold the variable annuity business in 2006, the Allstate agency distribution channel sold $736 million of non-proprietary variable annuities in the first nine months of the year. Earlier this year, we instituted a similar strategy for fixed annuities, fixed annuity deposits declined to $439 million so far this year. The Allstate agency distribution channel expenses were reduced by increased fees from these arrangements.
This capital management strategy, what it does is it enables us to meet our shareholders' objectives of getting a 13% operating return on equity without sacrificing customer relationships. We'll continue to aggressively use those tools as ways to improve shareholder value. We also completed our most recent billion-dollar share repurchase program at the end of the quarter, which was about five months ahead of schedule. As you know, we usually determine our capital plans in February after the conclusion of catastrophe season, and when we have a good read on year-end capital ratios. We're accelerating that review into the fourth quarter of this year. Let me finish current results by commenting on some important organizational changes. As you know, to drive higher performance and increase urgency, we've been changing our performance management practices and rebuilding Allstate's top management team, which includes replacing some people who retired.
60% of our senior leadership team joined the company within the last four years, which when combined with the breadth and depth of Allstate experience from the remaining 40%, gives us a really good blend of external and internal perspectives. As a group, this team is dedicated to urgency, has a great sense of urgency, is completely aligned, and is deeply committed to the strategy to deliver the value that we know you all expect. Given the strength of our senior leadership team and the similarities of our businesses, we decided to move to a flatter, more streamlined operating model that separates responsibilities for Allstate Protection along functional lines. In addition to his role at Allstate Financial, Matt will oversee Allstate Protection claims, product operations, risk management, and program management.
Mark LaNeve's responsibilities have been expanded to include Allstate Protection's field and agency operations, in addition to his role, which was to lead marketing and sales and service programs. This move will shorten the lines of communication and improve our response as an organization to an ever-changing marketplace. As we look forward to 2012, our priorities are very similar to 2011. We must maintain profitability of the auto insurance line. Improving returns in homeowners and annuities will continue to be an urgent priority for us. Aggressive capital management will continue to be a tool for us to improve operating return on equity to 13% by 2014. In addition, we need to adapt the strategic positions of our businesses to reflect a changing consumer marketplace.
The ability to ensure Allstate customers receive the highest level of service from our agency force is as critical as ever to the success of those Allstate agency businesses. That's why we're building stronger local agencies. This is a program that has been implemented in phases over the last four years, most recently including a prospective change to agency compensation in 2013. Our goals are to build up the average size of agencies so they have the capabilities and financial wherewithal to meet customers' needs at an affordable price. We support the mergers of agencies by loaning a portion of the purchase price to high-performing agencies. This program has loaned about $250 million at this point with minimal losses, and we expect it to continue to increase over the next three years.
Since 2009, the average size of our U.S. agencies has increased by 10%, and the overall number of agencies is down by 14%. The recently announced compensation change will have the same overall cost to the company, but compensation will be shifted to those agencies that are performing at higher levels. All of those changes are supporting increased performance on behalf of customers who prefer the personal touch of a local agency. For those customers who want a personal touch, but are less concerned about the brand and choose to buy through an independent agency, we have new leadership for Encompass and believe our skills and capabilities will enable us to earn solid profitability in that channel. We also closed on our purchase of Esurance and Allstate Answer Financial in early October and are implementing strategies to improve the value of that franchise.
Esurance will be able to leverage our preferred risk pricing expertise, and very importantly, our claim protocols and systems, both of which enable them to improve their competitive position. In addition, they're already leveraging the Allstate brand by changing the tagline to From Allstate, and they also hired a new advertising agency to position the Esurance brand to compete more effectively with those self-directed or self-serve customers. We now have all the business platforms we need to be successful in protecting U.S. customers while generating a 13% operating return on equity by 2014. One final update as we look forward to 2012. Based on the results of last May's shareholder vote, I embarked on a corporate governance listening tour. I met with shareholders that own about 30% of Allstate's outstanding shares and the major governance advisory firms. Those were productive and helpful meetings.
As a result, the board is actively working on governance and compensation plan changes to be responsive to their feedback. Bob and Don will cover more of the detail on this year's third quarter results.
Thanks, Tom. On a consolidated basis, total revenues of $8.2 billion increased 4.2% from the third quarter of 2010 on the strength of $264 million of realized capital gains versus $144 million of realized capital losses in the third quarter of 2010. Consolidated net income of $165 million declined by $202 million from last year's third quarter. Increased levels of catastrophe losses, which negatively impacted net income by $449 million after tax, were partially offset by the favorable effects of higher after-tax realized capital gains of $170 million. Looking at property liability on slide four, net premium written of $6.7 billion declined slightly quarter-over-quarter, a result similar to the first two quarters of the year. Allstate brand standard auto net premium written at $4 billion was down 0.8% compared to the third quarter 2010, as lower unit volume more than offset a small increase in average premium.
New business volume was comparable to the second quarter. Off by 13.2% from the third quarter of 2010. Retention improved by 4/10 of percentage points relative to last year's third quarter and remained consistent with the first two quarters of this year. Profitability actions taken in N.Y. and Florida have negatively impacted unit growth as expected. Excluding those two states, our policies in force growth was slightly positive for the quarter. Allstate brand homeowners net written premium of $1.6 billion increased 1.5% from the third quarter 2010, as we continue to seek and receive approval for rate increases. In the third quarter, we received approval for rate increases in 15 states, average 13.9%. Canada and emerging businesses both contributed positive net written premium and unit growth in the quarter. The property & liability combined ratio for the third quarter was 104.8 and included 16.7 points of catastrophe losses.
This compares to the combined ratio for the third quarter 2010 of 95.9, which contained 5.9 points of catastrophe losses. The underlying combined ratio was 89.2 for the quarter and 88.9 year-to-date, well within the range we established at the beginning of the year. During the third quarter, we conducted our annual detailed assessment of our discontinued lines and coverages reserve levels. We made some minor adjustments to the reserve similar to last year, which resulted in an immaterial increase to the overall combined ratio for the quarter. On slide five, we provide the loss cost trends for Allstate brand standard auto. Bodily injury frequency improved by 3.3% relative to the third quarter of 2010, while property damage frequency declined by 2.6%. Paid severity results for both coverages increased slightly, with increases of 0.2% and 1% for bodily injury and property damage, respectively.
Auto loss cost trends remain well within the range of expectations contemplated in our pricing. The combined ratio for standard auto was 94.2 for the quarter, an increase of one point from the third quarter of 2010. Homeowner loss cost trends are displayed on the next slide. Excluding catastrophe losses, frequency increased 6% from the third quarter 2010, reflecting heavier non-cat weather losses in the quarter. The frequency pattern was consistent with the last several years. Paid severity increased 3.3%, a level of increase similar to the first two quarters of the year. The combined ratio for homeowners was 131.9, with catastrophe losses accounting for 55.8 points. The underlying combined ratio improved relative to the third quarter of 2010, coming in at 73.3, 1.7 points better than last year's result. Rate actions to improve the profitability of this line continue to be reflected in these results.
Allstate Financial results are shown on slide seven. They had a solid quarter. Net income of $183 million increased $98 million from the third quarter 2010 on the strength of improving operating income and realized capital gains. Increases in investment spread and lower expenses were only partially offset by a decline in the benefit spread. Premium and contract charges were essentially flat in the quarter. Increases from underwritten products were offset by declines in annuity sales as expected. We continue to successfully execute on our strategy of reducing the concentration in investment spread products while improving the profitability of those products, focusing on the sales of underwritten products through the Allstate agencies and growing Allstate Benefits. Now I'll turn it over to Don.
Thanks, Bob. As we've done consistently in the past, we've had clear objectives, and we've been proactive in the way we managed our investment portfolio. Again, this quarter, our approach has paid off in the form of investment income, realized gains, and an attractive risk return position. Looking at page eight of the presentation, the overall portfolio finished the quarter at $97.5 billion, a small decline from the second quarter of 2011. As the Allstate Financial portfolio continued to decline as planned, consistent with Matt's strategy to downsize the annuity business. During the quarter, we took advantage of market opportunities to realize gains from sales of primarily government and corporate securities and reinvested those funds into intermediate term investment grade corporates. This resulted in a reduction in the allocation to governments and an increase in the allocation to corporates.
You can also see on the right side of this page that we're maintaining the shift in the distribution of fixed income securities by scheduled maturity date towards the 3 to 10-year category. This is again consistent with what we discussed last quarter. Net investment income and yield trends are displayed on the next slide. Even in this difficult environment, overall portfolio yields improved compared to prior year as a result of our first quarter interest rate curve and derivative positioning, additional high yield allocation, and limited partnership distributions. The sequential decline in the property & liability portfolio yield was driven by a seasonal drop in foreign dividend income in the third quarter relative to the second quarter. Overall net investment income at $994 million fell by 1% compared to Q3 2010.
Increased net investment income for property & liability was more than offset by the decline in Allstate Financial due to expected declines in the size of their portfolio. In both portfolios, enhanced yields produced favorable variances in income, while declines in the average assets countered the favorable trends. We generated $264 million of realized capital gains in the quarter as shown on the next slide. That compared to $144 million of realized capital losses in the third quarter of last year. As I mentioned previously, we took advantage of market opportunities in our fixed income portfolio to realize $692 million on sales of foreign governments, treasuries, and other fixed income securities, with the proceeds being reinvested primarily in intermediate term investment grade corporates. These gains were partially offset by $203 million of impairments and $234 million of derivative losses.
The impairments arose primarily in our residential and commercial real estate and equity asset classes, and in the derivative category, the majority of the losses were interest rate related. The unrealized net capital gain position at the end of the quarter was $2.36 billion, down slightly from the second quarter. Unrealized capital gains on our fixed income portfolio increased to $2.46 billion from $1.91 billion at the end of Q2. While the equity portfolio's unrealized position went from a $625 million gain to a $95 million loss, reflective of the equity market's experience in the third quarter of this year. Moving to our capital position on slide 11, shareholders' equity was $18.1 billion at the end of the third quarter, a decline of $664 million from the second quarter of 2011. We completed our share repurchase authorization, buying $308 million in the quarter.
Book value per share of $35.56 was essentially flat from prior year and down about $0.40 from Q2 2011. The statutory capital levels of our insurance companies remain strong, with an estimated $14.4 billion at the Allstate Insurance Company and an estimated $3.7 billion at Allstate Life Insurance Company. We paid a $200 million dividend from AIC to the holding company during the quarter, bringing invested assets at the holding company to $3.4 billion. As we've discussed previously, we've been hard at work to dissolve the Allstate Bank, and during the third quarter, we received regulatory approval to voluntarily dissolve Allstate Bank. We expect to return all funds to customers, cease bank operations, cancel the charter of the bank, and deregister The Allstate Corporation as a savings and loan holding company by the first half of 2012.
Following the close of the quarter, we completed the acquisition of Esurance and Answer Financial for approximately $1 billion, and we will begin to reflect their results with our fourth quarter report. Now let's open it up to your questions.
Thank you. 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 to remove yourself. Again, to ask a question, please press star then one. Our first question is from Bob Glasspiegel from Langen Maclany. Your question please.
Good morning, everyone. I was wondering if we could dig into Esurance and your strategy, and specifically how you're going to integrate Answer Financial into your agency distribution plan. For example, when they aren't able to close an account, or will you offer that as a vehicle to potentially save customer relationships?
Morning, Bob. This is Tom. I'll make a couple comments, and maybe Don or somebody will want to jump in as well. First, the way we look at the marketplace, we have four segments of customers. Those who want a personal touch with a local agency and want a branded product buy through the Allstate agencies. Esurance is really targeted towards those who are self-directed or prefer to sort of self-serve, and want a branded experience. What we intend to do with that business is position it squarely towards them. Before we acquired them, they had a value proposition which applied more across that board. It was people when you want a technology, when you don't. That sort of applies to the whole segment. We'll get it a little more focused on the self-directed customers with the new branding program they're working on.
At the same time, we're much better in preferred risk pricing, and we have great claims capabilities. We believe we can reduce the variability of their claims costs, use our resources, our systems, and our relationships to lower the cost, which will make them more competitive, which should help us compete more aggressively in that marketplace. It'll operate as a separate business, leveraging the skills and capabilities that reside inside Allstate, including things like the brand, as I mentioned earlier. Answer Financial, as you know, really serves those self-directed customers who have less preference for a brand. What Esurance does is when you call Esurance, if they can't close you, they then route you to Answer Financial. Answer Financial gets business from other places as well.
What that does is enable Esurance to lower its advertising cost versus other people because it's monetizing those people who call who they don't close. That program works quite well for Esurance and Answer Financial, as you point out. That segment of the market seems to be growing. Answer Financial then does is place that business with a whole variety of carriers, which we continue to do, and it continues to grow. We haven't decided yet to do with those quotes that come from the people who want personal touch loyalists in the Allstate agencies, whether we will route those to Answer Financial or not. We're going to test that in the next six months or so and get a feel for it. Of course, you know we get millions of quotes that come into the Allstate agencies.
Some of those quotes we don't close right at that particular time because either the person's not ready, they really want that local agency. Some of those people just called because they saw our ad, they'd be perfectly happy to buy it on their own or buy it from somebody else. We have to sort through really that flow, we are working as to how to optimize the overall system. Does that answer your question?
Yes, very well.
Okay.
One other follow-up. The comp change from 2012 to 2013, if so, what was behind the sort of delay?
It was initially discussed as middle of 2012. When we did this comp change, we don't just sort of sit in a room and make it up. We had over 300 agency owners working with us through various groups to help us figure out how to design it. When we looked at the timing of it, what it took for them to change their business model, how we could get accuracy around the numbers so that it really drove behavior, quite honestly, to give people a little runway to adapt to the thing, we moved it back to the beginning of 2013. We did give some people who were excited about the change, believe it will work, it's in support to business model, the opportunity to opt in in July of 2012 if they want.
It becomes effective for everybody, Bob, in beginning of 2013, we're letting some people choose to get in the program, which we see as a good opportunity to help people see how you can win with the new program. Does that make sense, Mark?
Yep. Thank you.
Our next question is from Jay Gelb of Barclays Capital. Your question please.
Thank you. In terms of being able to achieve the 13% return on equity by 2014, it seems that the biggest lever for that is improvement in the homeowners business. Given the recent track record on catastrophe losses, I'm just trying to get a better handle on what type of catastrophe load you're including on that to be able to achieve those results, or what other steps you're taking to improve the all-in homeowners results.
Well, Jay, your math is right. About 70% of the improvement is due to the homeowners business, from where we've been historically to where we are sort of recently to where we need to go. As it relates to the catastrophe load, it's sort of the average of what we would have experienced over the last 10 years as opposed to what we've experienced this year. This year, the last two quarters, we've had higher catastrophe losses than if you look back at the prior 20 years, higher in just this six months than 18 of the last 20 years. This last couple of months has been particularly bad as you all know and you can see in our results.
As it relates to how do we reduce our catastrophe exposure, that is part of what I talked about in terms of some of that we just do through normal insurance underwriting, insuring the right houses, getting deductibles up, making sure we have the right kind of standards as to what we charge for different kinds of roofs and things like that, so getting the pricing right. We also, of course, aggressively use reinsurance and brokering. I think this is an area where I haven't communicated enough to you how much brokering we actually do. We broker a huge number of policies where we can maintain the customer relationship. While we want to serve those personal touch loyalists with everything that they need, we don't have to make it all.
We've done that successfully in homeowners, we've done it in variable annuities, we're now doing it in fixed annuities. To the extent we need to do more of it in homeowners to get to our return, we'll do as much as we need to do. Kurt just pointed out to me that the opt-in on the agency stuff, Bob, was eliminated as part of some additional changes we made. People apparently didn't feel it was a big need to opt in, we took that out.
My second question is on the change in DAC accounting for 2012. It has $4.4 billion of deferred acquisition costs, even though you said in the 10-Q you're still trying to determine what the impact is, do you have an early sense of what the potential for write down may be, and whether or not that will impact 2012 earnings?
Jay, at this point, I have no estimates of the impact either on the balance sheet or the income statement. We will adopt it as we're required to at the beginning of next year. When we have an estimate, we'll share that with you.
Thank you.
Our next question is from Keith Walsh from Citi. Your question, please.
Hey, good morning, everybody. First question for Tom on standard auto, just looking at new applications down 13% and down 7% ex Florida and New York. Just trying to understand why that is if the ad spend continues to be robust, if you can give us some color around that. Thanks.
Sure, Keith. First, let me point out, the results on new business in a quarter are never due exactly to what you did in that quarter. I would say that the results in this quarter were due to things that we had done much earlier in the year, whether that's advertising, pricing, where we are with agency capacity. There's a lag impact as to what you do in a quarter. With that said, it's hard to do a variance analysis, of course, but I would say it's a combination of really three things. One, maybe four, I guess. Rate increases, lower share of ad spend in the third quarter, fewer producers, and higher homeowner rates. It's kind of hard to split that up.
When you look at the rate increases we've had, it's a little masked by the shift in reducing volumes in Florida and New York, which are high average premium states. We have had increases in other states. Not huge, but at the margin, they make a little bit of a difference. We have lowered our ad spend in the third quarter. Now we're up this quarter because the competition continues to stay strong. Sometimes we back off a little bit to see what other people will do. As ad spend stayed up, State Farm started spending more money. You'll see our ad spend be up again this quarter. Fewer producers. We're really working on now expanding the number of licensed sales professionals inside our agencies. While our number of agencies are down, we can increase capacity by increasing the number of licensed salespeople who work in those agencies.
Higher homeowner rates obviously takes a toll because homeowner rates are a place where you can start to lead the business. Once you get the homeowners, it's easier to get the auto insurance.
Okay, great. Just a follow-up for Matt on the life side. Just thinking about the new business returns there on the life side, are they in line with the 13% ROE objective or with interest rates at current levels? Is the mix of business now more dependent on mortality, morbidity margins than interest income? Thanks.
Those are great questions, Keith. Just for clarity, I think at our investor day, we talked about the Allstate Financial returns, getting them up to the 9%-10% range. The 13% you're referencing was for the overall enterprise. Within Allstate Financial, obviously, we had an overweighting in the investment products, the spread-based products that in today's interest rate environment, create a lot of pressure on returns. We've done, I think, a pretty good job with getting increasingly sophisticated in our ALM in order to maximize investment returns. We managed to do that again this quarter. Despite the decline in the size of the portfolio and the interest rate environment, we managed to actually grow our return. I think as time goes on, we'll be under additional pressure.
Certainly, if this interest rate environment persists for an extended period of time, it will probably accelerate our desire to shift the mix of business towards more of a morbidity, mortality component and a fee component and away from the spread component. We had already begun that at the end of 2008. We accelerated it in 2010. We're getting the results that we wanted, Keith. It's a fine line. You want that portfolio to roll off, but do so in an orderly and methodical manner so that you don't have pressure to sell assets at the wrong time. We've had the right runoff in the business. It's done what we'd hoped it would do, and at the same time, we've grown the mortality and morbidity-based business. We're comfortable there.
As you know, the returns on the underwritten business are significantly higher than the spread-based businesses and are in the low teens. We believe that on some of those products, especially the accident and health products, we can go in the high teens on a consistent basis. As a result, the more we shift away from the spread-based business towards the underwritten business, whatever interest rate environment we're in for the next three to four years, it'll be to our advantage as long as we do so fairly methodically. Did that answer your question?
Absolutely. Thank you.
The next question is from Alison Jacobovitz of Bank of America, Merrill Lynch. Your question please.
Hi, thanks. I was wondering if there's any chance you could give some more color on the extent that New York and Florida are holding back your margins or maybe how that might progress going forward, or some details on the progression already, but quantified.
Alison, it's Tom. Both of those businesses are now operating profitably. Of course, you get all kinds of measures of profit, whether that's run rate, includes reserve releases, doesn't include reserve releases, but we feel good about where those businesses are. As I mentioned, they are operating at a combined ratio that's higher than the overall level, but I feel very good about the trends. We made additional progress in the third quarter on a variety of fronts, including rates, including the way in which we handle our personal injury protection claims. We've made good progress in keep getting those costs down. As well, we've also gone in to do a bunch of correct classwork in New York in the third quarter as well. I feel very good about the underlying strength of what we're doing.
It'll bounce around from quarter to quarter. From my perspective, it certainly made the auto profitability much more robust when you look at it across all countries.
Thanks.
Our next question is from Michael Nannizzi from Goldman Sachs. Your question please.
Thanks. On your ROE goal, you mentioned homeowners. I guess I'm trying to understand, if that's a competitive market, how much can you raise pricing there without eventually hurting auto retention as a result of the bundlers and then just generally overall profitability? Then just have one follow-up. Thanks.
Mike, this is Tom. We're not having a lot of problems raising prices right now, either with regulators or competitors, of course, there's no surprise since we're all losing money. You can see the increases we've continued to get average premium is up 5%. That includes some fall through, because when you take rates up higher than that, some people raise deductibles and do other things. Which, of course, works too, even though you're not getting it in rate, you're getting it in margin because you don't have the loss cost associated with that. We don't see competitive pressure there. You do have some customers who obviously don't like big price increases, and one of the things we've been doing is put increased spread into our rates.
If we say rates are up 9% in the state, some customers might be up 30%, other customers might be down 5%, which is about getting more accurate in our pricing, particularly as it relates to roofs, and wind and hail damage. That does have a negative impact on the auto business. We don't accept it as a good excuse not to grow the auto business. We recognize that, in fact, it does have a negative impact, so you can't be down 1.2 million policies in homeowners and not have lost some auto policies as a result of it. That said, our goal, first and foremost, is we got to get our returns up. Our returns, we want to get to 13% operating return on equity. We're going to do everything we need to do that.
You can see we've done that in homeowners really over the last, since, I don't know, since 2004, 2005, we've been banging away at this thing. We're going to keep banging away as aggressively as we need to get returns up.
Okay, thanks. Then just on the other lever of being capital deployment, do you plan on buying back more in stock than you generate in cash?
Do I plan on buying back-
In other words, do you plan to deploy more than you make?
Well, if you look at our history, we've not used leverage in a massive way to buy back stock. Right?
We do occasionally restructure our capital structure. I think, I don't know, was it four or five years ago, or maybe it was six years ago, we did a hybrid, and we bought some stock back. In general, the way we look at stock repurchases is, if we have extra capital, we return that to shareholders, either through dividends or share repurchases. We always look to just optimize the capital structure. We'll do that in the fourth quarter. Normally, we would do that in February when we got through cat season, and we knew exactly where we were coming out on capital ratios for the year, and it sort of gives you a greater base from which to look forward. We're going to accelerate that into the fourth quarter of the year.
We didn't do it already, quite simply because the hurricane season is just ending, as evidenced by some activity down in Mexico last week.
Right.
We just didn't feel necessary to have it completely linked up. That said, we thought the stock price was attractive, we went and got it and decided we were going to finish the program early.
Great. I guess my question, if cash flow from the P&C companies year to date, I think it was $500 million. Last year, full year was a $1.4 billion. Before that, just over $2 billion. The cash dividend's about $400 million. I'm just trying to figure out how you're thinking about deployment versus how much you make, and how much you're deploying already through the dividend. Thank you.
Well, let me see if I can be helpful. We of course, look at how much capital we have at a given point in time. We think we're adequately capitalized today. We haven't made as much money as we would like this year because catastrophes are $3.7 billion, versus all year last year, they were at $2.2 billion. We had expected, of course, to make more money because we didn't think catastrophes would be at such a high level. We do believe we still have enough capital, which is why we went out and bought the stock back early. What we do is we look at how much capital we have at a particular point in time, and then we also look at what we think we're going to make going forward in the future. We tend to have a little bit of a lag on that.
I like to be a little long in capital rather than cut it right to the margin. As you look at where we are today versus where we thought we would be, we have less deployable capital today than we thought we would have because of higher catastrophes, which, that said, I feel good about the underlying profitability of the business. I don't feel good about catastrophes, but that's always a little speculative as to what it's going to be next year. I feel good about the underlying performance of the business. Of course, from a capital standpoint, we're incredibly solid. We have a lot of capital, and we're very strong in terms of our ratings. I'm not concerned about that part. I think we have flexibility to make choices.
I don't know what those choices will be yet because I want to see sort of where we're going to come out in our overall analysis in the fourth quarter.
Okay, thanks.
Our next question is from Michael Zaremski of Credit Suisse. Your question, please.
Hi, good morning. A follow-up to the earlier question regarding the interest rate environment. If the current environment did persist, I know you've talked in the past about a target of $1 billion of excess capital being generated in Allstate Financial. Would that be impacted? Also, if you could talk about the overall net interest income outlook for the company. I know you guys' yields have held up well. Are you guys going to continue to shift towards corporates? Thanks.
Let me see if I can break that into pieces. Matt, feel free to jump in. The returning $1 billion of capital from Allstate Financial continues to be our goal. Interest rates obviously will affect how much money we earn, remember, part of the capital coming out of Allstate Financial will be as he downsizes that fixed annuity business. It's down $4 billion in the last year. Matt's working hard to continue to downsize that business because we don't like the returns in it. We want our money back, and that's what he's going to go do. Matt, anything you want to add?
No. We feel confident that through some fairly sophisticated work on the asset liability management side and some additional work on liability governance on the enforce, that we're going to be able to maximize our potential for hitting that $1 billion figure in the required timeframe. We're also going to use our capital smartly and not do stupid things just to hit an artificial target. If the interest rate environment applies pressure on us in a way that seems no longer the prudent thing to do, we'll rethink that. Right now, we believe that's still a realistic target, and we still think we'll be able to achieve that. As far as the long-term impact of the interest rate environment, as I think we've said previously, most of our products are at minimums at this point.
Very few do we have additional room to lower crediting rates on. We are now spending a lot of our time on the ALM side and bundling our liabilities based upon both duration and liquidity needs. Therefore, working with the investment organization and Judy to get the proper investment mix and asset mix for each of those groups of liabilities. As a result, we feel pretty confident that we can do a pretty good job in the foreseeable future in this interest rate environment. It's undoubtedly true that if this interest rate environment persists for an extended period of time, it will put pressure on us.
Hey, Mike, let me maybe give you an overview of what Judy's doing in the investment world, and maybe she'll want to make some specific comments on it. The position we've taken in investments is sort of a two to three-year time horizon. We're not trying to make trades for tomorrow, but we're looking forward two or three years. Judy and her team, we want them to be proactive, to take action, to move ahead. It's really around risk and return. What's the right trade-off? Obviously, we took some gains this quarter because we thought that was the right thing to do over the medium term. It actually, I think, worked out quite well. Obviously, taking gains and then reinvesting, if you were to reinvest in a like security, would mean your overall investment income would go down.
That's not the approach we take, as Matt was pointing out. It's very much asset liability management. Maybe Judy wants to talk a little bit about the shift out of governments into corporates and what you've been doing to maintain yields.
Okay. As Tom mentioned, this year we have done quite a bit of shifting out of govies into corporates. For the most part, we feel good about that trade. I think that probably the more important shift that we've made this year is the curve repositioning. If you think about earlier this year, we moved the portfolio and moved some of our near-term maturities to the intermediate part of the curve. We moved some of our longer-term maturities to the intermediate part of the curve. Because of that move, we don't have that much in Allstate Protection that is maturing over the next 12 to 24 months. We've already done some of that reinvest in what was a higher interest rate environment.
If you look at what's coming off the Allstate Protection portfolio over the next three years, it's about $3 billion in three years, and it's about one and a half billion in prepays, all very manageable. In 2012, it's even more manageable in that we're looking at significantly less, like $500 million in maturities and $600 million in prepays. Those, again, at fairly decent yields in terms of being able to reinvest and not give up that much income.
That is very helpful.
Our next question is from Matthew Heimermann from J.P. Morgan. Your question, please.
Hi, good morning, everybody. First question, just on auto. Given that you're reporting some year-over-year gains in Florida and New York, I guess a little surprised that year-on-year, both in the quarter and nine months, that underlying combined ratios there look like they're sliding a little bit. Some color there. If you could just clarify your comment on New York and Florida being profitable. Was that kind of run rate 3Q or just some color on that would be great.
Matt, I don't know that I got the first part about the combined ratio sliding in other places. Were you talking about that the results were worse in other parts of the country?
In aggregate, you're reporting higher underlying combined ratios this year than last year, both for Q3 and for nine months. If New York and Florida have made progress, I guess that implies other places have gone backwards. Just some color on what's going on there.
I would start at the most macro level, Matt, and say that the returns we're getting on capital in our auto business, at the levels in all those states, even where the combined ratio has gone up a little bit, are great. We're getting really strong returns in those places, and we try to manage both overall return in an individual state, growth, and being competitive in the marketplace. There's nothing in the auto business that concerns me that combined ratio is ready to head to the sky. In fact, I feel better about it because specifically New York and Florida are in much better position. The story is different for each state as to why do I feel better about it.
One is certainly the run rate, the other is the current rate, where I see us preserving when I'm looking at the paid trends. On some measure, both states are profitable. When I look forward, the trends I see indicate that it will continue to stay strong and in fact, get better. We're still going to be stuck with a little bit of the overhang on growth in those states, because if you look at our decline in the items in force, 97% of it's due to those two states. We're trying to manage growth in the other states. Early last year, we took some changes in combined rates. It lowered rates to some place to get more competitive.
I guess-
The other part, I guess, would be, when you look at the quarter, I'm not sure how much. I'd look at maybe taking cash out of that number, too.
Well, I'm looking at underlying, so it already adjusted out. I guess I'm just trying to put that in context, given that one of the strategic and financial goals has been relative stability in those margins.
I see it, Matt. I do.
I get your ROIC comment. I'm just trying to put it in context with that.
Matt, we're not going to let the combined ratio in auto get out of control. We're on top of it. We watch it every state, every rating plan. We're all over that. It's a core goal of ours. I wouldn't read into what I would say are normal variations in the combined ratio. Frequency, you can't really predict frequency on a quarter-by-quarter or even the nine-month basis with that much accuracy. It bounces around. It can bounce around by one point easily. That's when we give our 88 to 91. It's with that in place, I feel very good that we'll continue to finish out the year strong. I feel good about where we're headed next year as well.
Okay. The second question I had was just on the corporate, the compensation and governance changes that you alluded to. I guess, based on how you historically have paid people in the proxy, it's been pretty specific metrics, corporate as well as SBU. I'm just curious, when you refine compensation, how we might think about that. Just general governance, I guess, where are the improvements that you're talking about there?
Well, there's a whole host of things we're doing. The biggest change that we're contemplating, and I say contemplating because this is a decision that the board has to make, and I have to work my way through with our management team. Is using performance stock units instead of restricted stock units as part of the compensation plan. There are some governance people do not consider options to be performance based, and they'd like a larger component of compensation to be performance based. We're likely to use performance stock units, instead of restricted stock units for the most senior members. There'll be lots of other people inside our company where restricted stock is absolutely the right way to compensate them. We do have very specific measures, as you point out, much more so than other companies. That, though, over the last four years, we've changed.
That is what funds the pool. It used to be what funded individual pay. We've now shifted to that still funds the pool. We have very specific measures that fund the pool, which protects shareholders. We allocate that amongst people based on their individual performance. That's where when I started, I said one of the things we're trying to do is drive increased performance, greater sense of urgency, more accountability in driving results in the company. We do that with pay and have been for the last three years. That's a change which we've implemented. As it relates to other governance things, there's a whole host of items that we're considering. The largest of which is probably a right of shareholders to act by written consent.
As you may or may not know, that has been proposed as a proxy item for us in each of the last two years. It got, I think 52% and 55% vote of the shares that voted support for it. We're likely to put that forward to shareholders as something they can vote on. There's a host of other things, Matt, that we've gone and looked at. What we did is we went out and listened to everybody, heard what they had to say, and we'll adopt those things that we think meet their needs, and drive what shareholders want in terms of governance, transparency, and compensation.
All right. Thanks for the call.
Our next question is from Ian Gutterman of Allegiance Capital. Your question, please.
Hi. Tom, I was hoping you could just talk a bit more about the agency consolidation, and I guess in regards to maybe two things. Just one, the effect on morale, especially as the compensation changes are coming soon, and I think that's created some anxiety as well. How are you managing morale with both of those changes? Then two, I guess I've just been a little bit confused. It seems every month or so I see a press release about Allstate adding 25 agencies in this state, 50 agencies in that state. Why are we adding new agencies, which I'm guessing would be small, at the same time we're trying to consolidate agencies on the top side?
Well, let me deal with the morale piece first as it relates to agencies. Obviously, when you change compensation programs, it creates concern amongst people who are subject to them. That would be true for our employees, it's true for our agency owners, it'd be true for each of us individually. Because any time there's a change, your sort of first perception is people don't want to pay you more money. They're probably trying to figure out how to get a better deal for themselves. That's not true in this case. In this case, what we've said is we're going to pay out the same amount of money. In fact, to the extent performance is better, we'd like to pay out more money. We do want to shift it, though, towards those people who are doing the best job for our customers.
That's kind of how we've designed the program. The program historically has paid out about 10.7% of premiums, of which 10% was stated and 0.7 was bonus and incentives, which we put in place, I think four or five years ago, something called the RFG bonus, which is about $200 million-$250 million a year in terms of compensation. We put that incentive-based plan in place four or five years ago. We like what we see in that in terms of its driving behavior, so we're working on a new compensation plan, which is still 10.7%, but has 8% locked in and then 2.7%, which is based on performance. Some of that is very easy to do. You have to be open. You have to have a certain number of licensed sales professionals per customer. You have to do protection reviews. You have to have good signage.
It's not like you have to jump over the Great Wall of China to get the money. That said, some people will end up with less in this new program unless they change their behavior and their practices, which is really driven by what the customers want. There are a couple options for them. One is we're trying to support them to help them get better with all kinds of programs and efforts. Secondly, if they don't want to do that, then it would be in their interest to sell to other agencies who do want to do it, who are close to them. So we then, as I mentioned, will loan agencies money to help them buy other agencies, and we do that out of Mass Portfolio, and that's worked quite well for us.
Despite that, in any change, you would expect to have some people be unhappy, and there are some people who are unhappy. It's our goal to try to make as many of them that want to be successful, so we can do a great job for our agencies. As it relates to adding new agencies, we're always looking for fresh blood and talent. Just because we want the average size to go up doesn't mean that we're not interested in having somebody come in who's entrepreneurial, who wants to build up an agency or somebody who wants to come in and buy an agency, one of the existing agencies. They don't all have to be consolidated amongst themselves. We're perfectly happy to have new buyers come in, buy an agency, and take it to a new level of performance because they see it.
We're always looking for talent and capabilities, and that's why I do it. Of course, there's obviously just the geographic footprint as people move around and stuff, and you have holes in your footprint. We're not as strong in the upper Midwest as we are in the urban areas along the coast because of our history. We obviously would like to have more agencies in those upper Midwest places where we're underrepresented relative to our brand. Does that make sense to you, Mark? Is there anything you want to add?
Yeah. I'll just add that we do continue to need to add what we call scratch agencies, as Tom said, in certain geographic locations. Texas right now is an expanding market, would be a good example. We continue to need to bring fresh talent in that's buying existing agencies as they exit out of the business or retire. We're doing that with a much stronger selection process and capital requirement than I think we had 7, 8 years ago. As a result, we're getting much higher success rates, much higher productivity levels. That's part of the overall plan. In addition to programs such as the loan program to have agents acquire other agents, either operate them in separate locations or merge them together when it makes sense to increase scale so they can serve our customers better. It kind of works in concert with each other.
I'd like to make a point that the agency's success is completely tied to and important to our success. Sometimes I think people hear some of the noise and people who are unhappy with what we're doing and think we're at odds. Those agencies are worth billions of dollars. We want them to be worth even more than they're worth today, because if they're worth more, that means they're bigger, they're growing, they have stronger customer relationships, which is good for us. We're in this together. We're already in for a quarter of a billion dollars supporting them, and we'll go in for more. This is about all of us being successful. We're not headed into this with a fight in mind or that thinking that it's a zero-sum game and we have to take money away from those agencies.
This is about meeting our customer needs. Doing the kind of change we need to do, which is never easy, but in competing in what's a pretty competitive marketplace.
No, that's all very fair. I agree with most of what you're trying to do, Tom. I guess I was trying to figure out is, just to some extent, if there are some morale challenges, is that part of what's behind the new apps declining some? Is it maybe a little bit too much, too fast, and it's going to hurt production for a while until things settle down? Am I reading too much into it?
No. I would say that the reduction in new apps as a company is on the company's performance, not on the agencies. The agencies, it has nothing to do with them. They're working hard every day. They're out talking to their customers. We have to get a broader pricing target in auto insurance than we have today. We need to be competitive from a technology standpoint and make sure our systems are working quickly and effectively. We have to do good work on customer service. I would not put that on the agencies. It's not like they've gone on strike or anything like that. They're busy doing other things. We need to help them. It's the company's job to start to drive that growth. I wouldn't put that on the agencies.
Very good. Thank you. Appreciate it.
Our next question is from Vinay Misra of Evercore Partners. Your question please.
Hi, good morning. I first wanted to follow up on the margins in the auto insurance. The loss ratio ex cat sort of went up about 100 basis points this quarter. Was there some non-cat weather in that number?
Vinay, hard to tell. We do cat code. When it goes to a particular state, and there's a catastrophe in that state, it obviously gets carved out. Sometimes people don't report it right away. Sometimes it's a neighboring state or a neighboring area. I would say that frequency bounces around a little bit. We're feeling okay about frequency this year. Importantly, our paid loss trends look good as well. We're feeling good about those. We were up a little bit in collision this quarter. We changed reserves a little bit on collision. We're feeling good about the rest of PD coverages. MBI as well.
Okay. On the auto insurance business, what's your targeted combined ratio for that business?
We don't have an established countrywide target the way some of our competitors do. We obviously think that if you're at 96%, you're still earning a good return. It's not our objective to take our combined ratio on standard auto up to 96%, however. What we want to do is maintain our margins overall and begin to grow the business, which we think we're now in a better position to do given the progress we've made in New York and Florida. It's not going to turn next quarter, so I don't think you should expect to see us suddenly be growing at incredibly high rates next quarter because we've got those fixed. Because as you know, the strength of this business is 80%-plus of what we will earn over the next year, we've already written.
The downside to that is it's harder to turn the overall growth side because you got to get past those renewals.
Okay, that's great. On the homeowner side, what are the loss cost trends? Are they up in the 5%-6% range? If you're getting rates up, say maybe about 8%, do you think you can get to your targets of low 60s or loss ratio by the end of 2030?
We're committed to getting a 13% return on equity using operating income by that period of time. We're going to do what we need to do in homeowners to get there.
Okay, thank you.
Maybe we do one last question.
Our final question today is from Brian Meredith from UBS. Your question, please.
Thank you. Just got in. Two questions here for you. First one, just looking at capital position and knowing that you had to fund the Esurance acquisition, I guess, in the fourth quarter, would it be a stretch to think that you could buy stock back in the fourth quarter? Or at least renew it and buy some back?
Brian, I think the question you're really asking is the one Tom already addressed, which is we're going to reexamine where we are on share repurchases in the fourth quarter. When we have something to announce, we'll tell you then.
Okay. The Esurance acquisition, I assume you funded that with cash.
Yes.
Okay. Terrific. The other one, I was just going to wonder, Tom, could you talk about the competitive environment out there, given we've gone through record catastrophe losses this year. Has it caused any, I know in the homeowners line, obviously companies are raising rates, but on the auto insurance side, have you seen it cause anybody to kind of step off the accelerator at all?
No. The three large competitors in auto insurance that we all spend a lot of time talking about, called State Farm, Progressive, and Geico, are all continuing to be very aggressive in the auto business. As you can see, just watch some football game or baseball game, and you can't kind of get away from us. That continues to be highly competitive. You're starting to see some other companies like USAA, Farmers, Nationwide step up a little bit. Whether they can stay in the game as advertising spend gets higher, I'm not sure. You're also starting to see the competition shift to new products. We didn't talk much about it here, but whether that's the telematics approaches or the products we've been launching. You're continuing to see pretty aggressive competition amongst those big carriers. Brian, I can't really speak to the smaller carriers.
Yeah
In total, as you know, they have about half the market. It doesn't look like they're all of a sudden taking price increases way up. They're having an increasingly difficult time to compete on advertising and new products, which probably means they'll keep their prices, sort of try to be as competitive they can on prices. I'm expecting that market to stay as competitive next year as it is this year. It's a market we think we can win in. We didn't have a great third quarter new business for some things that happened earlier in the year, but we feel good about what we've got going in the fourth quarter and as we head into next year.
Terrific. Thank you.
Okay. Thank you all for participating this quarter. We'll talk in three months.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day.