Pleased to have today, Matt Winter, Allstate's President, is presenting for the company. It's your first time being here?
It is.
First time. Rookie performance. Matt joined Allstate about eight years ago to run Allstate Financial. He moved over to run the property casualty business in 2011. Of course, now he's president. He is deeply familiar with, obviously, both of Allstate's main businesses. We look forward to hearing his comments today. Matt?
Thank you. Thanks, Jay. Good morning. Thank you all for taking time to learn more about why Allstate is an attractive investment. Joining me today is Mario Rizzo, our CFO of Allstate Personal Lines, and John Griek, who leads our investor relations team. Before we begin, this is a statement that says I may be making forward-looking statements and references to non-GAAP measures this morning. You can get to the presentation, along with a great deal of other information by visiting our investor relations website at allstateinvestors.com. Allstate serves over 16 million consumer households with a wide range of businesses and product offerings, the largest of which is our Personal Lines insurance for auto and home. We support our customers across all 50 states, D.C., and Canada, with a distribution footprint of over 36,000 agencies and licensed sales professionals.
In addition to auto and homeowners insurance, we have a number of other businesses which leverage our capabilities, brands, customer relationships, and distribution. Our operating priorities for 2017, shown on the right, are used to direct our business and to be transparent with our investors. The first three priorities, that is, serve our customers, achieve target economic returns on capital, and grow the customer base, are all intertwined, and they ensure the corporation has multiple paths to profitable long-term growth. Our fourth priority centers on the proactive management of our $80 billion investment portfolio to achieve the best risk-adjusted return over time. Investment income is relatively stable, with a large fixed income portfolio, with some additional income from performance-based investments. The total return on the portfolio will be largely dependent on U.S. interest rates and economic growth. Our fifth priority continues to focus on building long-term growth platforms.
We will accomplish this in the Allstate agency channel through our trusted advisor strategy. Esurance will continue to expand, Arity will build out our telematics offering, and SquareTrade will continue to grow new retail partners. Our strategy for competing in the Personal Lines insurance market is to segment consumers based on their desire for advice and assistance, shown on the horizontal axis, and their perception of insurance, as shown on the vertical axis. We have unique value propositions for each segment to best meet the needs and preferences for each consumer group and have established strategic priorities for each segment. The focus of today's presentation, however, will be on those priorities that will further strengthen our competitive position and create value in the Allstate brand, located in the lower left quadrant.
In the Allstate Personal Lines business, we manage for both near and long-term value creation. We have multiple initiatives underway across various time horizons to achieve our strategic priorities. First, from a near-term perspective, we are focused on fixing and stabilizing our core business. We've worked extensively on improving our auto returns and have made significant progress in catching up to the spike in auto frequency seen across the industry. This enables us to take a more balanced approach prospectively in both continuing to improve margins while driving profitable growth. From a midterm perspective, our priority is to create sustainable competitive advantages that can be leveraged for ongoing value creation. Successfully achieving this priority will be dependent upon our ability to fundamentally transform our existing business model.
We will do this through an integrated strategy that transforms our distribution system from a transaction focus to one that consistently delivers on our trusted advisor promise to our customers, fully leverages data and analytics, and enhances our digital capabilities. Over the longer term, we will further leverage these strategic advantages by expanding our product portfolio to provide new and innovative product offerings to consumers, fully leveraging our connected car platform, and potentially monetizing the data assets it creates. I know this is a busy slide, but since 2015, our highest priority has been to improve auto profitability. This work is ongoing and continues to generate substantial shareholder value. Auto insurance profitability declined beginning in 2015, resulting largely from an increase in the frequency of accidents and the average cost associated with them. As a result, we implemented a broad-based four-part auto profit improvement plan.
It include raising prices, tightening underwriting standards, focusing on claim process excellence, and reducing expense spending. Approved gross auto price increases of approximately $2.5 billion across all three underwriting brands over the last two years were the highest in over a decade and drove an 11% increase in annualized average premium. We reacted quickly and broadly to the uptick in the auto combined ratio, and auto margins, shown in the top right graph, are improving. As a result, we are able to take a more balanced approach now to generating value by focusing on both profit and growth. Our ability to execute in a consistent but local way has been critical to our success. Our strong execution capabilities will serve us well in delivering on our midterm priorities, which is the area I plan to focus on in more detail today.
These are the initiatives that will transform our existing business model over a one to three-year time period, and we will look to reduce expenses to help fund the necessary investments in these areas. The first initiative I will discuss is foundational to all the others. Our trusted advisor strategy is a critical component in transforming our business model. Our approach is based on three pillars, which we call the ABCs of the trusted advisor strategy, acquiring customers, building personalized solutions, and cultivating a trust-based relationship. In 2016, our focus was on relationship initiation, which cuts across the A and the B pillars. Over the course of the year, we built a strong foundation while partnering with our agents to introduce new trusted advisor capabilities. This year, we will start introducing capabilities more broadly, giving agents more tangible tools that they can use to drive the trusted advisor transformation.
First, we are enhancing the five R sales process shown on the top left by optimizing the talk paths and using technology that will shift customer interactions from transactional to relationship-based conversations. At the point of sale, licensed sales professionals are pivoting their conversations to fully identifying assets and liabilities and are therefore uncovering unmet customer needs. Second, we are implementing a major overhaul of our sales platform. The front-end needs analysis is being integrated into a new platform designed to enable more personalized conversations that focus on the unique needs of each customer and allows agents to deliver value-added advice and solutions. This allows a shift in the conversation from one that is exclusively focused on price to one that centers on the value being offered to the customer. Third, we are making additional enhancements to the personalized insurance proposal that rolled out in late 2015.
In 2016, we issued over 2 million personalized proposals and can already see meaningful improvement in close rates as a result. The personalized insurance proposal sets the tone for the ongoing relationship that customers can expect from the Allstate agency. The proposals go well beyond the traditional quote to provide a professional and customized offering to the customer based on their individual household needs. It also introduces the agency and the agency staff to the customer while establishing the commitment that the agency has to the household. Enhancements in 2017 will include the integration of life products, offering a Spanish language option, and including brokered products into the proposals. We are also creating and delivering automated agency workflows to improve efficiency, drive greater consistency, and ultimately drive higher close rates. Finally, we are focused intensely on simplifying customer onboarding.
We introduced a whole new customer onboarding process in 2016 that we will digitize in early 2017, along with creation of automated workflows. The combination of automated tasks and reminders will improve the new customer purchase experience and improve new customer retention. Data and analytics are a core part of our new organization. We are focused on continuing to enhance and broaden our data and analytics capabilities across the organization. There are two main components to this strategy. The first includes our ongoing investment in data and analytics infrastructure and talent. The second involves fully leveraging this investment to create business value. We have embedded data and analytics talent across the entire organization to help each area achieve their business goals. Highlighted on this slide are the primary areas of focus for Allstate Personal Lines.
In distribution, we are providing agency-level diagnostic measures and creating predictive models that identify customer needs. God bless you. To help agencies live into the trusted advisor model. Additionally, we utilize analytics to strategically deploy new agents in the most economically viable locations to increase the probability of their success. In the operations area, we are focused on service consistency and quality to improve the customer experience, reduce defections, and improve efficiency. This includes using data science and behavioral insights through speech analytics and cognitive computing. We are able to analyze customer interactions, determine patterns and emerging trends, and gather other detailed information to inform and guide our investment in self-service, in training, and in staffing. In claims, new sources of data through telematics and smart devices, coupled with advanced analytics, artificial intelligence, and machine learning, provide the opportunity to completely transform the claim process.
We view this as a win-win-win opportunity where we can improve customer satisfaction by reducing cycle time and streamlining our claims process, better manage our loss costs, and improve efficiency through a less labor-intensive model. In marketing, we are focused on the segmentation of our customers to enhance our targeted marketing efforts. We are also tracking and optimizing the routing and handling of leads to improve overall performance. Product and pricing has the longest history in utilizing data and analytics in our sophisticated pricing and underwriting algorithms. However, we continue to broaden our use of these capabilities in areas such as reducing the number and cost of homeowners' inspections without a decline in overall accuracy and are beginning now the transition from using telematics for discount purposes to true usage-based insurance.
We first rolled out Drivewise, our entry into telematics, in 2012 and utilized it to provide a discount to customers who exhibited safe driving patterns. We next introduced a mobile app that continues to be used for discount purposes, but also can be used to create a more personal and interactive driving experience while offering rewards for safe driving. Milewise, currently piloting in Texas and Oregon, is the next step in our evolution to true usage-based insurance. It is a pay-as-you-go insurance product that will help to modernize the auto experience. While Drivewise helps us better understand driving behavior, Milewise will help us fundamentally change customer expectations by giving them transparency into and control of premiums based on their individual driving.
The combination of these two products and the contextual data we are able to collect through their use will ultimately provide us with the ability to provide true customer-based pricing. We are also focused on digitizing the company. Through the use of technology, data, and advanced analytics, our claims business model will be completely transformed. Today, across the industry, the claims settlement model is a linear approach where each step is dependent on the completion of the prior step. The process puts a great burden on customers in terms of reporting facts, securing estimates, and seeking repairs. Internally, the claims process is highly dependent on technical experts to execute processes that are consistent across the insurance industry. Using an auto claim as an example, I'd like to take you through the current steps.
An accident occurs, we determine if coverage applies, we move the car if it is in a tow facility, we assess liability through statements of the parties, we travel to the car or have the customer bring the car to us, a process that can take up to a week. We pay the assessed damages, most often by mailing a check, and deal with the body shop on any potential supplementary payments for missed damage. During the process, it is common to have six to 10 contacts with the customer. We will dramatically simplify and streamline the claim handling process using automated loss notification, real-time processing, predictive damage assessments, self-service capabilities, and electronic payments. Imagine the future process for the same claim to be something more like this. We receive an automated notification of a loss from the car. The customer uploads photos of damage.
A predictive system evaluates the damages and produces a value. Fraud models run behind the scenes. Electronic payment is generated instantly to the customer within seconds of uploading the photos. This may sound like science fiction, but I would suggest that our current banking system would have sounded far-fetched 10 to 15 years ago as well. We dealt with paper checks, stopped at toll booths and deposited coins, mailed bills, and paid cash for goods. Today, we are seamlessly connected through a network of digitized payments through our devices. The digitization of claims is starting already. We will actually launch our Digital Operating Center for auto claims in the next few months. These centers will handle a significant portion of our auto claims by estimation through photos. This is an interim step to eliminate the transportation of a person to the car or the car to a person.
We are now working on longer-term systems to predict the damages accurately. Moving forward, we will expand the system to homeowner claims. Late last year, we launched a new immediate claim payment method, QuickCard Pay, the fastest claim payment method in the P&C industry, with payment directly to debit cards within seconds. This spring, we will assess damage and hail events using drones. We tested this process over the past two years, and we will fully operationalize it beginning in March. These advances will drive significant benefits to our business by reducing expenses, providing greater consistency and accuracy, quicker processing of claims, more customer and agency owner control, and a much better customer claims experience. Allstate is positioned well for profitable growth and represents an attractive growth in value investment opportunity as we are proactive, disciplined, and focused on creating economic value for our shareholders.
We are leveraging our brand capabilities and market position for growth in all four of our personal insurance customer segments. We are building long-term strategic platforms across our business through our trusted advisor initiative in the Allstate brand, in the technology company, Arity, and through the digitization of Allstate Roadside. We continue to invest in Allstate Benefits and Esurance while expanding into the consumer product protection plan market through our recent acquisition of SquareTrade. We have an investment portfolio of $80 billion, which continues to generate attractive long-term returns as we increase our performance-based investments and benefit from a rising interest rate environment. If you own Allstate, there are clear paths to value creation in the short, medium, and the long term.
The management team is proactive in its approach to managing the business and has an operating system that reacts quickly to unexpected events to protect and increase shareholder value. With this context, happy to invite Jay back up, let's take some questions.
I'm going to stay up here.
Oh, okay.
What kind of questions do you guys have? Right down front.
A couple of questions. Firstly, can you just talk a little bit more about how comfortable you are that current auto pricing reflects what we're seeing on the claims side? Just a slightly more general question about inflation. What hurts non-life insurers is not inflation on its own, it's unanticipated inflation. In the different bits of your business, how far ahead do you have to make judgments on that?
Well, let me address your first question about how comfortable I am that we're in a good position. I'm comfortable that we have caught up to the spike that occurred beginning in 2015. I think that took us and the industry somewhat off guard. We had been used to, up until that point, gradual increases in frequency, and the historical patterns all showed gentle slopes in increasing frequency. What we saw at the end of 2015 was that spike. It was a step function change. We know now that it was a combination of miles driven, which was itself driven by lower unemployment rates and lower gas prices, and also increased smartphone usage.
I know there's a lot of people who've been skeptical about that because they say that cell phone use has been prevalent and pervasive over the last five to seven years, and so it's unlikely that the spike in frequency was caused by that. I would encourage you to look at statistics for smartphone usage, not just cell phone usage, because cell phone usage is deceptive. That's for people making calls, and in fact, that was not as distracting as what occurred when people brought smartphones into the car and began texting and web surfing and videoing and everything else while they were driving. We had that step function change in 2015, and it took us a while to catch up. We put in place our four-part auto profitability plan immediately That I just referred to. I think we've done the catch-up part.
At this point, I think we're in a very good position to be able to adapt to increasing trends, assuming that those increasing trends are normal and gentle, and they don't operate as a step function change again. If they do, we'll be in catch-up mode again, along with the rest of the industry. I feel very good about the work that's been done. We had to balance the impact on growth, certainly taking rate as fast as we took it has a tremendous impact, not only on the ability to acquire new business, but on retention. For a book as large as ours and as tenured as ours, Items in Force is driven about 85% by retention and only 15% by new business. The impact on retention is important to us, and it's important to us because we also don't like disrupting our customers.
We have to remain profitable, and we had to put those rates in. We made a decision to put them in quickly and methodically and do it in concert with the underwriting changes and the expense management and claims efficiency work to try to mitigate the damage. On your question about the interest rate environment- Inflation. I'm sorry? You don't have to take it. On inflation. Clearly, there's components of that. There's materials inflation, and there's medical inflation. There's medical cost inflation, which impacts BI, and that is exacerbated by spikes in attorney involvement in cases. People tend to look at just inflationary measures in isolation, when in fact, I think they're part of a broader system. It's sometimes misleading to look just at one artificial inflation number and think that's driving everything, because there's always compounding effects.
I'll go back to the compounding effect of distracted driving. If there hadn't been an increased number of drivers on the road due to the increase in miles driven, the increase in distracted driving may not have created a frequency spike. Because of that greater density of people on the road and much lower margin for error as a result of that, distracted driving had the potential that was realized to create a huge spike. Similarly, inflation coupled with things like increased attorney advertising and increased attorney representation and increased litigation environments has the potential to cause additional spikes. Do you have, Mario, anything else you want to add on that?
Yeah. The only thing I'd add is, when we think about inflation, I would think about more generically increases in loss costs, because that's what affects our business. We just went through a period, loss costs can increase because of frequency or because prices go up in terms of what it costs us to settle claims. I would point you back to what's happened over the last couple of years as an example of where we've had to respond and catch up to unanticipated inflation and loss costs. Wasn't driven by prices as much as it was driven by frequency.
To Matt's point, we feel like we're at a point where we've caught up to the ground we had to make up, and to the extent we get more normalized increases in loss costs going forward, historically, we've been able to keep up with those types of increases. We feel good about where we're positioned, and to the extent something happens that's not anticipated, I think you can look back over the last couple of years, and it's kind of a case study on how we would respond.
I want to follow up on the first part of the question, because back in 2015, when you identified higher frequency, you kind of were out there on your own. Since then, almost every other company has been dealing with it. Since you were arguably ahead of the curve, your need for price at this point may not be as great as others. The argument can be made that you'd be much more competitive over the next year or so, and your growth rate should pick up really quite a bit. Is that oversimplifying it a bit?
I kind of liked it the way you said it. It's a little oversimplification. I think it is correct that we seem to identify it and act on it earlier than many of our peers. I think that's because of the way we track and report frequency and don't do it against a target, but do it based upon actual claim count as they come in. We don't put any filter on it. We don't have to look backward. We're reporting it real time, we saw it real time. That did put us in a position. You saw we took a fairly, I think, a historical high level of rate second quarter last year. My hope is that we never have to do that much. It's disruptive. It's disruptive to the whole system.
It's disruptive to customers, it's also disruptive to the agency force, which is dealing at the time with dealing with their customers during those massive rate increases. You saw that our rate taken in the second half of 2016 was slightly lower than the rate that was taken in the first half of the year or the end of 2015. We will now take rate as needed To continue to maintain our margins, our target margins. On the last earnings call, somebody asked me whether our margins were where we wanted them to be yet. Not all the rate has burned in yet. We took rate in the latter half of last year, and not all of that has been realized yet.
We are not at the targets that we intended, but most of the more dramatic rate action, except for a few exceptions, has already been taken. Should that put us in a better position? Two ways, yes. Number one, as our competitors take rate and raise prices, and you look in price comparisons, we should be better positioned. Number two, they'll trigger shopping behavior on their customers. When they put in the kind of rate that I think they will need to, they will trigger shopping behavior, and we stand to catch some of those customers. I have to point out, Jay, as I always do, that it's not all price, it's value.
Everything I just talked about trusted advisor and data analytics and the whole customer experience, and how we're working to completely change the customer experience during the claims process, all of that is important as well. From a pure price perspective, I think we're very well-situated.
We have got time for one more question. Right here again.
There's some talk in the industry of innovative use of big data. One example of that is looking at people's social media profiles. Do you do that? If you don't, can you give us some other example of innovative ways that you can use big data to help your underwriting process?
Sure. Look, I want to start out really high. Any of the data and analytics stuff that we talk about has the potential, if taken to an extreme, to get spooky, in my opinion, and feel invasive, and feel like we are now stepping over some imaginary line in what people believe is an expectation of privacy. Now we know that with predictive analytics and big data, what we used to think as private is no longer as private. Many companies are taking advantage of that aggressively. We are not taking advantage of it as aggressively when it invades what we believe is an expectation of privacy on the part of the customer. We are using big data, though, in so many other ways that I referred to on the slide, in distribution, in pricing, in the claims.
The ability to pre-fill data, the ability to get home values and home dimensions, the ability to do algorithms and predictive analytics and next logical product based upon trends. We just started working with a behavioral science firm that is allowing us to see voice pattern recognition during calls, and the use of certain phrases to trigger certain responses on our part to better deal with that conversation on the phone. We believe big data provides not just the ability to invade people's privacy, but the ability to add value. Big data creates all these capabilities that allow us to go to our customers with information that allows us to now customize offerings to them, instead of a one-size-fits-all offering that doesn't take into consideration their unique needs, their position, their economic position, and their risk tolerance. Anything else, John or Mario?
Great. We have just run out of time. Matt, thank you. Great presentation. Some very interesting things. Look forward to seeing some of the stuff emerge in the future. Thank you.
Thank you.