All right. We're going to get started here. First off, I just want to thank you all for being here. I want to thank Tom and Steve for being here. This is, I want to say the 10th, eighth consecutive time you've appeared here at the conference. We certainly appreciate your participation. Certainly a flagship company for us here at the conference. I want to thank you for that. For those of you who don't know, Allstate is the second largest writer of personal lines in the U.S., and the largest publicly traded personal lines insurer with a market cap of about $25 billion. Tom Wilson is Allstate's Chairman and CEO. This year is Tom's 20th anniversary. I think last year we said almost 20th. This year it is the 20th anniversary.
Tom was appointed CEO in 2007, just before a very tumultuous year in 2008 for the markets overall. We've seen a lot of change in Allstate in some areas since that point. The main core tenants have remained in place. I'm sure we'll be talking about that as well as some other factors here today. Before that, I'm going to turn it over to Tom. There you go.
Thanks, Tom. Thank you, Mike. Good morning. Our goal today is to help you decide if Allstate is the right investment for you. That's what we're going to attempt to achieve. Steve Shebik, Chief Financial Officer, worked with me the entire 20 years we've been together. Pat Macellaro, our Vice President of Investor Relations, is here to help us as well. Before we begin, there's a statement that says we'll be making, I guess I need to do this. Forward-looking statements references to our non-GAAP measures. You can get the presentation slides and a great deal of other information on our website, which is allstateinvestors.com. Allstate has been and is an attractive investment opportunity.
The three-year return from owning Allstate common stock is above the S&P, reflects a competitively differentiated strategy, attractive returns from providing insurance to consumers throughout the United States and Canada, includes our large investment portfolio, profitable growth, a proactive approach to risk and return management, and strong cash returns to our shareholders. Our strategy is to segment the consumer insurance market into four distinct segments based on their desire for advice and assistance. That's shown on the horizontal axis. Their interest in differentiated products versus simply price, which is shown on the vertical axis. We have unique value propositions for each segment to best meet the needs of the preferences for each of those customer groups, we are the only company with a presence in each of those segments.
Customers in the lower left segment prefer to have one insurance relationship for all their protection needs, and therefore, they tend to bundle their purchases together. These customers are served by the Allstate brand value proposition, and that includes a wide range of proprietary products in over 35,000 actively engaged Allstate exclusive agency owners, financial specialists, and licensed sales professionals. They're in virtually every local community in the U.S. This is our largest and most profitable segment, and we predominantly compete with State Farm, Nationwide, and Farmers here. To further strengthen our competitive position in this segment, we're changing our processes, technology, products, and rewards to position the Allstate agencies as trusted advisors. In the lower right-hand segment, we've invested heavily in strengthening Esurance's brand and expanding to new states and risk classes.
As a result, have almost doubled the size of the business since we acquired it four years ago. Esurance is also now expanding its product portfolio to underwrite homeowners insurance, motorcycle insurance, and renters insurance. We compete with GEICO, Progressive, Direct, and USAA in this segment. In the upper left, Encompass provides mass affluent customers with a packaged auto and homeowners policy sold through local independent agencies. Answer Financial in the upper right is the largest online agency in the U.S. and serves customers who prefer self-service and are brand neutral. We do not take underwriting risk in this upper right. We leverage our pricing sophistication, analytics, claims, and technology capabilities across all those segments. In the Allstate brand, our operating system is comprised of 15 market operating committees who engage on a local market basis and are supported by our teams in Northbrook.
The field teams take a micro-segmented approach to profitable growth that leverages all of our centrally generated analytics and capabilities, manage the business locally. Managing the business locally means these teams are continuously analyzing the results to identify profit and growth opportunities and react to local competitive pressures. Our operating system is one of the reasons we've been able to achieve profitability in excess of industry averages. A recent increase in auto frequency has negatively impacted earnings, I want to spend some time on that today, showing how we're adapting to that change. First, as you can see from the lower right, we've consistently earned excellent returns in auto insurance for over 10 years. While current profitability is lower than we would like, returns are still above the cost of capital. The recent decline in profits is largely due to an increase in frequency in accidents.
Auto accident frequency has been steadily declining for 20 of the last 25 years, due mostly to safety improvements in cars, as you can see from the graph on the bottom left. We experienced a divergence from the very favorable auto frequency starting in the fourth quarter of 2014. That trend continued through the first 3 quarters of 2015, as you can see on that chart, it's now at the highest level since 2003. When frequency increases, suddenly we utilize our deep analytical expertise to take action to improve margins. As you can see on the map in the upper right-hand corner of this slide, auto frequency pressure exists across the country with the exception of the upper Northeast region. Given the widespread nature of these trends, our analysis to identify and isolate the potential drivers of adverse frequency was both broad and deep.
Our conclusions were that the frequency increase was largely externally driven, likely caused by increased economic activity, more miles driven by customers, and increased distracted driving. As a result, we implemented a broad-based profit improvement plan which will improve auto returns. The auto profit improvement plan is being executed in all three underwritten brands and by our local market operating committees in the Allstate brand. It includes raising prices, lowering growth through tightened underwriting standards, controlling claims costs, and reducing expenses. Each of the three underwriting brands have profit improvement plans that are unique to the customers in that segment. Auto price increases in the Allstate brand through the first nine months of the year are more than double the average of the prior two years.
The Allstate brand has increased prices by 3.4% in the first nine months of the year, of 2015, and will continue to pursue price increases going forward until returns reach historical levels. In addition to broad price increases, our market operating committees are using their local knowledge to tighten underwriting standards in each state. Our claim organization is also responding to higher severity. To further accelerate margin improvement, we decreased spending on advertising, professional services, and compensation incentives through the first three quarters of 2015. In summary, we've reacted quickly, broadly, and precisely to the uptick in the auto combined ratio. This slide shows that there's much more to Allstate than just auto insurance.
As you can see from the bottom pie chart, auto insurance underwriting income shown in blue, while a large part of last year's $2.4 billion of operating income was less than a quarter of the total. Shareholders also benefit from the profits generated from homeowners, investments, and Allstate Financial. To summarize, Allstate represents an attractive investment opportunity for a number of reasons. Our strategy is to provide unique customer value propositions to each customer segment. We consistently produce good long-term underlying returns across a broad set of businesses. Our growth is diversified across customer segments, brand, geography, and product offerings, we stay focused on our priorities, proactively address issues, and execute well by balancing risk and return across the organization. We've had a long history of providing solid cash returns, as you can see from the charts on the left.
With this context, I'd like to take some questions from Michael, then we'll answer any questions you have as well.
Thanks, Tom. All right. Just sort of picking up on those questions or some of the points you made there, in some of the disclosure you've provided recently, I think on last quarter's call, you'd said that about, you had pushed through about $600 million of rate increases so far this year, and that that would earn through the next 12 months. You just noted now that you sort of expect with the rate increases to get back to historical profitability, and if we look back, you're kind of in that 94% range. Is that something, in terms of combined ratios, is that something that you're targeting or that you're hoping to see happen? In other words, do you expect that the rate increases you've taken will, and the loss trend that you're seeing will allow you to get back to that level at some run rate?
Yeah, let me answer it. Yes. The answer is I don't know it'll be exactly 94. We're not like some companies where we have a specific target. We try to manage our returns and growth together, because new business costs you some money, you do need to spend some money to grow. That said, our combined ratio today, while it's above the cost of capital, the job we've done for our customers in the past, and the way in which we've run our business has allowed us to earn in a return much higher than that. Our combined ratio relative to the industry is usually five to six points better than the industry average. We're not there today. We should be there and can be there in the future. I'm completely confident that we know how to get our business back to historical profitability levels.
I guess, obviously, we've seen in the industry very different experience from different companies. You guys started to see the trend of higher frequency manifest late last year or early this year, late 2014, early 2015. We've seen other players start to see it more recently. I've heard some theories about the driver for that sort of disparate recognition, some being economic activity, geographic exposure, demographic in terms of younger, older, sort of midlife. Do you have some thoughts in terms of what's sort of driving the difference in experience for companies?
Pun intended there.
Yes.
First, every company starts in a different place. Everybody's got a different risk profile. Everybody's got a different pricing position. Sometimes when you're doing the math, you're looking at percentage increase over the prior year, it's not a long enough period of time. That said, what I do know is our business. First thing you do is look and say, do we have a good book of business? Do we have a properly categorized risk? Do we think we have the right price for it? Our answer to that one is yes. Do other people have good books of business? Most of them have the same kind of precision that we do in terms of underwriting the book. I don't think the industry has decided to just lose money on auto insurance. That's a good thing.
In terms of the increases over time, there are all those factors you mentioned, whether it's geography, risk class, that kind of stuff. What I do know is that it's very broad based. It's by every risk class we have by amount of tenure. Whether you're a 10 year customer with us or a one year customer with us, your frequency is up, which means it's largely driven by external factors. I think if you look at that chart we showed, which is frequency was coming down for 20 years. You had the third brake light, anti-lock braking brakes, go down the whole list of things which help make cars safer. It's been flat for the last five years. Well, those safety features were still being rolled out into the fleet over that period of time as the fleet turns over.
You would have expected frequency to keep coming down. It did not. It stayed flat. I think what's probably happened was that the increase in distracted driving probably offset the decline due to economic activity. You had distracted driving taking it up, economic activity taking down. What we saw last year, beginning in the third quarter of last year, was economic activity picked up, frequency started to head up. It's higher. I think what we had is because of the decline, which is really employment driven. As unemployment goes up, people don't drive to work. About a third of their time is spent driving to work, about a third of the time on leisure, and about a third of the time kind of doing errands.
If they're not going to work, they're probably not doing as much leisure and probably not doing as maybe they do more errands, I suppose. You have frequency coming down. That's now gone back up. The long term trend will be hard to sort out. What I do know is from our standpoint, when frequency goes up, we charge more.
All right. As we've seen this now for about a year, has anything in the data suggested that maybe what initially drove the pop in frequency late last year, the sort of flavor of what's driving frequency today is different? Do you see it as a continuation of the same attributes that drove the lift earlier?
I would say it's hard to tell, Mike.
Sure
what happened in the fourth quarter and what continued through the first three quarters of this year. I would say it was unusual for it to move that rapidly in one quarter. I don't think we've ever had it move that rapidly in one quarter, not be weather driven.
It moved, and then it stayed there.
Yeah.
I would say that from that standpoint, we were surprised. It may have just been a confluence of things like the, you got some sort of tipping point on inflation. When the economy turns up, you get more trucks on the road. At the same time, gas prices came down. There were probably a number of things which resulted in driving it up. We're not seeing it come down.
Other factors, you mentioned distracted driving. I would imagine that that's a big factor just given how much information, even in the last year, is now contained on phones. Another factor I wonder maybe having an impact are some of these shared driving services like an UberX or Lyft or Sidecar, where it may be difficult to figure out if claims are coming to you through people driving for commercial purpose. I know you guys released a product recently with Lyft. Can you talk about your controls there and whether or not you think that also might be a factor and maybe getting that, if so, getting that under control or getting your arms around that might help to mitigate loss trends at some point?
Yeah, let me answer that specific one, then I'll go up a little bit.
Sure.
If that's all right. I don't think the ride sharing services are a big driver in increased frequency for us.
We have a way of doing claims in our claim protocols. You can know when multiple people in that car. There's a way to sort that out. We do need to make sure that those people who are using their cars for commercial purposes pay as if it's used for commercial purposes because they're driving it all day long. Most of you use your car, you drive it to work and from work. We insure it while it's sitting in the parking lot. We don't charge you much for that. If you were to drive it around all day, we would obviously have to charge you more. Ride sharing drivers will have to pay more for insurance, and we've introduced some products to do it. It's not a big driver of the frequency.
One of the things that sort of underlies your question is where are we with safety features in cars? The driverless car, where are we with people doing things in the car when they're connected with the car, how does that all relate to insurance? I would say that that game is still playing itself out. First, you will see people less involved in driving. I don't think there's. Everyone talks about the driverless car. That's the end of the spectrum. People are going to be taken out of driving because they're not particularly adept at it. It's just like we've taken people out of manufacturing. You're actually taken out of dialing your phone these days. If you're like me, I don't know anybody's phone number anymore. I just punch the button.
We've taken people out of processes where they don't need to be in them. That will continue to happen in cars, which should make frequency go down in driving. That's a good thing. What is not known is all the things you're doing in the car when they think the car is safer. I saw a study yesterday where about a little more than a third of the people acknowledge that they talk on the phone in the car, which seems low to me. About almost 30% of people now admit that they surf the web when they're in a car. Talking on the phone is one thing, surfing the web is another. You do have more distracted driving, and that drives frequency up. Those two, it's hard to tell where it will sort out.
What we do know is that as the cars get more sophisticated to take people out of the driving business, they're not in driving the car anymore, the cars get more expensive. Rearview mirrors or the outside side mirrors of cars now are over $1,000 because they got sensors and all kinds of other stuff on them. They used to be $150. You got all these various factors going on in terms of the cost of the car, the amount of accidents they get in. I think on a long-term basis, we think there will be less frequency, which means less need for insurance, which is why we're working hard on getting into the connected car space.
Maybe shifting a little bit. I also noticed on your side, you had shown that you're taking slightly more rate in Esurance than you are in Allstate brand. One question I had was just whether or not your experience so far this year has caused you to maybe be less patient than you would have otherwise been with Esurance in terms of getting it to GAAP profitability. Is that right, or can you maybe talk about how you're managing Esurance at this point? It's now been part of Allstate for some time.
We don't manage Esurance for GAAP profitability. We manage it for economic profitability. After we bought it, Steve and I talked about our goals for it, and we wanted to grow as fast as it could to get to scale as long as it was earning above a cost of capital. We manage, we really look at the loss ratio, not the expense ratio, because in that business, the expense ratio is quite high because we're spending a couple hundred million dollars a year advertising to grow it. That has worked well for us.
Cost to expand the business.
When we bought it, we were in 30, 31 states. Now we're in 43. We're in Canada in one province, and we'll continue to grow into Canada. We've gone from one product, as Tom indicated, from auto into homeowners, renters. All that takes a fair amount of money. We disclose all that, but that's two and a half points of the expense ratio.
That's worked for us.
Yeah.
What we said this year was we think we're upscale at $1.5 billion, which means in the normal pace of direct means that you could spend $150 million in advertising, which is enough to be known.
Before when we bought it was $800 million or something or $700-
$850.
It was not upsized. Now it's upsized. We've doubled the number of employees, and we said, now is the time to consolidate our gains, get the operating processes working, get the claims organization focused. It really has been about now let's build a more sustainable size of business of scale. In terms of taking higher price increases, that's just because we got a little too aggressive on preferred drivers. When we first got into that business, Esurance mostly sold high-risk drivers. We shifted it to the preferred drivers, and as Mario mentioned, we're now trying to broaden the product offering to be homeowners. We're having great success in cross-selling homeowners. We got a little too aggressive on the pricing there, so we had to raise it a little bit to get there.
Got it. Okay. Once you take those price increases in Esurance, you feel that that will be at your sort of targeted level of economic profitability?
I would say it was above the cost of capital.
Yes.
We think that given Allstate's broad Allstate skills capabilities, we should be able to earn the same kind of return long-term as we do in the Allstate brand. That's in the kind of called mid-'90s on auto insurance and low '80s in homeowners insurance. We won't get there in a year, but our goal is you ought to be able to make the same amount of money in Esurance as you do in the Allstate brand.
Yeah.
It'll take us three, four years, maybe five years to get there. We want to keep growing that business because while we're of scale, we're still substantially smaller than the other two big competitors in the space who are spending three to four times what we spend in advertising. We have to keep competing. We don't feel like we're of scale, we can stop and let's grow at 3%. We just don't feel like this is the year, 2015 was the year to drive real growth in that business.
Got it. Maybe shifting to another sizable area is your other personal lines business. Can you talk a little bit about that part of the business? Profitability, I think there has been okay. I think when we were talking about it last year, I think you were taking some actions there to get that book back to where you wanted it to be on the property side. Can you talk about how you're thinking about that book, and is growth an opportunity? Is pricing still conducive? Are margins where you want them?
Yes. Particularly in that lower left-hand box, now increasingly in the lower right-hand box, we want to sell more things to people. Not just auto insurance and home insurance. It could be boat insurance. It could be motorcycle insurance. It could be personal umbrella policies. We call that affectionately other.
Other.
It's about a $1.6 billion business operates at a combined ratio of around 90%.
Units in force are growing at about 3%, which we would think is above the overall market growth. We'd like to see it grow faster, because our market share in those products is less than our market share in auto and home insurance. If they'll buy car insurance and home insurance from us, they really ought to want to buy everything else from us. We have some work to do. That as a business, we'd like to expand even more aggressively.
Yes.
Agreed then.
Yeah, absolutely. On third quarter, one thing we noticed, your expense ratio was down a decent chunk, particularly in auto and in Allstate brand auto, and it looked like advertising was a piece of that. It looked like there were some other expenses that were a part of that as well. Can you talk a little bit about what the drivers were and whether or not you expect those trends to continue?
Yeah. First, when we're raising rates, as we talked about, it doesn't make economic sense to spend a huge amount of advertising.
We pulled back a little on our advertising. That's both for the Allstate brand business. It's also for the Esurance business. You saw in their disclosures, both of them went down in their advertising expenses. In terms of being more efficient and effective in our business, we've talked for a period of time about simplification in our technology group, continuous improvement. We're slowly starting to see some benefits of that spend we've had. The bigger part of the hit for maybe the third quarter really was we pay our people when they perform, from Tom and me down to our agencies. Profitability hasn't been as much as our targets were supposed to be. We effectively reversed some of the accruals, and we have lower effectively ideas at the end of the year of where we'll pay our people incentive compensations.
You saw that some in third quarter, too.
Correct.
In terms of continuing, when we want to grow our business again, marketing will come back up. When we have the right economic value we're making, we will certainly bring marketing up. The simplification, the continuous improvement savings will hopefully continue and will grow. Obviously, as we move into another year, we look at our targets every year, and presumably next year, hopefully we'll have a really great year, and you'll see that reverse, right? Is that fair, Tom? He's smiling.
I think he's right. I don't pay him enough.
Yeah. Is PIF on the auto side, is that something that your growth there was certainly an area that you guys were focusing on for a little bit of time in terms of something that you hadn't been doing, and then we started to see. Is that something that you look at still as an area that you'd like to see continue to grow, or are you more focused on these profitability initiatives, and PIF will be what it is?
Well, we'd like to grow the business because we think we create shareholder value in doing so. If you do it by brand, if we just talk the Allstate brand, auto growth was low for a period of years. Some people interpreted that to mean that our agencies were not successful, not a viable distribution method. It just wasn't true. What was true was we shrunk our homeowners business by about 2 million homes. When you tell somebody you're not going to insure their home anymore, they don't necessarily say, "Oh, I'd love to have you keep selling me my auto insurance." As a result of fixing the homeowners business, which we needed to do because the weather got worse, we had a decline in our auto business, or it got flat, depending which year you look at.
Once we got that fixed and got back in the market, you saw us growing our auto business in the Allstate brand at about 3%, which would be, I think, higher than the number of cars increasing on the road. It means we can take share. It'll come down a little bit as we raise prices because when you raise prices, people shop. The net of all of that will depend on when other people raise their prices and our competitive position. We think we'll still grow. I think growth won't be at 3%, but we still ought to be able to grow the business. Esurance is a different business. That was growing quite rapidly for a while.
We brought its growth down this year, it's sort of flat right now, last couple of quarters, on a sequential basis because we want to get the business solidified as we were talking about before.
Got it. There's a question in the audience.
Thanks. I recognize in auto loss costs, frequency in particular are always moving targets. If the current increased level of frequency is at a new plateau, let's say, without further movement for the basis of an assumption, will the rate action or the incremental rate action that you're in the process of getting and charging, is that going to be a one renewal cycle sort of phenomena, or is the new level of frequency going to require sort of a multi-renewal process rate rise? For the customer base
It's a good question. Let me preface it with we're always changing prices. As I said, we have these [50 Market Operating Committees]. They split the world into even more sub-segments, and we split it by ZIP code, by risk class, by type of driver, by everything. We're always changing prices. That said, from a total, if you were just trying to do a forecast on total average premiums, I would expect average premiums to continue to increase next year at a higher than average level, because it's just going to take us a while to get through all of the states. We've got prices up in 42 states so far this year. That was based on sort of what happened in the fourth quarter of last year and the first quarter this year.
Yeah.
As it's continued in the second and third quarter this year, we think we need to increase prices even further. You should expect to see our average premium continue to go up kind of in the range of what it has this year.
Thanks. You made a point in the matrix, I'll call it sort of the customer preference matrix, of noting that in the Answer Financial, you don't take underwriting risk, which I understand. I just wanted to make sure I understood the relationship between Answer and let's say, Esurance. Is Esurance sort of a quoting market and a participant in Answer Financial? Or like you said, do you in fact have no sort of underwriting relationship or participation in the Answer Financial network distribution channel?
Yeah. The Answer Financial is basically in the U.K. what you would call an aggregator. You call it, and we'll sell a variety of people's products. We have many companies, I think 20 companies on that platform. None of those companies are our companies, so we don't underwrite any product there. That said, there is a relationship between Esurance and Answer Financial, which is perhaps not as well known. It enables us to monetize failed leads at Esurance so that we bring our advertising cost down. We advertise for Esurance. We spend $200 million a year. You call us. If we can't close a sale with you, we flip that to Answer Financial, and we sell somebody else's product. We make money on that, and that money helps reduce our average acquisition cost in Esurance.
We have a slightly different model than you would see from the other direct carriers in terms of being able to lower our advertising costs per policy. Now we need that because we don't have the awareness and consideration they do because we're relatively new in the market, and they've been banging away at it for 15 years.
Thanks a lot. Anybody else from the audience? Yep, Mike. Go ahead, Michael Hallatt. Yep.
I just wanted to clarify, you mentioned some of the drivers causing the increased frequency. Is it your expectation that the frequency in 2016, as we annualize some of the numbers that we've seen over the past several quarters, will stay at the same level percentage year-over-year change as we've seen in 2015 thus far?
We don't know the answer to that question.
No.
We can only tell frequency when it happens. We price for what we see and what we experience. I would tell you that in any given year, historically, frequency can move around by a good point just by weather. If you add economic activity on top of that, frequency could continue to go up next year. If it does, we'll just keep adjusting our pricing until we get the returns on capital that are commensurate with what we've done historically.
Just one follow-up. You mentioned you've raised rates in 42 states. How's the regulatory environment right now to raise rates where you need to get them to get to your mid-90s?
So far it's been okay. We haven't had a lot of pushback. I mean, regulators see the increased frequency. There are many other companies. It's not like we're the only company coming in. It is a cost plus business. Are they excited about it? No. Do sometimes they take longer than we would like? Yes. Is the structure set up so that you can raise price when costs go up? Yes.
Yeah, go ahead.
Tom, you mentioned when you build up 2 million houses, how you lost a number of the auto policies, they're in the process of doing a rate increase. Is there some model that you've built between what the, for every 1% increase in price, what it might be in terms of attrition?
We have models. Yeah, we're long models of math. They may be too long. I think I would say it'll be twofold. You will see a double-digit decline in our new business because that's because we've tightened underwriting standards. When we tighten underwriting standards, we know highly specifically how many customers will not get into the system because we can go back and look at who came through the filter before and what we did to the new filter. It's a little harder to tell on new business how many customers where we'll be in a price position because it's hard to tell where other companies are going, too. You'll see a pretty decent decline in new business. Started to see it in the third quarter. You'll see it even more in the fourth quarter. The bigger driver, though, to overall growth is retention.
that's a question because a good 80% in the auto business of what we earn next year will be customers we have this year.
Yes.
we got to keep as many of those we can. We work hard on improving customer service, making sure we're talking to customers about the price increase in the right way. That one is a little hard to predict, but a small movement in retention can make a big difference to your policies in force. We actively manage it. We think we'll still grow. The net of all of that is we think we're still going to grow next year, but it won't be at the 3% level.
All right. I think that takes us to the end of our session. Thank you so much, Tom.
Thank you.
Thank you, Steve. Thanks, everyone.