Allstate Corp (The) (ALL) — Q1 2016 Earnings Call Transcript

Thank you, Jonathan. Good morning, and thanks, everyone, for joining us today for Allstate's first quarter 2016 earnings conference call. After prepared remarks by our Chairman and CEO, Tom Wilson, Chief Financial Officer Steve Shebik, and myself, we'll have a question-and-answer session. Yesterday, following the close of the market, we issued our news release and investor supplement, filed our 10-Q for the first quarter, and posted the results presentation we will use this morning in conjunction with our prepared remarks. The documents are all available on our website at allstateinvestors.com. As noted on the first slide, our discussion today will contain forward-looking statements regarding Allstate's operations. Allstate's results may differ materially from these statements, so please refer to our 10-K for 2015, the slides, and our most recent news release for information on potential risks. Also, this discussion will contain some non-GAAP measures for which there are reconciliations in our news release and in our investor supplement. As always, I'll be available to answer any follow-up questions you have after the call. And now I'll turn it over to Tom Wilson.

Well, good morning. We appreciate you taking the time to stay current on Allstate's operating results. This quarter shows really why we're in business, which is to protect people when disaster strikes. Overall operating profit is down largely because of two significant hailstorms in Texas in March. At the same time, good progress was made in improving the underlying combined ratio for auto insurance, and the homeowners business continued to generate margins that enable us to handle large catastrophe losses like we saw in March, and still generate a good return for shareholders. So as you know, severe weather creates a need for our customers to be protected. It's an increasing market these days. And Allstate does an excellent job of helping customers when these events happen. In Texas, we have over 1,100 local agencies, many of whom are close to our customers that are impacted by these hailstorms so that they can help provide initial claim response. We also have about 1,200 specially trained catastrophe adjusters on the ground in Texas with the expertise, technology, and relationships that enable our customers to rebuild after these storms. If we go to slide two, I'll begin by reviewing the overall results and priorities and then pass to Steve who will discuss the results in greater detail. As always, Matt Winter, our President, is here as is Don Civgin who leads the emerging businesses and Sam Pilch, our Corporate Controller. Net income for the quarter was $217 million, and operating income was $322 million or $0.84 per share. The largest driver of the variance from last year's first quarter was catastrophe losses which increased by $533 million to $827 million. The underlying combined ratio was 87.2 as the auto profitability actions we've put into place for Allstate Esurance and Encompass all made progress in the first quarter from where we ended 2015. Allstate brand homeowners insurance had a recorded combined ratio of 93.4 for the quarter despite the significant catastrophe losses. The recorded combined ratio was 82.3 for the last 12 months. From an investment perspective, we had what felt like a whole year of volatility in the first three months of the year and ended up with a 2% total return on the portfolio reflecting three components: interest income for the fixed income portfolio, good returns from performance-based investments, and the decline in interest rates over the three-month period. Total return over the last 12 months was only 1.3%, which reflected the low returns in the fixed income investments in the last three quarters of 2015 given the general uptrend in interest rates. Net investment income declined 14% as a result of our strategy to create additional shareholder value by increasing performance-based investments where risk-adjusted returns are higher, but reported accounting income fluctuates in the short term. Two-thirds of the decline in investment income reflects the performance-based annualized yield of 9.4% in the first quarter of 2016 versus an outstanding 17.5% in the first quarter of 2015. As a result of the underlying strength of Allstate's businesses, the board authorized a new $1.5 billion share repurchase program, which is in addition to the 10% dividend increase that was approved in February. We also made progress on the five operating priorities established for 2016. Customers, of course, are at the heart of our strategy, and better serving them will create additional growth and profit. Our internal measures of overall customer satisfaction did deteriorate slightly as we raised auto insurance prices to reflect the increasing number and cost of auto accidents. That said, we made progress in some of the underlying drivers through expansion of continuous improvement programs and good expense control. Overall, economic returns on capital improved as the auto profitability plan progresses, homeowners stay strong, and we position the investment portfolios to align with our liability structure. While not the same as economic capital, the operating return on book equity was 10% for the last 12 months, and it was 8% on a net income basis. Growing the number of customer relationships also faces headwinds as we adapt to the increasing cost of providing auto insurance. Property liability items in force were comparable to a year ago but were down from where we ended 2015. We did have great growth through Allstate Benefits' work site business, which added over 0.5 million policies over the last 12 months. Steve will discuss how we proactively manage the investment portfolio, but progress was also made in expanding the telematics insurance offering both in terms of customer offering and the number of customers. At over 1 million active connections, we're amongst the leaders in the connected car space. Let's go to slide three, which provides an overview of the first quarter operating results for our four property-liability customer segments.

Thanks, Tom. I'll begin with a review of our property-liability results on slide four. Beginning with the chart on the top of this page, property-liability earned premium of $7.7 billion in the first quarter of 2016 was 4% higher than the same period of last year. Recorded combined ratio of 98.4 increased 4.7 points versus the first quarter of 2015, driven by the $827 million catastrophe losses Tom mentioned earlier. While the underlying combined ratio of 87.2 improved by 1.8 points. Net investment income of $302 million for the property-liability segment decreased 15.6% from the prior-year quarter driven by a decline in performance-based investment income, which had strong results in 2015. As a result, property-liability operating income in the first quarter was $291 million, which was $264 million lower than the first quarter of last year. The chart on the lower left-hand side of this page shows property-liability net written premium and policy in force growth rates. The red line represents policy in force growth versus the prior year and shows that policy growth was comparable to the prior-year quarter given actions in place across all three underwritten brands to improve auto returns. The blue line on this chart shows that net written premium grew by 2.9% in the first quarter of 2016 as average premium continued to increase. The bottom right-hand side of this page shows the property-liability recorded and underlying combined ratio results. Let's go first to the red line, which shows the recorded property-liability combined ratio in the first quarter of 2016 was 98.4. This was 4.7 points higher than the first quarter of 2015 result of 93.7 but included 6.7 more points in catastrophe losses. The underlying combined ratio of 87.2 showed by the blue bar was 1.8 points below the first quarter of 2015.

Thanks, Pat. Slide eight provides an overview of Allstate Financial's results for the first quarter of 2016. There are three main businesses in Allstate Financial with a total of 6 million policies outstanding. A life insurance business that provides products sold to Allstate agencies, Allstate Benefits which provide life, disability, and flex health products at the work site, and an annuity business which is largely closed for new businesses. We began to reposition Allstate Financial in 2006 when we exited the variable annuity business, then accelerated the repositioning post the financial crisis in a low interest rate environment. The bar chart on the upper left shows that there's an impact to the balance sheet over the last four years with total reserves declining by $21 billion due to exiting the broker-dealer and bank channels for deferred annuities and the sale of Lincoln Benefit Life. Notice that the grey bar representing immediate annuity reserves has been relatively constant. Although these annuities begin paying out benefits immediately upon issuance, they have extremely long lives. The current financial results are shown in the upper right. Premiums and contract charges increased 5.4% in the quarter versus the prior year driven by 9.6% growth of Allstate Benefits and an increase in traditional life insurance products. Net investment income declined to $419 million or 13.4% as you saw long-duration fixed income bonds in the immediate annuity portfolio in the third quarter of 2015. These sales harvested the gain on these bonds given the decline in interest rates. The proceeds will be shifted over time to performance-based investments which are expected to generate higher long-term returns. I will discuss this in more detail on the next slide.

Good morning, and thank you for hosting the call. I appreciate the chart you had in your presentation about the increase in average premium. In the auto profitability measures slide, in your supplement, the loss ratio looks like it stabilized. Nevertheless, I'm wondering when should we expect that to start improving in the context of your rate actions that you've implemented over the last year.

Good morning, Greg. It's Tom. As you know, and Pat mentioned, it takes a while. So when we get a price approved, we obviously have to go through the regulators, and then once we do that, we have to program it in and start to roll it out to our customers, and those policies roll out over six months. And then of course it takes another six months before you collect it all. Matt can talk about the pace of change, but his team has been highly focused on this and aggressive making sure we are ahead of where the industry is going in terms of getting our pricing fixed so that when they catch up with us, we'll have an opportunity to grow again at profitable levels.

Greg, it's Matt. Thanks for the question. Everything that Tom just said is true, and that would be true if we were in a completely static environment, but we're not. So we're in a still moving environment. So we did see auto frequency moderate in the first quarter compared to the last half of 2015. And as a result, as you said, because of the rate taken, average earned begun outpacing loss cost trends in the quarter. That's a really good thing. But we are questioning whether some of the moderation of frequency may have been due to weather in the first quarter; we don't know. But we're not sure exactly whether or not we've seen the rise – the end of the rise in auto frequency, a stabilization or just normal fluctuation. So from that perspective, we continue to execute on our profit improvement plan, and we refine that profit improvement plan as time goes on and we get more information, greater clarity on the trend line, and that's true not only on frequency but it's true on severity as well.

Excellent color. Thank you. Just one follow-up. How should we think about the expense ratio over the next several quarters in the context of, I guess, you've announced a new advertising campaign, and it's clear that you've booked substantial improvement in the expense ratio over the last three quarters?

Yeah, well, we have. Obviously, we're always trying to make sure we watch expenses, whether that be our marketing expenses, our technology expenses or our general overhead expenses. And our team has a lot of work going on on that third category. In marketing, you're right, it did come down. We took the opportunity. There's really no reason to continue to bang away and drop lots of money on advertising if your underwriting standards are tight and you don't really want to grow. Despite the fact that more people are shopping, one of the reasons we try to get out ahead of it is with our brand and our marketing we want to be open for business when other people are raising their rates so we pick up those shoppers. And so I think you should expect to see our expense ratio go up, but we're going to manage it to make sure that we still get the combined ratio target we're trying to get to. We did take this opportunity to refresh some of our programs, and we feel good about what we're going to launch. But it's not like we went dark either. We advertise all the time. We look for folks. We have stuff going on. So it's not like we shut the place down; we just toggled it back a little bit.

Thanks. Good morning. Just a question I guess on the capital management. $1.5 billion buyback, it sounds like over the next five or six quarters with the common dividend it doesn't seem like it would quite add up to sort of what the street is thinking of for overall operating earnings. Just curious if we're at a point now where you think about needing to retain some capital to grow whether it's through M&A or just organic growth? I know in the 10-K you mentioned your strategic priority is now to build and acquire long-term growth platforms, not just to build. So I'm just curious if there is any M&A component to that. Thanks.

Ryan, this is Tom. We have plenty of financial firepower to do whatever we need to do. Steve mentioned our debt to capital ratio is the lowest it's been, I think, since I've been here, and I've been here over 20 years. And we're in a really strong position if we need to do anything. Steve mentioned that the thing that we had done historically, so the last $3 billion program, had over $1 billion in it from Lincoln Benefit Life. So I think what happens is sometimes the confusion is people get the capital actions in the divestitures mixed up with how much we need to grow in that. And so we think this is the right amount of money; it keeps the company really strong. We have plenty of capacity to either grow our business, handle any kind of large catastrophes that might come our way or see if we find something that's attractive to us externally, we would want to add to the portfolio, we can do that.

Ryan, it's Matt. It's an interesting question. But let me be clear that we have an Allstate philosophy for both how we reserve, which is very conservatively. Somebody else's prior-year development is really not that instructive for us. It's interesting; we look at it. It always provides context and information, but we have fairly precise ways that we approach this and that we ensure that we're reserved appropriately. And as I said when I answered Greg's, I think our level of detailed study as we determine where to take rate, how much rate to take, what the net trends are, what the indications are, number one, the level of thoroughness has shown up in our effectiveness in getting rate approved in each of the states. But two, it allows us to react to our information as opposed to others. Everybody is in a different place. Everybody is in a different place in terms of what the rate is, where their rate is, how much rate they need to take to respond to current trends. We saw at the beginning of last year very few people talking about any frequency or severity issues. And then later on, everybody talking about it. So everybody's timing appears to be different, and we're focused on our own book of business, our own trends and our own math.

Yeah, good morning, everyone. Two questions. One is can we talk a little about your rate need in auto going forward and maybe touch on rate need in Texas homeowners on top of that? And my second question relates to mass hitting about two or three quarters ago, but we're getting well ahead of it. There's always this fourth quarter seasonality in losses that didn't happen at all last 4Q as we start discounting the end of the year into our thoughts; was that seasonality just a coincidence?

Josh, it's Matt. I'll start with the first question about rate in auto going forward. You know that we don't disclose our rate plan for the year. We do disclose the fact that we have every intention of staying ahead of our loss cost trends, and as we monitor those, we continue to take rate as necessary. We have robust rate plans. We revise and amend and change them on an almost ongoing basis as we watch the emergence of loss costs. Well, I'll answer it this way: as we look, we always have a cat load that we take into account as we're looking at rate need overall. We have to figure out what is normal volatility and normal catastrophe activity and when we're at a new norm and whether weather patterns are changing and non-modeled cats are increasing due to global warming; we will and are continuing to look at that. And if we determine that this is a new norm, we will price appropriately for it. But that's a tough question, and I don't think that we will change something based upon a set of cats that took place over a ten-day period. So it will take more than that. But it's a good point that we have to look at whether or not we're in a new weather environment and a new cat environment, and if so, how we react. I guarantee we will react to ensure that we earn economic risk-adjusted returns in Texas and every other state where we have cat exposure.

Let me add one. So as Matt pointed out, he looks at – and our team really focuses on homeowners by state, or by total, which you saw the numbers in total, by state and by territory, right. So it's broken down. What I would say is that severe losses like hail, straight-line winds, or tornados do come through the pricing models faster than severe losses that are caused by hurricanes or earthquakes because of the longer-term nature of the actuarial science on that.

Thanks. And good morning, and congrats on the quarter. Two quick follow-up questions, if I may. The first I guess goes back to what Greg was asking about the loss cost trends. On the last call, you had talked about competitors and spent more time on the industry. Recently one of the larger companies had adverse development in their results. Does that sort of news – did that lead you to maybe take a pause or sort of recalibrate the growth plans for 2016? Or do you just feel that, okay, this is others addressing the issues that we have addressed in the past?

Amit, it's Matt. It's an interesting question. But let me be clear that we have an Allstate philosophy for both how we reserve, which is very conservatively. Somebody else's prior-year development is really not that instructive for us. It's interesting; we look at it. It always provides context and information, but we have fairly precise ways that we approach this and that we ensure that we're reserved appropriately.

That's a good question, Bob. So as you point out, we've been working on improving the returns in that business for some time. We feel like we've been making good progress. But the other thing I would say is we look at ROE, but we really manage for shareholder value. So the items when you look at that lower right-hand side and see what happened to annuities in terms of operating income, that hurt the current ROE. But we're okay with that. It hurt it for two reasons.

Good morning, Allstate. I really appreciate the disclosure in the bottom of slide eight on Allstate Life decomposition of earnings. And hopefully, we will get that prospectively and retroactively would be even better. As we think about the Allstate Life ROE progression, Matt, when you took over several years ago, the idea was to go into mortality, morbidity, and cut back spread products, and that's played out well.

Hi. Good morning. Thank you for taking the question. So I wanted to start with a kind of a numbers question, in a sense I want to make sure I understand. So you said this quarter the weather appeared to be light in auto and home and that's probably driving the frequency benefit. And so the headwind there would be – in the future may be loss ratios would sort of bounce back, but the upside from an investor perspective is that you're not going to slow raising price increases because you're not ready to declare victory on frequency yet. So that's my first actuarial question. And my second related point, I'm just looking at your BI severity which has been negative for a couple of quarters and I'm trying to understand what's driving that.

Hey, Josh, so Matt will answer your question, but just to be clear, we didn't say that favorable weather impacted first-quarter results.

Yeah, Josh, it's Matt. I think your question is really about – I think you referred to it as actuarial, but I think you were referring to whether or not if we have some uncertainty about some of the causal factors in gross frequency, whether that impacts our ability to price and take rate. Rate indications are at a paid, not at a gross and they're based upon your net trends and your indication, and we go to the regulators and the insurance departments with a robust actuarial package that shows net trends current indications.

So that's really helpful color. I guess, I don't want to put words in your mouth, but I'm trying to sort of synthesize what the net takeaway would be from all this. Which is I think you're probably going to continue raising prices at more or less the rates you've been because you're going to look through the severity thing as sort of mix-driven and at the same time the frequency you're going to rely on the paid data more than the gross?

I think to be fair we'll go through a period where we'll have to continue to raise prices.

Thank you so much for fitting me in. And first question is on the guidance. It looks like the first quarter 87 is below the 88 to 90 full year guidance? And it looks like the auto book will continue to improve over the coming quarters. So what is holding you back?

It's a 12-month forecast and we're 3 months in.

Josh, it's Matt. I'll start with the first question about rate in auto going forward. You know that we don't disclose our rate plan for the year. We do disclose the fact that we have every intention of staying ahead of our loss cost trends, and as we monitor those, we continue to take rate as necessary. We have robust rate plans. We revise and amend and change them on an almost ongoing basis as we watch the emergence of loss costs.

Well, as you point out, we now have I think it's 1,050,000 or so people currently connected to us on a daily basis. We pull different kinds of information from them. That enables us to do a couple of things. You're absolutely right it enables us to price more accurately because when we are determining what we should charge somebody, we have to put them into groups and actuarially sort that out. In this case, we can basically put them into different groups because we know how you brake, what time you drive, there's a variety of things that enable us to give customers more accurate price and oftentimes that's a lower price, more attractive price for them.