If I can ask everybody to find their seats. We're just going to let them get settled, and we will. Great. Next up is Allstate, I think another perennial speaker. I think you guys have been here almost as long as we have also. We have Tom Wilson, Allstate's CEO, presenting. He personally has an extensive history with the company, has seen it through many evolutionary changes. Now I'm very happy to turn the podium over to him so we can get a glimpse into where they see the company going over the next several years.
Thank you, Allison. I've always been impressed by the depth of your knowledge of us. I didn't realize you had the history of us as well. Good afternoon. I'm joined by Bob Block, who's on my far left, who's our Senior Vice President of Investor Relations, and Steven Shebik, our Chief Financial Officer, who's to my immediate left. Our goal is to help you understand Allstate's strategy and the proactive approach we take to creating shareholder value. First, let me give you a message from our lawyers. It says that I'll be making some forward-looking statements, there's all kinds of information in our SEC filings and our website to help you look at the potential risks of investing in Allstate. Let's move on to Allstate specifically. Please. Now what? Okay, I need the message from the lawyers, I suppose. Get that thing down.
There we go. Okay. Now it clicked. Now our impatience is just like pushing the button on that computer when you hit return a bunch of times. There we go. Okay. Okay, read that fast? Okay. Allstate represents a unique investment opportunity. Last year, our shareholders had a total return of 50%, and we still trade at a book value multiple that's substantially below the long-term average. We have a strategy that will enable us to fully leverage our insurance expertise, our brands, and the proactive approach we have to investing in dealing with the world as it comes our way. Our consumer-focused strategy is depicted visually at the top of this slide. What it does is it breaks down the consumer insurance market based on preferences for the type of interaction, and then their beliefs about insurance companies. Let me just walk you through that.
On the left-hand side are consumers that prefer to get local advice and assistance as it relates to their insurance needs. On the right-hand side are those customers who feel comfortable dealing with insurance on their own. On the bottom half are people who value insurance and see a difference between the various brands in the marketplace. On the top half are consumers that see little difference between insurance offerings other than price, they're really brand neutral. The Allstate brand is delivered by our local Allstate agencies, serves customers in the lower left-hand quadrant, which by our estimates makes up about half of the total consumer market. This is a place of historical strength for Allstate, and it's a significant portion of our overall franchise, and we compete primarily with State Farm, Nationwide, Farmers, and the regional companies in that sector.
We acquired Esurance in the fourth quarter of 2011. They have a unique customer value proposition that for those customers who prefer self-service but still want the value of a branded experience. While our market position is lower in this segment, we're growing rapidly. Units were up 31% in our first full year of ownership last year, in premiums of now over $1 billion. The largest companies in this segment, of course, are GEICO and Progressive Direct. In the upper left are customers that want local advice but do not see a significant difference between insurance companies. They're served by independent agencies, of course, who offer products from a whole range of companies, including our Encompass offering. We have plenty of room to grow market share in this segment as well, and our major competitors up there are Liberty, Progressive, Travelers, and Hartford.
With Answer Financial completing the picture in the upper right, we're the only insurance company that has unique offerings and business models for each segment of the market. To help shareholders assess our progress in implementing this strategy, we established four priorities in 2012, which are shown on the bottom half of the slide. Maintain auto profitability, raise returns in the homeowners' annuity businesses, grow insurance premiums, and proactively manage our investments in capital. We achieved all of those objectives in 2012. The underlying combined ratio in the Allstate brand standard auto insurance, which excludes catastrophe losses and prior year reserve re-estimates, improved to 94 as we successfully implemented profit improvement programs in New York and Florida, and we had the benefit of a decline in frequency in auto accidents.
The Allstate brand homeowners business had an underlying combined ratio that improved to just over 65, which is really as a result of five years of hard work. It started to pay off for us, and we also enjoyed the benefits of some good weather outside of catastrophe losses. In total, on a recorded business basis, this business went from an underwriting loss of $1.3 billion in 2011 to a profit of $718 million in 2012. That's a $2 billion swing. Returns also improved in the fixed annuity as a result of good limited partnership returns, although that business is still going to continue to underperform given record low interest rates.
We also grew insurance premiums in total, reflecting the acquisition of Esurance, unit growth in Esurance, Encompass, and emerging businesses, along with higher average auto and home premiums in the Allstate brand were the major drivers of premium growth in 2012. The net return from the investment portfolio was 7.3% due to a number of proactive investment decisions as well as, of course, the decline in interest rates helped that fixed income portfolio. We provided substantial cash returns to our shareholders through both dividends and share repurchases. These results are the outcome from strategically responding to a dramatic external change over the last decade. When you choose to invest in Allstate, you get a team that uses facts to face reality. We proactively make decisions to adapt, and then we execute to generate good returns for shareholders.
There have been three significant external events driving change at Allstate outside of that segmentation that I just talked about in the consumer market. In 2004, there were four hurricanes in Florida. In 2005, we had hurricanes Katrina, Rita, and Wilma that hit the Gulf Coast, sort of ushering in a new era of severe hurricanes. In 2008, that increased severe weather started to extend into tornadoes, hailstorms, straight-line winds, and wildfires, other smaller catastrophes. At the same time, we entered the global financial crisis, of course, which is still with us today. In response, we took on five initiatives to help us execute our strategy focused on the customer, which are shown on the bottom of this slide. I'm going to walk through each one of those. If we start with delivering industry-leading auto margins.
Given that tumultuous external environment, we stayed focused on maintaining industry-leading auto margins, which are shown over the last 11 years on the bottom of this slide. Allstate's performance is shown in blue, and lower is better. As you can see, we've been substantially below the industry average. We compare well with GEICO and Progressive, and we far exceed State Farm. We're among the best in the industry at matching price with risk and then managing our loss cost. On the right-hand side, our returns on capital of our auto business have been in the high teens or low twenties, depending on the assumption of capital required to support the business. In terms of the homeowners business, given the increase in hurricanes and the severe weather, we took action to lower our risk levels and raise returns in that line.
Our exposure to hurricanes and earthquakes has declined by about 50% since 2005, as you can see by the red line on that left-hand side. We've achieved the goal we set up to reduce our exposure to that area. The yellow bars on the graph show catastrophe loss impact on a combined ratio. As you can see by the large increase in actual losses, you can see why we took the action we did. In addition, we set about raising prices, tightening underwriting standards, changing coverages, and introducing new products. The outcome of these actions are shown on the right-hand graph with total premiums growing, but the number of risks declining significantly. Total homeowner policies have declined by 1.6 million since 2005.
The average gross premium, on the other hand, went from just under $800 in 2005 to just over $1,100 in 2012. The benefits of these action are shown by the combined ratio results in 2012, where you can see the profit excluding catastrophes increased enough to offset another year of high catastrophe losses. For the Allstate brand homeowners, we recorded a combined ratio of 88 for the year, as you can see back on that left-hand chart. Maintaining auto profitability, improving returns in homeowners protected shareholder value from those external changes. It did have a negative impact on policy growth, and despite a substantial increase in the brokering of homeowner policies for other companies. Let's go to the annuity business.
The global financial crisis and subsequent record low interest rates brought on by central banks has led us to a whole bunch of different strategies in Allstate Financial and the investment portfolio. Allstate Financial shifted its focus to underwritten products and shifted away from spread-based products such as annuities. In 2006, we sold our variable annuity business because we didn't like the competitive nature of that business. We thought people were giving product away. Then we started to downsize our fixed annuity business. You can see we've continued to downsize that business. You can see in the left, it's in the yellow on that chart. The underwritten products generate operating returns in excess of our cost of capital, and largely either support the Allstate agency customer value proposition, that lower left-hand quadrant, or there are people who buy them through the worksite.
We have a very successful worksite business. In addition to reducing the size of that annuity business, though, we're also investing differently. Many of these liabilities have very long maturities, so we're shifting a portion of our investments into higher return, less liquid assets. Proactively managing the investment portfolio has also enabled us to generate good shareholder returns. On the left bar, you can see that the real estate assets declined from $24 billion in 2008 to about $11 billion at the end of last year. Similarly, we didn't really like their risk and return portfolio on municipal debt, so we reduced our holdings from $24 billion to $12 billion. The risk and return characteristics of corporate credit, though, were attractive, so we shifted and increased our holdings from $37 billion to $51 billion, even as the assets declined due to our actions in the fixed annuities.
As a result of lower interest rates and tighter corporate spreads, this portfolio has generated very attractive risk-adjusted returns. Looking forward, we're taking action to reduce the impact that higher interest rates will have on the value of this portfolio. About two-thirds of the portfolio backs Allstate Financial, and those liabilities are sort of matched economically with the investments. They both change with interest rates. The property liability portfolio, however, is about $38 billion, and the economic value of its liabilities really don't change much with interest rates. We've been selling our long bonds in that portfolio, expect to continue to do that this year, as you can see on the right-hand chart. This essentially pulls income forward as capital gains and takes it at the cost of lower investment income, which goes through operating earnings in the future.
The success we've had in these four initiatives now gives us the ability to aggressively develop competitively differentiated value propositions. The Allstate agency business volumes declined last year as we continued to reduce the size of that homeowners business and took aggressive action in New York and Florida to improve auto profitability. We're focused on reducing the negative impact of those actions by raising customer loyalty, strengthening our agencies, expanding the auto risk targets, and creating new and differentiated products, like our telematics offering, Drivewise. We have a Claim Satisfaction Guarantee or our new House & Home product. Esurance will grow by expanding its preferred auto business and broadening its product line beyond auto insurance. The marketing expertise, claims capabilities, and buying power of our company are also supporting that growth. As I mentioned earlier, unit growth in that business was 31% last year.
Encompass grew units by 5.6% last year by deepening relationships with independent agencies and focusing on its packaged auto and home policy. We'll maintain that strategy to capture additional market share in that segment. Our capital management is also a strength of Allstate, the results of which are shown on this slide. Since 2000, we've returned over $19 billion to shareholders through either dividends or share repurchases. Last week, we increased the quarterly dividend by 13.6% and added another $1 billion to our share repurchase authorization, bringing the total authorization to $2 billion. We're also focused on further raising operating return on equity to our long-term goal of 13%. We established this goal a couple of years ago looking at the 10-year average, which you can see at the top of the graph. We made four assumptions. First, that we would maintain auto margins, which we have.
Secondly, that we can improve returns in the homeowners business, which we've also made substantial progress on. While I don't think we're yet to our long-term goals on that line, the actions we've taken are working, and we're confident in our ability to keep moving forward there. We also said we would raise returns on Allstate Financial and maintain investment income. Low interest rates and our decision to reduce interest rate risk both have a negative impact on operating income. While that makes achieving our goal harder, they are smart economic choices, and those are the choices we make for our shareholders. To achieve the target, we have a variety of other things we're working on, including reducing our cost structure, which you can see in our 2013 priorities.
Expense management has always been part of our culture, but given the difficult economic climate, we're focusing on what customers really want to pay for, which can be different by segment. In summary, when you invest in Allstate, you own a fabulous personal lines franchise with a competitively differentiated business strategy to meet the needs of each different customer segment. We're focused on meeting those customers' needs, and we are proactively executing on our 2013 priorities, which will drive value for our customers and shareholders. As we achieve those goals, we'll generate significant capital, which will enable to leverage our profitable market share growth, continue to return capital to shareholders, and drive additional shareholder value. We're excited about the future for our customers, our agency owners, our employees, and our shareholders. I now will take any questions you have. All right, Bruce?
Yeah.
Tom, my question is on top-line growth in the Allstate brand. We're hearing from other auto insurance companies, they're complaining about their margins, haven't been able to deal with the higher severity seemingly as well as you guys have been able to. It feels as if your competitive position should be improving in auto insurance. It also seems as if you've been dealing with Florida and New York for quite a while now. You should be close to being profitable there. It feels as if you're on the cusp of better growth within Allstate brand auto. Is that fair?
I think that's fair. I would say, though, the challenge is how do you bend the line, right? In our business, because we've sold it a year in advance, it takes a while before you can turn the line. It's not like you put out a new iPhone, and all of a sudden everybody comes and buys it. It takes you a while to get through retention rates. You should start to see the decline get smaller, and then we should start growing again, both in auto and homeowner. It'll take longer in homeowners than it will auto.
I was thinking more auto, though.
Yeah.
While we're on the subject of growth, Encompass did see growth last year. Any reason that shouldn't continue?
No. As I tell them, they still owe me about $500 million because that business, instead of being $1.1 billion, used to be $1.9 billion. Some of it we had to get rid of because we didn't want to be in the homeowners business a bunch of places, and we're exiting the Florida market from both the auto and home standpoint in Encompass. We've pretty much got most of that done, the business should grow. We should be able to pick up share. There's no reason why our skills, capabilities, insurance expertise shouldn't enable us to grow in that business. We got a new management team about a year plus ago, and it's made a huge difference.
Hi. Given some of the developments have happened in the annuity market, do you guys any consideration to maybe selling the life business at any point? How do you think about how that fits into your sort of product offering, especially as you look to grow some of the self-serve distribution channels?
Okay. Appreciate it. When you look at Allstate Financial, one thing you have to do is break it into four segments. There's the life insurance business, which is largely sold through Allstate agencies. There's the worksite business, which serves a couple million customers sold through the worksite, sort of biweekly, disability and some modest health programs. You have the annuity business, which you referred to, the fixed annuity business, deferred fixed annuities. You have the payout annuity business, which is long-dated structured settlements. Those first two businesses have good returns in them and fit with our strategy. The returns in the Allstate life business are pretty good. When you go down to that left quadrant, customers in that lower left quadrant like to buy all their stuff from as few people as possible. It kind of makes sense.
If you're going to have a relationship and want some help, you don't want to have five insurance people you talk to. You want a few. That business has been way up in the last couple of years in terms of selling more of that product through our Allstate agencies as we seek to kind of change those agencies. That's working pretty well. The worksite business has got great returns. We sell both through our agents, through independent agents, who we sell direct. We got some very large companies we serve. That's a really high return business. The two bad businesses are the two annuity businesses. The one you're talking about, some of the deals being made today are in the fixed annuity space. You maybe got a seven or eight year duration on those assets and liabilities. We've looked at deals, we've looked at reinsurance.
We'll continue to look at it as a way to try to improve our results and get money back out of that business. If we can find something that we think makes sense, we'll do it. We don't have to do it, though. We can carry it that way. The payout annuity business is the lowest returning business. Those liabilities can go out to 20 to 40 years. We'd rather not sell that business right now at the lowest point in interest rates. As interest rates move, that business turns better quickly, particularly from this low level. We're looking at anything we can on the fixed annuity piece and the payout annuities. If somebody was to decide they would price in higher interest rates, maybe we'd make a transaction, but nobody wants to.
I was wondering if you could give an update on your own, I know I surprised you right there, didn't I? Your own agency channel, how the sentiment is regarding the comp. Maybe we've talked in the past about consolidation among your own agents, just how that's going or how the sentiment is there.
Okay. I can put up longitudinal perspective. Today we have slightly over 9,000 agency owners and about 30,000 people who work in those local agencies who are licensed to sell product for us. I look at both of those numbers, how many people we got who can actually pick up the phone and sell something and service customers, how many locations are therein. The first number, the number of what I would call agency owners, some people call them agents, is down some in the last three or four years, that was intentional on our part. The second number is not down as much, which is where you focus on delivering your value for your customers.
The reason it's down is about four years ago, we said, if we're going to be more consumer-focused, we're going to have to help our agencies do a better job for their customers. We're going to have to strengthen them both individually and collectively. Individually means giving them the skills, capabilities, technology, resources, not to be a human modem. By a human modem, I mean somebody calls you punch in the information, you spit back a price. There's no future in being a human modem. There is a future, though, in giving people advice, understanding their family, understanding all their insurance needs. We've been working to try to do that individually. At the same time, collectively, there were some people who weren't going to get there individually. They just weren't going to be able to make the transition.
We provided them a way to exit the company, we've lent the people who are staying over $300 million to buy those other agencies out, consolidating them in, bring better skills and capabilities to those people. Working hard at doing that. We chose to do that at the time when we knew we weren't going to be growing really fast. When you go out to change your sales force, you don't want to do it when you got the hottest product and everybody's trying to get it. We said, look, we know we're going to have to fight through homeowners. We know we're going to have to maintain profit in auto, which is going to put some pressure on the top line there. Let's change while we got some calm in the volume and not have to give up future growth.
We're pretty much through that now. I think we got the right team in place. We did put a new, Allison, as you mentioned, new compensation program into place last year. People are used to it now. You see them acting according to it. That was not a cost reduction effort. I think it got mis-spun by some people who are not our fans that it was a cost reduction effort. Actually, it's about getting paid for value. Done right, our agencies ought to be able to make more money. If they make more money, we'll be growing faster, and we'll have happier customers. That's what it's all about.
I was wondering if you could just elaborate a little more on what kind of things you can do on the expense part of the strategic goals and how meaningful you think that might be to the expense ratio over time.
Well, first, we look at the expense ratio in every channel separately. The Allstate agency, we look at its competitors. We look at the Esurance one separately. Then Encompass separately. I'll talk about them each separately. So, I guess I would say in all three of them, there is a way we can simplify and take work out of the system, and that does everything from technology to processing steps. We have not put a number out that we're prepared to have ourselves measured against yet, because we're still working through it. We think we can cut costs in all three channels that way. We believe in the Esurance channel that extra expenses will go up. That's because, as you know, in that business, it's a direct channel. You spend a bunch of money in advertising.
Last year, I think we spent $190 million in advertising, $140 million, $150 million. We'll keep ramping that up as long as we have economic growth. You look at that business, you look at the loss ratio on what you get, you look at the retention on it, and as long as the present value of that stream is better than your acquisition cost, you keep funding your business. That expense ratio will probably stay high for a while. As that business grows, it'll take up more of the overall expense ratio when you look at it on a blended basis, so it'll be important for you to look at the two of them separately. In the Encompass side, I believe the biggest way we can reduce expenses there is to grow. We got a bunch of infrastructure sized for more policies than we have.
As we put on new policies, we don't add a lot more fixed expense. Did I miss that?
No, I think that's right. The Affordable Care Act fully takes effect next year. Do you see that having any effect on your auto liability business, positive or negative? That's number one. Number two, you said you were reducing the duration of your bond portfolio. Is that in anticipation of a higher rate of inflation or just relatively narrow spreads?
Both good questions, Mike. On the auto liability question, I think what we've been focusing on is what's the secondary impact of those law changes. There's nothing really in the law that's going to change our cost structure as it speaks today. Remember, we're served by many hospitals and doctors and stuff, so as they seek to maintain their margins and their revenue, they do other things. If they can't do it for the government, we want to make sure if they're doing it for us and for our customers or the people we've hurt, our customers have hurt, that it's appropriate. We're closely watching that cost shift from the public sector to the private sector, to make sure we're controlling costs. You can put processes in place ahead of time. You don't have to wait to see it happen.
You can manage your data, you can look at your provider stuff. We're on top of trying to make sure from a claims side, we're watching to make sure if the government quits paying a hospital $100, they don't decide they're going to get the $100 from us. You just got to be on top of the pricing on that one and make sure that because whatever happens to us, will probably happen to other people, and you want to make sure you're competitive there. On the bond portfolio, it wouldn't be any surprise to anybody here, interest rates will obviously go up at some point. We're not trying to predict them. When I went through the changes we make, we're not trying to pick every top or bottom of the market. We just look at it from a risk-return standpoint.
We said, when you look at the return you get from owning a 10-year bond today, not very good, particularly when you look at the risk, given where interest rates are so low today. It's pure interest rate risk we're shedding. We're kind of okay on corporate credit. We made a bunch of money on corporate credit. Spreads are still decent. They're not as low as they were in the heyday when there was so much money floating around, but we think they're about right. Maybe they could come down a little bit. We're trying to shed that interest rate risk and at the same time, maintain corporate risk, because we do have to find a return on the portfolio, since it's getting reasonably difficult these days with interest rates so low.
What you'll see, Mike, and what you'll be able to see in our numbers, we'll take capital gains, and that will mean we'll get lower operating income in the future. We're doing that on purpose. I'm not going to be a slave to some external measure of operating earnings if it's a bad idea for the shareholders. We're doing what's right.
Good.
Okay. Thank you.