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The Allstate Corporation (NYSE:ALL)

Q4 2009 Earnings Call

February 11, 2010 9:00 am ET

Executives

Robert Block – Vice President, Investor Relations

Tom Wilson – Chairman, Chief Executive Officer

Don Civgin – Chief Financial Officer

Judy Greffin – Chief Investment Officer

Joe Lacher – President, Allstate Protection

Sam Pilch – Controller

Matt Winter – President, Allstate Financial

Analysts

Jay Gelb - Barclays Capital

Robert Glasspiegel - Langen McAlenney

Vinay Misquith - Credit Suisse

Daniel Johnson - Citadel Investment Group, LLC

Matthew Heimermann - J.P. Morgan

Joshua Shanker - Deutsche Bank

Paul Newsome - Sandler O'Neill & Partners, LP

Brian Meredith - UBS

Meyer Shields - Stifel Nicolaus & Co., Inc.

Alison Jacobwitz - BofA Merrill Lynch

Operator

Good day, ladies and gentlemen, and welcome to The Allstate Corporation fourth quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the conference over to your host, Mr. Robert Block, Vice President, Investor Relations. Mr. Block, you may begin.

Robert Block

Thanks, Matt, and good morning everyone and thank you for joining us today for Allstate’s fourth quarter 2009 earnings conference call. As always Tom Wilson, Don Civgin and I will make some opening comments providing color on our fourth quarter and yearly results for 2009. Following our comments we will have a question-and-answer session when Judy Greffin, our Chief Investment Officer; Joe Lacher, President of Allstate Protection; Sam Pilch, our Controller; and Matt Winter, President of Allstate Financial, will join us.

During the session we ask that you please limit yourself to one question and a follow up so that we can hear from as many of you as time permits. Last night we issued our press release and the majority of our investor supplement for the fourth quarter. We also posted a Slide presentation that will be used this morning during our presentation. You can locate these documents on our website.

As noted on Slide 1, this discussion may contain forward-looking statements regarding Allstate’s operations and actual results may differ materially, so refer to our Form 10-K for 2008, our 10-Q for the third quarter 2009 and our most recent press release for information on potential risks. We expect to file our 10-K for 2009 by the end of February. Also this discussion will contain some non-GAAP measures for which there are reconciliations in our press release and on our website. This call is being recorded and a replay will be available following the call.

Christine Yeider and I will be available to answer any of your questions that you may have once this call is completed. Now let’s begin with Tom Wilson.

Tom Wilson

Well, good morning and thanks for your continuing interest in Allstate. I’ll begin with my thoughts on our progress then Bob will go through the business unit results and Don will cover investments and the balance sheet.

We entered 2009 with three priorities; that was to keep Allstate financially strong, to improve customer loyalty and to reinvent protection retirement for consumer. And we made outstanding progress on the first two goals and while we made less progress on reinventing, we did lay out a foundation for growth.

Let me go through each of these priorities in order. First, we did further strengthen Allstate’s financial position. We generated operating income of $592 million for the quarter and almost $1.9 billion for the year, which was 7% higher than the full year of 2008. We had double digit returns on our $100 billion investment portfolio, realized capital losses were reduced to $33 million for the quarter and $583 million for the year. Importantly the pretax net unrealized position improved by $6.5 billion throughout the year. Net income was $518 million in the fourth quarter and $854 million for the year. As a result, book value grew by 31% in 2009.

We also built up a stronger capital base on both the GAAP and statutory basis. And we achieved this through focused operational efforts at Allstate Protection, Allstate Financial and in our investment activity. Allstate Protection achieved its objectives of providing a strong source of operating profit, improving customer loyalty and laying a foundation for growth. The combined ratio was 93.2 for the quarter as excellent operating practices, expense controls and pricing discipline resulted in all major lines generating an underwriting profit in the fourth quarter.

Over the last five years, our personal lines business has generated an underwriting profit in 18 of 20 quarters with an average of 93.9.

As you know we provide annual guidance on a combined ratio. This year was 87 to 89 for 2009, excluding the cash freeze and prior year reserve changes, we ended the year at 88.1, almost exactly in the middle of our expectations.

We expect to capitalize on our positive momentum with continued focus on targeting high lifetime value customers, further improvements in customer loyalty, taking steps to improve homeowner returns, improve sales and service results from our agencies and expansion of our new product development and marketing programs.

Allstate Financial also made substantial progress in the quarter to focus the win plan, to reduce expenses, to lower fixed costs and focus on profitability, has achieved 90% of its original goals and is on schedule. Operating income was $95 million for the quarter and $340 million for the year.

Importantly we also made progress in focusing our strategy in this new investment and economic climate. Allstate Financials’ primary focus will be on providing mortality, morbidity and preservation of income products to customers through Allstate agencies and at worksites. We’re restructuring our sales programs and support, our product offerings and our marketing efforts, to broaden our relationships with the 17 million households that currently do business with Allstate.

Our workplace business is growing rapidly, with premiums increasing 9% last year as we expanded both the small and large employer segments. We will continue to reduce our fixed annuity book, value portfolio, which are the sales through banks, independent agencies and broker dealers. We began this process in 2006 and will continue to exit unprofitable relationships and lower our concentration spread based products.

We had a good quarter and a great year on investments. We had strong overall total returns and made progress in positioning our portfolio for future success by both mitigating our risks and seeking to optimize our returns. We reinvested excess liquidity, which increased throughout the year as the markets improved, raising returns. We reduced our exposure to commercial real estate by over $5 billion last year and lowered our municipal bond investments by $1.9 billion. We shortened the duration of our fixed income investments and hedged the unmatched portion of our portfolio for large increases in interest rates. And while both of these lowered our investment operating income, we will be well positioned should interest rates rise.

On our second goal we also did very well, which was to improve customer loyalty. Loyalty has three components, as you’ll remember; customer satisfaction, intent to renew and willingness to refer. Obviously all of those are important to future growth. We raised our customer loyalty scores on an absolute basis and improved our relative position to the competition. At Allstate Protection we achieved those results in 13 of our 14 regional operations throughout the U.S. Our agencies also improved their performance in all of our regions. As a result, we were able to share this benefit with the employees by making the maximum contribution to the 401(k) plan, which is tied to customer loyalty.

Finally, on reinventing protection retirement for the consumer, we laid a foundation for growth. We made good progress in improving the value proposition for our high lifetime valued customers, enhancing our service and sales capabilities, and started the development of new products to further differentiate us from the competition. Overall, we had a strong finish to a good year.

Now, Bob will go through the business results.

Robert Block

Thanks, Don. Turning to Slide 3, property liability net written premium fell 0.4% for the quarter and 2.3% for the year compared to similar periods in 2008. This decline was primarily driven by reductions in units as we intentionally chose to maintain pricing discipline in a highly competitive marketplace.

That said, when you look at the details by line, there are some trends indicating positive results in the future. Beginning with Allstate brand standard auto, net written premium increased 0.7% in the fourth quarter 2009 compared to the prior year quarter as new issued applications increased 11.4%, quarter over quarter. We issued over 2 million applications for the year, a 12.3% increase year-over-year. Retention increased 0.2 of a point to 88.8% after a similar increase in the third quarter 2009. Average premium climbed 2.6% reflecting our consistent approach to seeking rate changes where needed while providing distribution and product choices for consumers.

Allstate brand homeowner’s net written premium increased 0.9% in fourth quarter 2009 versus the fourth quarter of 2008. Increases in average premium and retention are essentially offset by reductions in units as we continue to manage our exposure to catastrophic losses. We continue to focus on gaining appropriate rate changes in order to bring this line of business back to an acceptable return on capital. During the fourth quarter we received approval for rate changes averaging 6.5% in 22 states, bringing the countrywide impact for the year to 8.4%. The majority of these rate changes will be earned over the next two years.

While the two major lines of business were both slightly improved in the fourth quarter, the primary source of the overall decline in the quarter was business written through Encompass. Efforts to improve the margins here are limiting top line growth as we maintain our philosophy of profitable growth in all areas of our business.

Shifting to a discussion of margins, our overall combined ratio for the quarter was 93.2%, significantly improved from the fourth quarter of 2008. The underlying combined ratio was 88.1% in the quarter and for the entire year, consistent with the range we expected at the beginning of the year.

In the quarter we recorded $328 million in catastrophe losses, bringing our total for the year to just over $2 billion. The fourth quarter included 13 events for $210 million, a relatively light catastrophe quarter. However, we also experienced $148 million in cat losses related to re-estimates of events that occurred earlier in 2009, offset slightly by a $30 million favorable re-estimate related to prior years. The upward development of these current year events was due primarily to adverse frequency related to hail events that occurred in the southeast.

As we have done for the last few years, we have provided an outlook for the underlying combined ratio for 2010, a range of 88 to 90%. Remember that this combined ratio outlook excludes the effects of catastrophe losses and prior year reserve re-estimates. This range is a point higher on each end than our outlook for 2009 and reflects a conservative view on the short term trends for auto frequency and non-catastrophe weather losses for homeowners. While higher than the 2009 outlook, it represents an industry leading performance.

On Slide 4 we give you a look at the loss trends for auto. As we expected, reported frequencies for both bodily injury and property damage increased significantly in the fourth quarter compared to prior years. Bodily injury frequency rose 14.4% for the quarter and 13.1% for the year. Property damage frequency increased 7.6% in the quarter and 6.2% for the year. We provided explanations in the past for these large increases primarily related to the significant drop in 2008 frequency levels. While the comparisons are large, the fact is that the level of frequency in 2009 is similar to that recorded in 2007, with bodily injury frequency a little higher in 2009 compared to 2007 levels, and property damage levels a little lower than 2007. That said, we watch and will react appropriately to these trends, incorporating them into our rate indications in order to remain profitable over time.

Auto bodily injury paid severity continues to perform better than anticipated and property damage paid severity is essentially in line with expectations, offsetting to some extent the increases in frequency. The combined effects of frequency and severity or pure premium are well within our pricing expectations and translate into a combined ratio for the quarter of 93.7%, 5.7 points better than the fourth quarter of 2008. For the year we posted a combined ratio for Allstate brand standard auto of 93. [inaudible] %, a 1 point increase compared to 2008. These results complete another year of excellent underwriting margins for auto, indicative of our strong capabilities in marketing, pricing and claims management. We have been operating at these margins or better for the last several years.

The loss cost trends for homeowners continue to be negatively impacted by non-catastrophe weather. Non-cat frequency increased 13.9% from prior year with lightning, wind, hail and water claims being the primary drivers of the increase. Homeowners paid severity declined 8.5% quarter over quarter, reflecting the mix shift in the type of claims paid in the quarter. The combined ratio for the quarter was 89%, up 4.4 points from the fourth quarter of 2008 with catastrophe losses accounting for 9 points of that increase. The results excluding catastrophes were better in the quarter, but we will continue to reach for better returns in the future. We remain focused on gaining approval for appropriate rate changes to return this line to acceptable returns.

On Slide 5 we shift to Allstate Financial results. We generated an operating income of $95 million in the fourth quarter, an increase of 7% from the fourth quarter of 2008. This increase was driven by lower DAC amortization and reduced operating expenses, somewhat offset by lower benefit and investment margins. The decline in DAC amortization was due to lower investment spreads and a lower amortization rate resulting from updated assumptions for fixed annuity performance. The reduced operating expenses primarily reflect proactive management actions taken through the Focus to Win restructuring program. As you will recall, the Focus to Win initiative is expected to produce annual cost savings of $90 million. Through the fourth quarter we’ve attained about 90% of the expected annual expense savings, with the remaining reductions to be achieved by 2011.

The benefit spread declined due to higher mortality experience, which as we said last quarter can bounce around a little bit, and non-recurring benefit costs. The lower investment margin was the result of intentionally making higher than normal levels of liquidity affecting the portfolio yield, as well as reduced asset balances, partly offset by lower interest credited on contract holder funds. From the top line perspective, the premium and deposits fell by $401 million to $1.2 billion as we continue to focus on generating acceptable returns and reducing our concentration in spread rate products.

Our focus remains on improving the overall returns to this business while seeking longer term solutions to consumers’ protection and retirement needs. Now I’ll turn it over to Don.

Don Civgin

Thanks Bob. I’ll cover our investment portfolio and results and finish with a look at our capital position.

During 2009 we generated strong results from our investments with substantially improved portfolio valuations more than offsetting lower investment income. We consistently acted in a proactive way to manage the risks and returns in our investment portfolio and our approach paid off throughout the year. By remaining focused on limiting our exposure to rising interest rates while maintaining our view of credit spreads and taking specific actions to reduce exposure to specific asset classes, we ended 2009 in a strong position.

On Slide 6 you can see a breakdown of our consolidated portfolio. At year end the value of the portfolio was $99.8 billion, a slight decline from September 2009 due to a lower balance in Allstate Financial and the $750 million debt repayment at corporate that we refinanced back in May. Fixed income securities still make up about 80% of the portfolio, with the bulk being high quality corporate and municipal bonds.

During the year we reduced exposure to commercial real estate by $5.4 billion, reduced municipal bond positions by $1.9 billion and reduced our durations by 5% and maintained derivative positions designed to protect against rising interest rates. Our fixed income portfolio continued to generate significant amounts of cash, with $2.6 billion for the fourth quarter, consistent with our track record throughout 2009. We aggressively deployed both these cash receipts in our short term cash position by a further $7 billion for the quarter.

On Slide 7, you’ll see our two year investment transfer income and realized capital gains. Our investment income declined for the fourth quarter, which was down 19% over the prior year but is consistent with the first three quarters of the year. The reasons remain the same, lower yields; our continuing emphasis on maintaining shorter durations in spite of the yield environment; higher levels of liquidity; and reduced average asset balances. For the quarter, we generated realized capital losses of $33 million, a huge improvement over the fourth quarter of 2008. We continued to experience some credit impairments, although it was down to $270 million for the fourth quarter, and we proactively took $215 million of intent writedowns, consistent with our desire to reduce exposure to commercial real estate. Subsequent to year end, we did sell the majority of these securities.

We also generated $390 million in realized capital gains through asset sales. Finally, we had a small net gain on derivatives related to rising interest rates at year end. Unrealized net capital gains and losses are on Slide 8. For the full year 2009, our pretax unrealized loss position improved dramatically from $8.8 billion to $2.3 billion while unrealized losses after tax and DAC showed similar declines from $3.7 billion to $0.9 billion. The primary driver was improved credit spreads during the year. During the fourth quarter, while pretax unrealized losses continued to improve, there was a disproportionate decrease in shadow DAC due to updated assumptions on the investment performance, which resulted in lower DAC amortization rates. While it was a volatile year in the investment markets, our unrealized capital loss position both before and after tax and DAC, are at roughly one-quarter the levels they were at the end of 2008.

Finally, on Slide 9 you can see our capital position for year end 2009 as well as the four preceding quarters. We finished the year with shareholders equity of $16.7 billion, an improvement of approximately $4.1 billion from year end 2008. As a result, book value per share at $30.84 climbed 31% during the year. Statutory surplus for both Allstate insurance and ALIC improved during the year as well, with estimated statutory surplus of $14.9 billion at AIC, inclusive of ALIC.

Lastly, the holding company continues to maintain high levels of capital, with over $3 billion of capital with which to service our relatively light fixed charges. As a reminder, we continue to have full access to $1 billion of credit facilities which remained unused at year end, and our next corporate debt maturity is about $40 million in 2011, with a total of about $600 million coming due in 2012 and 2013 combined.

In summary, by consistently and proactively focusing on our priorities during 2009, we ended the year not just financially strong but well positioned and confident in our ability to grow our business and deliver shareholder value as we move into 2010 and beyond.

Tom Wilson

Thank you, Don. Let’s go to Slide 10. That shows our priorities for this year. We’ve obviously come through a very difficult economic time. We’ve improved upon our strong financial condition and so we have three goals for 2010. First, continue to improve customer loyalty. Two, to continue to differentiate ourselves amongst our competitors by reinventing protection retirement for the consumer, and third to begin to grow our businesses.

So with that I would be happy to hear what’s on your mind.

Robert Block

Matt, if you want to start the Q&A.

Question-and-Answer Session

Operator

Thank you sir. (Operator Instructions) Your first question comes from Jay Gelb - Barclays Capital.

Jay Gelb - Barclays Capital

Two issues I’d like to touch on. Joe, if you could give an outline of your goals and plans to achieve them given your new role as head of P&C at Allstate that would be helpful. And then Tom if you can update us or give us a bit more color in terms of your comfort level with the combine ratio range, given that it went up maybe a bit more in 2009 versus 2008. What gives you the comfort level that you’ll be maybe at the mid point of that combined ratio range [inaudible] as opposed to the higher end for 2010?

Tom Wilson

Well, let me start with the second and then give Joe a chance to come up with his goals, which are, you know, he’s been here 90 days so we’ve got to give him a little bit of a break. But they will obviously be consistent with our overall goals. So first, in terms of the combine ratio I feel pretty good about the range we have given for 2010, Jay. The reason being we’ve done a lot of work on improving the targeted pricing for our auto business and we’ve been very consistent and thoughtful in increasing prices when we need to. When you look at our competitors, they have started to raise their prices throughout ’08 and ’09 and so I feel good about our competitive position. So I think we should be able to retain customers which obviously helps our profitability because of pricing and because of what we’re doing on customer loyalty. So I feel good about our numbers here.

Joe Lacher

Jay, this is Joe. Terrific question and one that I’ve been spending a fair amount of time on in the brief time that I’ve been here. The exciting part about being part of the Allstate group is we have a lot of bright and talented people who’ve been working on a strong set of core strategies, to focus on growing our business and leveraging and realizing the scale advantage that we have. Using a stronger set of business intelligence and analytics to fuel reinvention of protection and retirement for consumers, we think will ultimately help us deliver that. We’ve got a great tradition and great strength at delivering strong profit margins. I think if we find a way to continue the improvement we’ve got in the homeowners lines we can use that business as an offensive weapon at some point, we’re not there yet; drive growth initiatives through our auto business and the other businesses inside of protection.

Operator

Your next question comes from Robert Glasspiegel - Langen McAlenney.

Robert Glasspiegel - Langen McAlenney

I’m going to actually take Jay’s question in reverse. It seems like the fourth quarter your underlying property casualty combined ratio improved by a point or two versus three quarters where it had been deteriorating. You’re getting more rate. If you take the mid point in the range, it looks like you’re looking for one point deterioration in underlying combined ratio. Aren’t you getting enough rate to keep up with underlying loss experience?

Tom Wilson

The answer is frequency, so if you look at frequency of course it was up a lot this year, it was down a lot last year. ’09 looked like ’07 and ’05. If you look at ’06, that was down. So frequency’s been bouncing around a lot lately so when we make a commitment we like to make sure that we stick to it and when we look at frequency we think it’s hard to determine where that will be next year, given where we are in the economy, the cycle. Hopefully unemployment will go down a little bit next year so you ought to see miles driven going up. So the bottom line is we’re still earning great returns in our auto business and have for a number of years. Secondly, in our homeowner business as Joe pointed out we’re well on the way to improving the profitability of that business. We earned in underwriting profit in the fourth quarter combined ratio was 89.2, so we’re feeling good about that business.

Obviously one quarter does not history make, but when you look at the price increases that Bob talked about, we think we’re well on the way to keeping that business highly profitable as well.

Robert Glasspiegel - Langen McAlenney

In the third page of the release you say risk mitigation programs continue to protect the hedges against interest rate and performed as expected during the fourth quarter. I mean the fourth quarter was sort of a funky quarter from an investment point of view where equities were up and some risky assets did well and non-risky assets did poorly. I guess the question is what number should I look at to say your hedges against equity risks performed as expected in an up sort of 5, 6% market?

Judy Greffin

I guess in an up market our hedges mostly are just a cost to us, because we’re protecting against equities going down, not necessarily you wouldn’t see the value of those hedges when equities go up.

Robert Glasspiegel - Langen McAlenney

So in a sense you mean you spent what you thought you were going to spend during the quarter? Or is there some convexity thing that you’re doing that you’re looking at?

Judy Greffin

No, we spent what we thought we were going to spend. And in fact I think we came in a little bit under what we thought we were going to spend on the equity component.

Robert Glasspiegel - Langen McAlenney

Over the year you increased your equities at cost, but you’re hedging against it? And you mentioned that you sort of went passive in the quarter, I think, if I read it correctly. I mean, what are you trying to do in your equity portfolio?

Judy Greffin

So a couple of things there. First, the strategy around equities, we decided to go to a passive strategy in terms of active management around the portfolio. So the mix in the portfolio really hasn’t changed that much. It’s more that we’ve decided we’ll manage it passively. With regard to the amount of equities that we own, not only did we get the appreciation as the market rose, but also we have put more dollars into the equity market, both domestic markets as well as foreign markets.

Tom Wilson

So Bob, thanks for the second follow up. But you’re after a good point which is in our investment portfolio, it’s an equity portfolio you were talking about or what we’re doing on interest rates, we’ve taken the approach we will spend what it takes to make the right risk return trade off, whether that’s the hundreds of millions of dollars we spend making sure that if interest rates go up we don’t get clobbered. And or if it’s making sure that equity prices go down dramatically, we don’t feel that dollar for dollar pain as well. So we have continued to be proactive in our approach to risk management, spending what we think we need to spend to protect the company.

Operator

Your next question comes from Vinay Misquith - Credit Suisse.

Vinay Misquith - Credit Suisse

On the shadow DAC [proviso] this quarter, could you help us understand whether there’s going to be any impact on the amortization of DAC for the future? And also related to that, could you explain whether you’ve taken any realized losses or whether you’ve made a provision for the higher expected losses that expect in 2011 and 2012 on your fixed annuity business?

Don Civgin

Hi, it’s Don. Let me try and take both those questions. First of all, the shadow DAC to a large extent obviously is driven by the DAC amortization rate. So what we do every quarter, and I’m going to start with the income statement here, we will look at all the facts and circumstances that are available to us. We’ll look at both experience and what we anticipate for the future and then we’ll make a determination of what the proper DAC amortization rate should be for that quarter. And what we’ve done, if you’ll recall, in the third quarter which we followed in the fourth is decided not to recapitalize DAC for realized capital losses so that we did not jeopardize the future recoverability of that.

In the fourth quarter we did update our assumptions including anticipated results related to the fixed annuity investment performance. All that stuff goes into a box and we end up with what is essentially a DAC amortization rate. So that’s why when we talked about the DAC amortization on the income statement, we pointed out that it was lower during the fourth quarter.

And now I’m going to switch to shadow DAC, which of course only goes through OCI and not the income statement. In accordance with GAAP then we’ll take that shadow DAC, we’ll take that DAC amortization rate and apply it to the unrealized loss position on those investments in the portfolio, not all the investments that relate to the unrealized loss but only those relate to the products that we sell that relate to DAC. So let me take a step back. Shadow DAC, if you look at it on a year-over-year basis, it did kind of what you would have expected. So the unrealized loss position went down by about 75% and if you look at it net of tax and shadow DAC, it went down by a very similar amount.

It does move around in the quarters, though, and it moves around because to be honest I don’t think DAC was designed to operate necessarily smoothly in this sort of very volatile environment. So it did move around a bit in the quarter. So I think the answer, though, is we’re comfortable with the numbers on a year-over-year basis and there is some disproportionately in the fourth quarter on shadow DAC but that’s just kind of the outcome of how it works. As it relates to the amortization going forward, obviously because we’re not recapitalizing DAC, not shadow DAC now, talking about DAC on the I’ll call it real DAC, there will be less amortization going forward through the income statement.

Vinay Misquith - Credit Suisse

On the agent rationalization plan, Tom, can you give us a sense for where that is going and what are the risks to that strategy? What if you decide to let go of some agents? Do you think that there’s going to be some lawsuits against the company?

Tom Wilson

Vinay, we don’t have a rationalization plan so to speak. What we have is a strategy of making sure we provide our customers the best service possible and offer all of our products and services in the best way with the most experienced people we can. You will see that the number of agencies that we have in the United States has gone down over a couple of years, and that’s due to a couple of things. One is A, as the business gets more competitive and more complex, those agencies need to be larger so that they can have more experienced people in them, whether they sell all let’s say financial products, they sell boat insurance or renters insurance, things beyond auto insurance. So the size and scale of those has increased.

What you don’t necessarily see in that number is the number of people we have on the street, dedicated to only our products, which includes licensed sales professionals which in fact has gone up throughout that period as well. So we look at it and say how many people do we have working on behalf of our customers? And so you’ll see that that number has gone up. So the number of agencies is a little bit of a construct of just how many contracts do we have out there as opposed to how many people sit in that agency.

In addition, this year we’ve started putting standards in on performance as it relates to the agency loyalty index, which as I said in my earlier comments went up in every region across the country. All of our agencies did a better job for their customers. Those, however, that did not make that transition are leaving our organization. So I don’t see it as a risk to our organization, I see it as a benefit to all those agencies that are doing a great job for their customers. This raises the overall bar and raises our position in the marketplace.

Vinay Misquith - Credit Suisse

So on store’s policy, does Allstate own those policies for which the agents are leaving and therefore you run the risk in the short term you might have lower policy in force count?

Tom Wilson

Vinay, I would start with the concept that nobody owns the customer. The customer owns themselves and their own relationship. When those agencies leave, they can either sell their agency to somebody else and we’d provide for a transition and help them do that. If there is nobody available to buy that agency we will buy it from them and then we have a variety of ways in which we take care of those customers. Sometimes we transition those customers to other agencies in the local marketplace, sometimes while we’re looking for another agency owner we have our call centers handle it. But in all cases the first and primary goal is to make sure we take care of our customers.

Operator

Your next question comes from Daniel Johnson - Citadel Investment Group, LLC.

Daniel Johnson - Citadel Investment Group, LLC

If I do this right, the Allstate brand written premium looks like it is up year-over-year and kind of having to go back and find when that happened last. It looks like sometime in 2006, although maybe these numbers are touch wrong but I think they’re right. Do you want to point to a few things that’s helped make the turnaround? I saw new issue apps look good for a couple quarters in a row and obviously more importantly then sort of why it’s gone up is do those trends have a good chance of persisting into 2010?

Tom Wilson

I’ll start with the longer term perspective on the Allstate agencies. Joe can make a comment about Encompass which you didn’t talk about but also obviously impacts our overall auto results, as Bob talked about.

On the Allstate agencies, I think it’s important to step back and look at the decisions we talked about in 2007 and 2008, which was in the face of what we saw as an upcoming difficulty in the economic environment we decided not to take price decreases in 2007, despite the fact that some of our big competitors were. We didn’t think those price decreases were justified. We didn’t think it was the right thing to do to buy growth and we chose to work on value and not reduce prices to grow. That turned out to be a good choice for us. We didn’t know the economy was going to get as bad as it did, but we’re glad that we have that strong source of profitability.

It also turned out to be a good choice because many of our competitors are now increasing their prices. They started in the second half of ’08 and throughout ’09, so I think in the third quarter, Joe, I think it was about three to one increases to decreases when you look at the industry. He’s nodding acceptance of that. And so that turned out to be a good choice. When you look at the Allstate brand business itself, I would say there are three components you have to look at for growth. One is new business, which as you correctly point is up; two is retention, which is flat basically. But the leading indicator being customer loyalty headed up gives us some confidence that we should be able to move that number up, combined with the fact that our competitors are raising prices, we think that should help us some there as well. The third component which is less obvious is just the trend line.

And so if you’re down because over that ’07 to ’09 period we did reduce the number of policies we have in force, that trend you’ve got to kind of turn around. We call that availables but you’ve got to do enough on new business, you’ve got to do enough on retention to offset that trend line. You’re starting to see that work its way out so we would hope to be able to see that business begin to grow as Joe pointed out as we move through 2010. Encompass you didn’t ask about, but I think it would be worthwhile to get Joe to give some perspective on that as well.

Joe Lacher

Thanks Tom. Encompass is continuing to be a challenge for us. We’ve had a couple of different strategy changes over the last several years, some of which let us into a little bit of profitability challenges and then as we worked our [inaudible] management actions, a large percentage of the Encompass book and in areas where we’ve got excess catastrophe exposure or those actions have been at their highest.

What we’re seeing through 2009 and the early part of 2010 will be the results of sort of rationalizing all of those challenges and refocusing Encompass on its core value proposition and its core set of target customers. Fixing a few of those items and then getting it positioned for growth. I think we’re going to see for at least a couple more quarters’ similar results, perhaps at a lower rate of decline, and we’re going to refocus the organization and again position it to start seeing some upside.

Daniel Johnson - Citadel Investment Group, LLC

So at least on the Allstate side, I didn’t hear anything that said the things that have been helpful over the last couple of quarters to turn premium around to the positive should be changing back to the negative.

Tom Wilson

I agree with that.

Daniel Johnson - Citadel Investment Group, LLC

My follow up question pertains to capital I think maybe best put on Slide 9. AIC added almost $2 billion in capital this year. I realize a little bit of that came from the hold co, but sort of back of the envelope you would think that a roughly similar performance absent any super major catastrophes would be on tap again for 2010. If that’s not correct I’d be interested to hear why. And if it is correct, at what point is AIC and therefore ALIC sufficiently capitalized at a point that you risk being over capitalized in that segment?

Tom Wilson

Dan, we think obviously as Don said we think we are well capitalized. We thought we were well capitalized at the beginning of the year when many people were concerned about that and we felt we had the strategies in place to keep ourselves well capitalized. And of course that turned out to be true and we’re happy that we had the performance we did. As we’ve always said, we have a long track record and history of doing what’s right for shareholders whether that’s our dividend or our share repurchase program. I’m feeling comfortable where we are today. I’m not so comfortable with the external environment that you should expect to see a dramatic change in that which we’re doing at this point. But obviously as the external environment changes, as our performance continues to be strong, we’ll keep thinking about that.

Daniel Johnson - Citadel Investment Group, LLC

Are you not comfortable enough to even consider replacing a piece of the lost dividend?

Tom Wilson

You know the dividend as I said, the dividend wasn’t really a capital issue. I mean it certainly helped capital by sort of $400 or $500 million, but when you look at the size of those numbers it’s important but it’s not the key driver. The dividend change was really you should pay out dividends out of what you earn. And when you look at our operating income and our net income last year that was about a 27 and maybe 50% payout, which is the net income one is obviously higher than you would see over a long term basis, the operating income looks about to be in line. And when you look at the dividend yield, it looks to be about where it’s traditionally been. So that’s the way we size the dividend, Dan, is based on how much money we’re making as opposed to using it as a way to give money back to shareholders. If we have extra capital, the most tax efficient way to give that back to shareholders is through share repurchases, not by raising the dividend.

Operator

Your next question comes from Matthew Heimermann - J.P. Morgan.

Matthew Heimermann - J.P. Morgan

The first question is can you just help me understand what happened with the statutory surplus in AIC this quarter? Did you actually pay a dividend to the hold co?

Don Civgin

No, we did not. However, what we did is put $400, I think $48 million into the life company.

Matthew Heimermann - J.P. Morgan

So it was a transfer from AIC to the life and then nothing at hold co?

Don Civgin

We did not take a dividend or put any capital into AIC. That’s right.

Matthew Heimermann - J.P. Morgan

I guess on the business that we don’t talk about very much, everything that gets lumped into the other segment, can you talk a little bit about two things? One, just what’s happening with respect to growth trends there and two, it looks like over the last three years you’ve been seeing ex-cats, ex-development, kind of a gradual increase in the loss ratio and I’m wondering if that’s mix or if there’s something else driving that.

Tom Wilson

Matt, just help narrow down, other is a pretty broad category. Are you talking about our emerging businesses? Are you talking about discontinued?

Matthew Heimermann - J.P. Morgan

Well, everything that’s non-homeowners and non-auto.

Tom Wilson

Okay, that would be our emerging businesses which is a large and diverse set of about five different businesses. Everything from commercial auto and a little bit of property in there into jet skis, motor homes, renter insurance. So if that’s where you’re at we’ll make some comments.

Matthew Heimermann - J.P. Morgan

Yes, that’s exactly what I’m talking about.

Joe Lacher

Yes, it’s down over the prior year and the prior quarter, principally as a result of some contraction in the business insurance side of the house. And that’s offset by some growth in some of those other businesses that we mentioned as a group. It’s a little bit of a hard number to read when you look at it in aggregate, because it has those diverse businesses in there. The declines would be driven by refocusing a little bit on what we’re doing in the small commercial space.

Tom Wilson

What we did before Joe got here was we repositioned that commercial business, we brought in some new management, we shut down a bunch of the operating centers to bring the cost structure down. So they’re well on their way and with Joe’s help here now we’re going to accelerate their performance in rebuilding that business actually and there were some reserve releases in that business, so I’m not sure the second piece of your question made it sound like there was some drift from prior years.

Matthew Heimermann - J.P. Morgan

Well, I actually was looking at the ex-cat and ex-development loss ratio looks like it’s been turning up and I’m not trying to imply it’s at an unhealthy level, just curious what’s driving that.

Tom Wilson

One driver underneath there may be some gap insurance we do through dealers, so.

Operator

Your next question comes from Joshua Shanker - Deutsche Bank.

Joshua Shanker - Deutsche Bank

Two related questions, one’s probably my own inability to crunch the numbers here. I’m just trying to understand the unrealized capital loss was stagnant pretty much from the end of the last quarter to this one, yet the DAC reserves came down dramatically. And then you had another small, you know, $178 million DAC charge in the Allstate financial book. I’m trying to reconcile all those three numbers together, how that works.

Tom Wilson

On the first piece, could I suggest that that was Vinay’s question to Don about shadow DAC, so if that answer didn’t work for you maybe we can [inaudible].

Joshua Shanker - Deutsche Bank

Yes. [inaudible]

Tom Wilson

On the second piece, Matt or Don do you want to make a comment, the question was on $145 million?

Joshua Shanker - Deutsche Bank

I guess $178 million DAC charged in Allstate financial.

Don Civgin

Well we continued to amortize DAC as we did in previous quarters through Allstate financial. And then the other thing is we did take against some of the realized capital gains we had in Allstate financial, we took some between operating income and net income as well. We took some amortization there.

We’re continuing to amortize DAC in Allstate financial as we always have.

Joshua Shanker - Deutsche Bank

So from that perspective we saw it in the third quarter, you know there’s the odd [second quarter], should we expect this to be a sort of run rate sort of view for the near term, given no real dramatic change in the investment portfolio?

Don Civgin

Run rate for what?

Joshua Shanker - Deutsche Bank

For the amortization rate of DAC.

Don Civgin

Maybe let me go up a second and answer it as it relates to Allstate financial operating income, because the DAC moves around depending on where investment income is, what kind of realized capital gains or losses you have. When we look at the operating income for Allstate financial, we feel good about its prospects going forward. Matt’s got a plan in place to begin to finish up on Focus to Win and to grow that business, which he might want to make a few comments about in terms of where the focus will be, but Josh I wouldn’t just focus on the DAC piece. I would look at the operating income. DAC kind of rattles through depending on what happens to the other components of that operating income as we go forward.

Robert Block

Josh, this is Bob. Christine and I can take you through the details of how that whole thing works after the call.

Joshua Shanker - Deutsche Bank

The other question was on muni, if you sold a bunch of munis during the quarter. You also had about a $450 million unrealized movement in the unrealized position. What’s your thought on munis and can you talk a little bit about the make up of the portfolio?

Judy Greffin

The make up of the portfolio continues to be a well diversified, fairly large portfolio. We are as you noted we are reducing the balance in munis. The unrealized position in the fourth quarter though was partially impacted by the rise in interest rates. So that’s a long duration portfolio relatively to the rest of our portfolio, and rates rose during the quarter.

Joshua Shanker - Deutsche Bank

So it’s not really credit related, it’s just interest rate driven.

Judy Greffin

I would say that, over the quarter. You know we’re not that crazy about the outlook for municipal credit but during the quarter there wasn’t any big move one way or the other.

Tom Wilson

In fact I would say that the market has been strong for municipals as people are seeking yield and are worried about increases in tax rates. So we’ve been selling into that because we’re more concerned about the long-term prospects given the 9 to 10% decline in state municipal revenue and balance sheets, which don’t look pretty.

Operator

Your next question comes from Paul Newsome - Sandler O'Neill & Partners, LP.

Paul Newsome - Sandler O'Neill & Partners, Liane J. Pelletier

Turning to claim frequency, is it fair to say that Allstate has had a level of profitability where they can’t pass on that increase in frequency? And at what point if frequency continues to rise do you think you can start pushing it out as [formed] rate?

Don Civgin

Paul, I would say a couple of things. First, there’s always 1,000 stories because there’s 51 different places that we go for pricing changes in the United States. And if you look at the average increases, they are small but consistent, reflecting what happens in that individual area. Secondly, I wouldn’t just look at frequency. I would look at frequency and severity combined. And if you look at that, which is called pay per premium, as you know that’s relatively modest and in line with where we are on average pricing, which gives us confidence to say we can be at 88 to 90 next year.

Operator

Your next question comes from Brian Meredith – UBS.

Brian Meredith - UBS

A couple of questions here for you. The first one, Bob, could you elaborate a little bit on the whole severity situation in homeowners? You said it was a mix of claims and exactly what happened there and should we expect that to continue here going forward?

Robert Block

In the quarter if you get more water damage claims versus fire versus lightning, that can distort the overall severity and it’s not something that you should necessarily expect each quarter happening. It’s a lever for these claims that get paid how that works out when you’re looking at the total homeowners’ severity.

Brian Meredith – UBS

And then the second question, on the investment yield portfolio yields, is there any more portfolio kind of repositioning to go here and if so, given where yields are right now, should we expect the portfolio yields to potentially move down a little bit here?

Judy Greffin

The portfolio repositioning, you know, as Tom said earlier we’ve made a lot of progress in commercial real estate; we’ve made some progress in repositioning the muni portfolio. We continue to expect that we’ll bring down our balances in commercial real estate and in municipals. In terms of the yields, we are monitoring yield very closely. You know the reality is, though, that when you reposition, rates typically are lower on the reinvest than they are coming off the portfolio. So we are risk mitigating and when you risk mitigate at times it eats some of the income.

Tom Wilson

The only thing that would change would be if short term rates of course which are near zero go up, you would expect to see higher investment income in our portfolio. Offsetting that some will be what Matt has to do to fix annuity rates, so it’s not like everything will come through the portfolio. But net net, it ought to help us increase our margins in the fixed annuity portfolio.

Operator

Your next question comes from Meyer Shields - Stifel Nicolaus & Co., Inc.

Meyer Shields - Stifel Nicolaus & Co., Inc.

I saw in the supplement that you’re breaking out the premiums for the direct channel and I was hoping to get either Tom or Joe to comment on what we should expect to see in terms of, I guess, supporting and advertising for the direct business.

Tom Wilson

Let me take it and if Joe wants to jump in, since I am trying to be cognizant of the fact that he’s been here I guess 90 days or close to 90, maybe not even 90, but first we do advertising in total. So when we run ads, they call our agencies, they call our call centers, they get on the Internet and when they get on the Internet they sometimes look at prices and they roll over to the agencies. So we don’t have specific advertising programs that are just targeted towards one channel, which is one of the benefits of our model which is we can spread that across all of our businesses and everybody gets a lift. So our current advertising’s working pretty well. We like the tone and tenor of the brand positioning has worked well. We pushed hard at price last year, which reduced some of the differential we had versus Geico and Progressive in terms of people thinking we were thinking more expensive so we reduced that some. We probably won’t have to do as much of that.

We continue to talk about our value going forward, which is what we would hope to do. In terms of the direct business, Meyer, I think you should expect to continue to see it grow because it’s working pretty well and it’s supporting all of our business activities.

Joe Lacher

I was just going to say I echo the comments and think that’s the direction we’re heading. And one of the strengths that the place has and one of the neat opportunities is the synergies and how effectively we’re allowing consumers to move back and forth between channels. So it’s a plus for us.

Meyer Shields - Stifel Nicolaus & Co., Inc.

Is it better to look at [healthy] owner retention on a sequential basis or on a year-over-year basis?

Tom Wilson

It depends on what you want to use it for. It provides insight in both cases, but it provides different insights. So I think there’s a value looking at it internally both ways and we look at it from a lot of different lenses.

Operator

Your last question comes from Alison Jacobwitz - BofA Merrill Lynch.

Alison Jacobwitz - BofA Merrill Lynch

I was just wondering if you could talk a bit more abut the life operation and maybe put some parameters around what you’re thinking for 2010 for earnings.

Tom Wilson

We moved away from the guidance, Alison, as you’ll remember a couple of years ago. We’re not anxious to go back there. We do like to provide some sense for what the largest business, that being the property casualty business, does absent catastrophes which are not highly predictable on either a quarter or an annual basis. But I think Matt could give you some perspective on, now that he’s been here over 90 days, as we kind of have a 90 day rule here, just barely, he can give you some perspective on the business and where he’s going to take it, which I think will help you be able to start to build out what you think the forecast will look like.

Matt Winter

As Tom mentioned in his opening remarks, we’re making some kind of fundamental, core changes to the strategic approach for Allstate financial. And we have developed what we have laid out as a six part strategy but I’ll kind of do the 80/20 rule here and focus on just two core pieces of that. The first is that we’re kind of making an all in bet. We believe the pot, the pot of gold here, is the existing Allstate channel and the existing Allstate customers and the ability to leverage the 12,000 storefronts and the mammoth customer base, the 17 million households that we have and supplement that with some worksite. So we are going to refocus and redeploy some of our resources, not necessarily to the exclusion of some of the other channels, but we are certainly going to minimize some of the investments being made in some of the other channels to allow us to really focus on the channel that we think has the greatest long-term opportunity.

And at the same time we’re focusing on that channel, we’re focusing on some different product sets. I think as the last 18 to 24 months have shown, an over concentration in spread based business, specifically book value annuities and some institutional funds, have hurt us. And we are shifting our concentration towards the underwritten products, the mortality and morbidity based products. And to the extent that we need and should offer income preservation products to our customers, we’ll probably do that through a different type of annuity that has a better risk return ratio, such as the market value adjusted annuities. And to the extent that we can get it to work in our environment, through equity indexed annuities that provide strong value to the customers as well as to Allstate.

So what you’ll see is a shift. You’ll see a concentration shift, again away from the spread based business towards the more underwritten products. And you’ll see a shift of resources towards working together with a protection organization and approaching our business here, not as an independent operating entity trying to compete in the vast life and retirement space, but to build enterprise value, working in conjunction with the rest of the organization, that we think actually gives us far greater leverage, a greater competitive advantage and a greater likelihood of success.

Tom Wilson

So, thank you all. Let me close. You know we’ve obviously faced a number of what I would call unprecedented challenges over the last couple of years, whether that’s high level catastrophes, tough competition in the auto insurance market, the financial market meltdown or an economic recession. We’ve successfully dealt with all of those challenges. A couple of ways we do it, being good at what we do, taking decisive action and focusing on the right answer rather than the constraints that we face. So we’ll continue to be proactive in driving shareholder value for you all, and we have three goals for this year, improved customer loyalty; reinvent protection in retirement for the consumer, and grow our businesses.

If we do that while we maintain the margins we have in our strong core businesses, we should drive good shareholder value this year and that’s what we’re up to. So thank you for your interest in Allstate and we’ll see you next quarter.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may now disconnect. Good day.

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Source: The Allstate Corporation Q4 2009 Earnings Call Transcript

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