The Allstate Corporation (ALL) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to The Allstate Fourth Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Mr. Pat Macellaro, Vice President of Investor Relations. Please go ahead.

Thank you, Jonathan. Good morning and welcome, everyone, to Allstate's fourth quarter 2015 earnings conference call. After prepared remarks by Tom Wilson, 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, and posted the results presentation we will use this morning in conjunction with our prepared remarks. All of these documents are available on our website at allstateinvestors.com. We plan to file our 2015 Form 10-K later this month. 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 2014, 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. We're recording the call today and a replay will be available following its conclusion. I'll be available to answer any follow-up questions you may have after the call. And now, we'll turn it over Tom Wilson.

Well, good morning. Thank you for investing time to keep up on our progress at Allstate. I'll cover an overview of the results and then Pat and Steve will take you through the details. Our comments today are more detailed on four topics to make sure we provide you with good transparency. I will spend some time discussing our rationale for 2016’s underlying combined ratio outlook, Pat will provide more detail on the auto profitability plan, Steve will discuss the asset liability investment decisions including Allstate's financial – operating income and the impact that has on operating income. And then Steve is also going to provide some prospective on the overall investment portfolio. That will include both the investments including limited partnerships and energy. Also in the room today to answer any questions on any and all topics are Matt Winter, our President; Don Civgin, who leads our Emerging Businesses; Judith Greffin, our Chief Investment Officer; and Sam Pilch, our Corporate Controller. So let's begin on Slide 2. We finished 2015 with a strong fourth quarter that was driven by our repositioned homeowners business, continued progress in executing our auto insurance profit improvement plan and reducing expenses. The underlying property liability combined ratio for the fourth quarter was 87.4, which brought the full year result to 88.7, which was within the original annual outlook range we gave last year at this time. The recorded combined ratio in the fourth quarter was 92.0, which generated $611 million of underwriting income. The comprehensive program we implemented shortly after a significant increase in auto accident frequency and claim severities include seeking higher approval for auto insurance prices, making changes to our underwriting standards to slow new business growth and addressing underperforming segments that does both of those, and reducing expenses. This proactive approach however did not offset the impact to the external trend and underwriting profits from our auto insurance declined significantly in 2015. Continued strong results from homeowners insurance and moderate catastrophe losses resulted in operating income of $1.60 per diluted common share for the quarter and $5.19 for the full year. And the return on equity on an operating income basis was 11.6% in 2015, down 1% from the prior year. Common shareholders received $691 million in cash during the fourth quarter and $3.3 billion for the full year through a combination of common share dividends and share repurchases. If you move to the chart on the bottom of the slide, revenues were up 1.2% for 2015 and property liability premiums grew by 4.8%. Net investment income declined 8.8% compared to the prior year and that reflects a smaller balance sheet, which is due to the sale of Lincoln Benefit in April of 2014 and the continued downsizing of our annuity business, lower interest income which resulted from shortening the duration of our fixed income portfolio, and a slight decline in income from performance-based investments. Net income for the year was $2.055 billion, which was $5.05 per diluted common share. If you go to Slide 3, it shows our full year operating results for our four property liability customer segments. So total policy in force growth across all brands was 1.3% in 2015 as you can see at the top and the recorded combined ratio was 94.9. The Allstate brand, which is in the lower left is our largest segment and comprises 90% of premiums written and it serves customers who prefer a branded product and value local advice and assistance. Allstate brand total policies in force in 2015 were 1.7% higher than 2014. Auto insurance, which is on the left-hand side of that box, new business and retention were both impacted by profit improvement actions but policy still increased by 2.1% for the year. Homeowner policies grew over the prior year at a rate of 1.1% and other personal lines grew by 2.7% compared to 2014. The underlying combined ratio was a strong 87.4 for this segment at year-end 2015 as you can see in the red box at the bottom. Esurance in the lower right serves customers that prefer a branded product but are comfortable handling their own insurance needs. Growth was slow throughout2015 in this segment as our focus shifted to profit improvement. Policies in force were 1.4% higher at the end of 2015 than the prior year and net written premiums grew by 6.6%. The underlying loss ratio in Esurance improved by 1.2 points in 2015 and they neared 75.4. As a result, the underlying combined ratio declined to 108.4, which includes about 4 points due to a number of expansion initiatives. Encompassed in the upper left competes for customers that want local advice, but are less concerned about their choice of insurance company. This business decreased in size in 2015 as policies in force declined by 8.2% from a year ago due to lower new business and retention, which is largely a result of price increases and underwriting changes. The net written premium decline of 2.8% for 2015 that reflects higher average premiums from increasing rates to improved returns. The underlying combined ratio was 92.6 for 2015, which was 1.1 points better than the prior year. Answer Financial in the upper right that serves brand-new self service customers is essentially an aggregator that does not underwrite insurance risks. Total non-proprietary written premiums of $581 million in 2015 were 10% higher than the prior year. So let us go to Slide 4, looking forward to 2016 we expect our annual underlying combined ratio to be in the range of 88 to 90. That range is comprised of a number of key assumptions. First, we assume that we continued improvement in auto insurance profitability across all three brands given the profit improvement actions we undertook in 2015 and that will continue in 2016. We do expect modest increases in both auto accident frequency and claim severity, which reflects the broad based trends we experienced in 2015. Third, we assume the homeowners underlying combined ratio will increase slightly from last year's level and as our profit improvements are realized as we start to realize the benefit of the lower combined ratio we will continue to invest to generate long-term value, which will likely increase our expense ratio. As you know, of course, predicting frequency and loss trends in a rapidly changing external environment is difficult. As a result we put a range on our outlook every year. Now what you also know is that we react quickly to trends whether they are positive or negative to adapt our business priorities, so we are building long-term shareholder value. So our operating priorities for 2016 are designed to build long-term value and as you can see they are generally the same as 2015. Serving our customers and generating returns on shareholder capital are two top priorities and they are central to our plan. When we do these well we grow insurance policies in force. We intentionally slowed auto insurance growth in 2015 to improve auto margins since new business typically has a higher loss ratio than more tenured business. New auto insurance volumes in the Allstate brand declined by 24% in the fourth quarter as a result of tighter underwriting, lower advertising and increased prices. While these actions are necessary they are also flexible. So our appetite for new business will increase as the auto profit improvement efforts translate into a lower combined ratio. The largest factor in overall growth however is the rate at which we retain customers. The auto retention rate declined in the fourth quarter in part reflecting higher auto insurance prices. We are implementing actions to reduce the impact that will have on growth, but what competitors do in their pricing is also a major driver and that is not controllable. So our 2016 growth plans and prospects vary by customer segment. Growth in the Allstate brand auto insurance will depend on the timing of the successful implementation of auto profitability action and competitors’ pricing action. The sooner we see a lower combined ratio, the sooner we will increase new business. We do have growth plans in place for homeowners and other personal lines policies given the attractive returns on those products. We expect Esurance and Allstate Benefits to continue to grow in 2016. Encompass had a decline in policies in force in 2015 and is not yet in a position to grow. So we are still committed to growing policy in force across the company but it will be more difficult in 2016 than it has been in the past. Pat will now go through the property liability results in more detail.

Thanks Tom. Let's start with a review of our Property-Liability results on Slide 5. Beginning with the chart on the top of this page, Property-Liability net written premium of $30.9 billion in 2015 grew $1.3 billion or 4.2% over 2015. The recorded combined ratio for the year of 94.9, increased one point versus 2014 driven by an increase in auto losses, which was partially offset by lower expenses, strong homeowner underlying margins and catastrophe losses of $1.7 billion, which was 13.7% lower than 2014. As Tom mentioned earlier, the year-end 2015 underlying combined ratio of 88.7, while 1.5 points higher than 2014, finished within our original annual guidance range given the strong results in the fourth quarter. Net investment income for the Property-Liability segment decreased 4.9% from the prior year due primarily to lower performance based investment income. Property-Liability operating income in 2015 was $1.9 billion, which was 8.2% lower than 2014. 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 representing policy in force growth versus the prior year shows a slowing growth rate of 1.3% given the actions in place across all three underwriting brands to improve auto margins. Even with these headwinds, we grew policy counts 449,000 to 34.6 million in 2015 compared to 2014. The Allstate brand accounted for almost all policy growth in 2015 as Esurance policy growth slowed and Encompass policies were lower than 2014. These policy growth results exclude 5.6 million Allstate Financial policies, which grew by 6.1% in 2015 driven by 11.1% policy growth in Allstate Benefits. Average premium increases to reflect higher costs resulted in the net written premium trends you see shown by the blue line. The bottom right-hand side of this page shows property liability recorded and underlying combined ratio results. The recorded and underlying combined ratios both finished the year strong compared to results earlier in the year given our actions to improve auto returns. The underlying property liability combined ratio in the fourth quarter of 2015 was 87.4 and was 2.1 points lower than the fourth quarter of 2014. Slide 6 highlights the margin trends for Allstate brand auto and Allstate brand homeowners. The chart on the top left of this page provides a view of quarterly recorded and underlying margin performance for Allstate's brand auto. As Tom mentioned earlier, our fourth-quarter results continued to be impacted by elevated frequency and severity as they have been since the fourth quarter of 2014. Our efforts to respond to higher cost trends to price underwriting and expense management resulted in an underlying combined ratio of 97.6 in the fourth quarter of 2015, which was six tenths of a point improvement from the fourth quarter a year ago. On a sequential basis the underlying combined ratio improved by half a point compared to the third quarter of 2015. The chart on the top right highlights the trends driving the change in the Allstate brand auto underlying combined ratio. Annualized average earned premium per policy shown by the blue line continued to show upward momentum as rate increases implemented throughout 2015 resulted in a 3.9% increase in the fourth quarter of 2015 compared to the quarter a year ago. Average underlying losses and expenses per policy in the fourth quarter of 2015 increased 3.2% compared with the fourth quarter of 2014 given the influence of higher frequency and severity of lower expenses per policy. The gap between these two points remains positive but it is smaller than where it has been historically. Similar information is shown for Allstate brand homeowners on the bottom of this page. On the bottom left you can see that the favorable impact from low catastrophes that we experienced for most of 2015 continued in the fourth quarter resulting in the 71 Allstate brand homeowners recorded combined ratio. Lower frequency of fire claims in the fourth quarter benefited the underlying homeowners combined ratio which at 56 was 5 points below the results in the fourth quarter of 2014. Components of the fourth quarter homeowners underlying combined ratio are in the chart on the bottom right. Average earned premium per policy increased to $1085 or 1.9% over the prior year quarter. Underlying losses per policy decreased 6.6% in the quarter compared to the fourth quarter of 2014 resulting in continuing favorable underlying gap between the two trends. Slide 7 provides some context on combined ratio and top line trends for both Esurance and Encompass. The chart on the top of this page includes fourth-quarter and annual combined ratio results for both companies. Esurance’s recorded combined ratio of 107 in the fourth quarter of 2015 was 8.5 points lower than the same period a year ago given decreased investment in marketing, along with a 5 point improvement in the loss ratio, which is reflective of ongoing actions taken in the business to improve auto returns. Esurance’s combined ratio of 110.3 in 2015 improved by 7.4 points compared to 2014. Encompass’ recorded combined ratio of 95.5 in the fourth quarter of 2015 was 2.4 points worse than the prior year quarter and was adversely impacted by 2.9 points of higher catastrophe losses compared to the prior year quarter. Encompass’ combined ratio of 102 in 2015 was 4.1 points better than the full year results in 2014. The two charts on the bottom of this page show how growth is being impacted by profit improvement actions in both of the brands. In Esurance, policy in force growth slowed to 1.4% over the prior year and continued to decline sequentially while net written premium grew by 5.3% in the fourth quarter of 2015 compared to the same quarter a year ago. In Encompass, net written premium declined by 5.5% in the fourth quarter of 2015 compared to the fourth quarter of 2014 as the 8.2% decline in policy in force more than offset higher average premiums from increased rates and underwriting actions. As with the Allstate brand we continue to evaluate our results and will adjust profit improvement actions to ensure returns in both of these brands are appropriate. Slide 8 provides an update on our ongoing plan to improve auto returns. As we discussed throughout 2015, our auto profit improvement plan is comprised of four parts, which we have designed to work together to address the higher loss trends we are experiencing. First, we have sought approval for higher auto rate across the country. Second, we have implemented underwriting changes to slow new business and address specific underperforming segments of business. Along with underwriting changes we have also increased our ongoing credit classification programs. Third, we focused on claims operational excellence and precision. And fourth, we have reduced expenses across the organization to quickly impact the combined ratio while the other components took hold. These actions in total helped us to finish 2015 within our underlying combined ratio guidance range. Details to the fourth quarter of 2015 are shown on the bottom of this slide. Approved auto rate increases for all three underlying brands in the fourth quarter of 2015 are worth $401 million in net written premium while the total amount of approved rate increases for 2015 in total were worth $1.1 billion in net written premium, the highest amount of approved auto rate increases in over 10 years. We also continued to intentionally slow new business and make underwriting changes on isolated underperforming segments of business and geographies across the country to improve auto returns. These underwriting actions in conjunction with our credit classification programs and price increases have slowed new business and impacted retention. As Tom mentioned earlier, all of these actions are flexible and they are all driven by local market conditions. We will continue to adjust them selectively for market-to-market as auto returns improve. Maintaining claims operational excellence and precision also continue to be priorities given cost trends that we and others in the industry are experiencing. Property liability expense ratio decreased by 2.8 points in the fourth quarter of 2015 compared to the fourth quarter of 2014 and was 1.2 points lower than 2014 at year-end reflecting expense actions taken across the company. You can see the impact by underwriting brand in the chart on the lower left. These actions included reductions in advertising in the Allstate and Esurance brands, as well as professional services costs and lower compensation incentives across the company. The bottom right-hand chart shows the net written premium amounts generated by the rates we have received approval for over the past three years across all three underwriting brands. The Allstate brand represents the largest component of these rate increases accounting for $942 million of the $1.1 billion for the full year of 2015 and $342 million of $401 million for the fourth quarter of 2015. Rate and underwriting changes will drive customers to shop their insurance with other carriers, not renew their policies, or change their level of coverage, which will result in lower levels of premium in aggregate than what is shown on this chart. Allstate agency owners and their staff proactively consult with their customers during the insurance review process to arrive at the best coverage and deductible options for their specific situations and needs. We feel that having a trusted advisor to help guide customers understanding of protection needs during a period of rising auto prices across the industry is a key competitive advantage for us. This analysis only includes rates approved through December 31st. We continue to evaluate and run our business on a local market-by-market basis and continue to adjust our actions going forward whether it be through price, underwriting, claims excellence or expense management to ensure appropriate auto returns. And now I will turn it over to Steve, who will cover Allstate Financial investments and capital management.

Thanks Pat. Slide 9 provides an overview of Allstate Financial's results for the fourth quarter and full year 2015, as highlighted on the top of the slide. Overall we have made good progress and narrowed Allstate Financial's focus and positioned the business to support long-term value creation. In 2015, we continued our efforts to fully integrate the life and retirement business into the Allstate brand customer value proposition, and repositioned the investment portfolio supporting our immediate annuities. Premiums and contract charges in 2015 increased 4.2% when excluding the impact of the 2014 results of Lincoln Benefit Life Company driven by 5.7% growth in Allstate Benefits' accident and health insurance business as well as a 7.3% increase in traditional life insurance premiums. Operating income for 2015 of $509 million was 16.1% lower than 2014 driven primarily by higher life insurance claims, the disposition of LBL and lower investment income. In the fourth quarter operating income of $98 million was $30 million below the prior year quarter driven by a lower fixed income yield and a decrease in performance based long-term investment income. The bottom half of the slide depicts the liabilities and investments of our immediate annuity business. The approximately $12 billion of liabilities payout over the next 40 plus years our investment strategy is to match near term cash flows with fixed income and commercial mortgages. However, for longer-term liabilities we believe equity investments provide the best risk-adjusted returns. As such in the third quarter we sold approximately $2 billion of long duration fixed income securities to make the portfolio less sensitive to rising interest rates. Sale proceeds were invested in shorter duration fixed income and public equity securities, which will lower net investment income in the near-term. Over time, we will shift the majority of the proceeds to performance based investments that we expect to deliver attractive long-term economic returns although income will be volatile from quarter-to-quarter. Moving onto Slide 10 and investments. I will start with our portfolio composition at the top of the slide. We have a diverse $77.8 billion portfolio. Fixed income represents 74% of the portfolio value with $8.6 billion or 15% below investment grade. As we have discussed previously we are increasing and shifting the risk posture of our portfolio to deliver more attractive long-term returns. We traded capacity for this incremental risk by strengthening our capital position through issuing preferred securities, reducing debt, exposure reduction to catastrophe prone regions and shrinking our annuity business over the past two or three years. We are utilizing a portion of that capacity in our investment portfolio to increase idiosyncratic risk through performance based investing and selectively increasing our high yield holdings. Our high yield portfolio is conservatively positioned relative to the broader market weighted meaningfully towards BB and to a lesser extent single B issuers. We have also managed with [Indiscernible] to certain sectors including metals and mining and energy. Our portfolio breakdown by investment approach is at the bottom left. Within the context of these four approaches we target asset mix that reflects our risk tolerance and liability profile. Our market based core by far the largest part of the portfolio delivers predictable earnings aligned to our business needs. We seek to outperform the public markets and take advantage of volatility through our market based active strategy. We will be growing allocation through performance based investments, both [long-term] and opportunistic including private equity and real estate partnerships and direct investments. The majority of our energy holding shown in the middle table are investment grade corporate bonds. We are conservatively positioned versus the broader energy market preferring midstream and higher quality exploration and production players, which we believe are better equipped to withstand the dislocation of energy prices. With that said this is a dynamic environment, and the implications of the falling energy prices are being felt across the market. During the fourth quarter, 47 million of the trading loss is 82 million of the recognized impairments related to energy holdings. Losses were split between public and private securities. Details of limited partnership holdings in our performance-based long term strategy are shown in the table on the right. Approximately, three quarters of these investments are in private equity including timber and agriculture and one quarter in real-estate, [indiscernible] over the term EMA. Our performance based long-term strategy had strong results despite a lower fourth quarter, with 2015 being our second highest income year. We received significant cash distributions from realization in this portfolio, which have reduced the amount on distributed income related to our EMA investments. Moving now to Slide 11. Net investment income was $710 million in total for the quarter and 3.2 billion for the full-year of 2015. Investment income and yield by business segment is provided at the top of this slide. In addition to a multi-year shift in the long-term mix, we continue to proactively manage the portfolio in light of current economic and market conditions. This includes reducing the duration of our fixed income holdings in both the property-liability and Allstate Financial portfolios with a belief that the markets were not providing sufficient compensation for taking interest rate risk in the low yield environment. To left is property-liability. Reduce our interest rate risk in this portfolio in 2013, which resulted in a lower yield to the Allstate Financial portfolio. Yield is now increasing reflecting our increased allocation to high yield bonds as well as reinvestment in the higher interest rates are continued shift of the portfolios performance-based long-term investments. To the right is Allstate Financial. We took actions in 2015 to make the portfolio less sensitive to rising interest rates. As I covered a bit earlier in talking about the immediate annuity business which reflected in a lower interest bearing yield in 2015. Moving to the bottom half of the slide, at the left, is our GAAP total return. The investment income component of return has been fairly consistent or the valuation contribution was negative in 2015, on wider credit spreads across the market, with the majority attributed in our returns to invest in great securities given a weight in our portfolio. In the middle is our realized capital gains and losses. In 2015, we had a net capital gain of $30 million, which included 470 million of net gains on sales, including the gain and long duration fixed income securities we saw from the Allstate Financial portfolio. Largely offset by impairments and intent write-downs. The impact of lower valuations can be seen in the decrease on our fixed income unrealized gains in the chart to the right. Slide 12 provides an overview of our capital position and highlights the cash returns common shareholder received out 2015. Allstate remains in a position of financial strength and strategic flexibility. Our deployable holding company assets totaled $2.6 billion at December 31, 2015. Book value per common share was $47.34 as of year-end 2015 down 1.9% from 2014, reflecting lower unrealized net capital gains in losses on fixed income securities. Excluding this impact, book value per common share was 4.2% in 2015 versus 2014. We returned 3.3 billion in cash to common shareholders in 2015 to a combination of common dividends and common share repurchases. We repurchased 9.3 million common shares for $572 million during the fourth quarter of 2015, which brought the annual total to 42.8 million shares, 10.2% of our beginning of year common shares outstanding. As of December 31, we have 532 million remaining our current repurchase authorization which we expect to complete by July 2016. Now, let's open it up to call for your questions.

[Operator Instructions] Our first question comes from the line of Ryan Tunis from Credit Suisse. Your question, please.

Hey, thanks. Good morning. My first question I guess is just on the expense side. I appreciate there's a good amount of flexibility there whether it's advertising expenses or slower incentive comp. But I guess in the base case that you highlighted in your guidance that assumes I guess some step-up in severity and frequency. How should we think about the Allstate brand expense ratio?

I'll make an over a comment and Matt might have some perspective as well. First, you should expect the expense ratio to go up because we this year to make our goal, we did cut advertising, I wanted to improve some of the effectiveness to the advertising stuff anyway which move through advertising. And then we took some nice to do technology stuff and differed it and decided not to do it and cut some other expenses. And if you look at it, over the quarters you can see we increasingly reduced our expenses throughout the year which was a focus. That said, there were a number of things we're investing heavily and in one investment in term of either long-term growth or short-term growth, everything from technology I mentioned to things like telematics. Matthew, you want to add anything to that?

I think the only thing I would add Ryan, is that as Tom said in his prepared remarks, as we see the combined ratio in each local geography getting to an appropriate point in our loss ratios, getting where they need to be in the profit improvement actions fully taking hold in rate burning in. We will want to be able to stimulate growth in selected areas as long as we're earning appropriate return and growth requires some investment. And so, part of the expense ratio this year will be influenced by our growth plan and when we're able to turn on growth in certain areas and when we want to invest. We're focused on long-term value creation. And long-term value creation does require some investment, but it requires investment with appropriate levels of profitability. And so, it's flexible, it will go up, the degree it goes up will depend upon thoughtful analysis of whether or not we add appropriate profitability, appropriate margin, and whether or not we're going to earn an appropriate return on the investment.

Okay. That's helpful. And then my follow-up is just, I guess in the supplement, you guys a few quarters ago started breaking out gross versus paid frequency. In a way I understand it as you incur the losses based on what the gross frequency is and that's also what I think you guys tend to talk about what the investment community tends to talk about. But the paid frequency number has been running significantly below the gross, over the past several quarters. I'm just wondering how we should think about that, is there a possibility that you've been over-estimating what frequency is?

Ryan, at first we think our reserves are properly established. So, we do that in a bunch of different ways. We look at both gross and net. We look at what the original amount -- we do it by claims. So, when a claim comes up, we put up some dollar amount toward, then as they adjust -- more they keep building that up and at least to an incurred. And then obviously we think that we have to factor in future upward development in that. So, we look at that as well. So, we look at paid, incurred, incurred but not reported, and we come up with a number, obviously for things like physical damage claims where they really settled out in about 90 days. That tends to run through pretty quickly. The bottom of the injury where it takes about four years before you get 80% paid out, has a little bit longer trend line on it. And as a result of that longer trend line, you tend to have more process changes along the way because you do things differently every year. And so, that never tends to bounce around a little more. But I think we're appropriately reserved. I don’t think you should think there was more or less in there then than we thought it. It's the right number.

Thanks. I'll stop there.

Thank you. Your next question comes from the line of Josh Shanker from Deutsche Bank. Your question, please.

Yes. Thank you, very much. A two question. Tom, the first one's a revisiting last quarter actually. We talked about the 4Q auto acts and seasonality that did not seem to appear this quarter. In the end, is it just a dream or is there something really there or what do you think?

Josh, its Matt.

Hi, Matt.

How are you? I'm going to refer you to a page in the appendix that we put in there. If you look at the presentation slide 14, there is a whole bunch of drivers of the combined ratio and whole bunch of drivers, are these in frequency. Some of them are controllable, some of them are uncontrollable. Some of them we can manage and some we can't. Even within the ones that are somewhat manageable like new business quality and volume of new business and geographic mix, there's also some things that you just can't predict. Seasonality and weather especially is one of those completely unpredictable pieces of this puzzle. And so, when we look at year-over-year, you can look back, we have some charts to show fourth quarter seasonality that tend to spike up and then you have last year where we had almost no catastrophes and benign weather and this year much more normalized catastrophe year but I would say also a more normalized weather environment. Seasonality is one of those high level generalities that tends to pan out over multiple years, but you can have dislocation and abrasions in that on a year-by-year and quarter-by-quarter basis. So, I would not draw trend line conclusions based upon one or two quarters and how they appear versus previous quarters.

And Josh, I don't know if I'm reading into your question but it sounded like frequency was actually up quite a bit in the fourth quarter. So, I couldn't tell what your underlying assumption is. Matt has slide in there as well and the increase in frequency in the fourth quarter.

I would -- just look in the past and I have always am anticipating fourth quarter being a tough comp every year. My other question, look I listened to your prepared remarks and I know you are going to invest in the future and home owners can change a little bit, but you did an 88.7% underlying combined ratio firm wide for 2015. And you have a 5.5% rate increases coming through on the auto side, that you've guided to 88% to 90% underlying for 2016. It seems to me a very hard thing to believe that there is world where the underlying combined ratio is going to be worse in 2016 than it was in 2015. Are you just being conservative or I mean do you really think that that's the right range and 89% with a plus or minus one around it?

We think it's the right range. I think we've been doing this since I became CEO. I think it's like it's maybe the ninth or 10th year that I've done this. We've never missed it. So, we do it. So, that we think it's the right range but that's reasonable. You get a point swing either way from frequency and severity. I mean you can get, as Matt mentioned, you can't predict frequency and to be honest it's really difficult to predict severity within a point. So, that alone gives you two points spread. There have been some years, Josh, where we've had a three point spread but that was when we weren't sure how quickly the home owners business is going to take hold and we did quite well. We got ahead of that and it was faster than we had done in our modeling. But we do a lot of statistical modeling around this. We think it's about right I mean if you are right we will see a lot of rate come through that $1.1 billion. And if loss cost and which is result of frequency and severity keep going up which is what we have in our projections, we'll put more in rate increases. So, no, we think it’s the right number. I am not, we set it up to get there and if you want to assume your case, then that would in the middle of the range. We don't get to a precise, so we do at this tangible point. It's like I like to give just round numbers and we think 88 to 90 will be in that range.

All right. Well, good luck and I hope it will be even better than that.

Thank you.

Thank you. Our next question comes from the line of Amit Kumar from Macquarie. Your question please.

Thanks and good morning and congrats on the trend. Maybe two quick follow-up on Josh's question. First of all, just going back to the discussion on guidance and rate increases, how should we think about future rate increases, you've obviously have meaningful rate increases over the past few quarters. Are you factoring in that based on where we stand, that number to diminish or continue to ramp up from here?

It will be reflective of our results in the cost basis. So, if frequency and severity continue to increase, you'll continue to see us going to individual states with targeted rate increases. If it moderates, and I think we should expect to see it come down but we can't we don't know for sure.

So, I guess, related to that is what -- I mean, what are you baking in for frequency and severity here?

We have a plan, obviously, that we have frequency and severity, but when we move to do -- when we got away from EPS guidance, which I thought in our business didn't make a lot of sense. We said, we'll give you an underlying combined ratio guidance which excludes catastrophe. So, things we can pretty much predict, we think at 88 to 90 what happens with increases in frequency and severity, we can manage to it with the premium increases we will be able to get next year.

Okay.

We don't give out this specific sub-components. They just ends up being, it helps people do their models but it turns our conversations into one of modeling as opposed to the pace of the business. We feel good about the business where it is, we'd like to make more money in auto insurance even though the returns are above our cost of capital. We've made much higher returns in that at our competitive position and strength enabled us to do that and we are headed down that path. When we get there, we will be dependent what happens with the external environment.

Got it. That's fair enough. And just like there are some external factors, I know Josh was asking about this. One of the questions you were getting was the benign sort of weather in Q4. If you were to normalize it, would it be materially different what you are looking at in charts I guess 21 and 22 or would it be modestly different?

Well, let me talk about, so the fourth quarter we came in and we were able to get with insight our range. So, at 88, seven, for the year. The good weather really was a result -- wasn't really good weather necessarily. The home owners business feel a little better because we had fewer fire losses, which tend to be big losses. I don't know whether that's weather or just luck. We obviously on the other end of that which is completely controllable as Matt pointed out, is expensive. We did a good job getting expenses down because we want to be within the range. And then, the profit improvement actions did start to go through, but Matt, maybe lets -- maybe Matt taken to Slide 15 which shows the frequency. Just so because I think everyone saying it's like benign weather and like we had a big increase in our frequency in the fourth quarter and I don't want you to walk away thinking that it wasn't there.

Yes. So, Tom referred to Slide 15. What Slide 15 does is show what we believe is one of the primary drivers of frequency as we talked about on almost every call frequency is driven by primarily miles driven but also weather distracted driving, new business volume, new business quality and underwriting and miles driven itself is driven by employment or even gas prices. We know what's happened to both of those over this last year. One of the confusing things is that I have referred in the past to the fact that the frequency trend is wide spread. But I think some of you have taken that to me that it is consistent across the country. It is widespread but it is not consistent across the country, in fact it's geographically varied. And Slide 15 is just some data from the federal highway administration that shows how miles driven as of November versus prior year has gone up in each of the different regions and you will notice that in the North East it only went up 2.9 while in the West it went up 5.5 and South Atlantic 5.1 etcetera. So, this is one driver but it's a major driver and it does help to explain some of the other questions that you've been raising about why different companies have different experiences. They have different geographic concentrations of their business, books of business, and the miles driven in those areas is different. It will clearly impact results.

Got it. Okay. This is very helpful. Thanks for the answers.

Thanks, thank you.

Thank you. Our next question comes from the line of Bob Glasspiegel from Janney Montgomery. Your question, please.

Good morning, Allstate. Just an observation to when you hit your forecast nine years in a row, I guess it's another way of saying you tend to be conservative with your outlooks because no one is that good to be able to forecast. My question --.

And that's your way to say. And Bob, I will say that we have a good system, we have a great team. They are goal driven. They know how to deliver what we said we would deliver. If you had asked me as last year when we gave our range of 87, 89, did I think frequency and severity were in a clip up at above five points, I would have said "No". So, the point is you really can't forecast frequency and that what I -- we can do is tell you given the strengthen of our system and the transparency we have our management process is in place, we think we can manage to 88 to 90 next year and so that we've set out to do. If we do better than that, then that will be because we reacted well and did well but we don't set it up so we can be below it. I guess it's not the goal here because obviously as you would expect, you want to be balanced, thoughtful, and transparent with your shareholders. You don't want to under-promise and over deliver because then everybody will think well the whole world's falling apart, nor do you want to over promise and under deliver. So, we try to do it and what we think the system can delivery and we think 88 to 90. We did not set it up to be too optimistic or set out to be too conserved. It's right down the middle.

I hear you. My question is, I understand all your profit moves and am encouraged by the fourth quarter underlined showing some improvement, which suggest that you are on track. I guess I understand what you are doing in Allstate brand and Encompass, on insurance, trying to slow the growth dramatically, certainly fits within your profit objective and it seems like its own way to go to achieve your short-term plan. But I guess my question is are you where you want to be in scale in that business in long-term and what is your overall sort of long-term game play in insurance, how big you have to be in that business to be a long term player?

Let me make an overall long-term comment and then Don can give you some specific. So, insurance is twice the size from when we bought it three years ago. So, and we think it is of scale at a billion six because if you look at normal direct marketing company should be 10% of your premium you would spend on advertising and at a $160 million, that's enough media weight to make sure people hear you. If you're half that size, you don't, you just don't have enough throw weight in the marketing world. So, I think it's up scaled today. That said, we have good growth plans and I don’t want you to think that this is the backing off of insurance growth. Don can talk about the things we're doing to get into home owners and motorcycles and Canada and new market. So, there is plenty of growth up there. We just were managing this year to some objectives that Don had set with the teams. Don, maybe you want to comment about it?

Yes, Bob. First remember when we acquired insurance, we did it for the strategic reason of going into the lower right hand corner with the self serve rent sensitive customer and really focusing the customer value proposition against the GEICO and progressive direct model. And when we acquired it, what we said we were going to do is was run it for economics as opposed to GAAP accounting. So, as you know, in the direct model, your expense, all your marketing expense is up front. And as a result, the first year or the first quarter looks particularly bad when you are growing, but then in later years you tend to make money as the business retains and you don't have to spend in the marketing again. As Tom said, the business is now twice as large as it was when we acquired it a little over four years ago. It does have meaningful impact on where Allstate reports. And with twice as much growth we were having some pressure on the loss ratio. And so what we decided to do this year was slow the growth down, really focus on getting more efficiency out of our model that meant both on the marketing side and on the operation side. And I would tell you I am absolutely delighted with how they responded and how the business is doing. I mean you talk about slowing it down dramatically. It's still growing 4% to 5% in the fourth quarter and more than that for the year, not as high as it had been, but given the reduction in marketing, still a good growth rate. And the underlying combined ratio is down over eight points from last year in the quarter. So, we feel really good about where they are. Having said that, I would echo what Tom said, the business is at scale. It could run at this size with meaningful growth rates I think and certainly do it in economic way. But we do want to grow the business in the future as aggressively as we can. We just want to do it with a balanced profitability and growth. We felt that was getting a little out of filter a year or 18 months ago. We're getting it back in line now. We feel good about what they're doing. And the one other thing I would amplify is, I think Tom mentioned in his comments, we had four points of investment in 2015 that shows up in the combined ratio, but you don't get the benefit of those investments in the current year. Things like expanding home owners which is now in 25 states, renters which is in 20 states, motorcycles in all, auto continues to expand to 43 states and one Ontario in Canada as well. And so we are investing heavily in building our capabilities for the future, building out features and expanding our footprint. So, we have -- I think the answer to your questions, we have very aggressive growth plans for the future. We are investing heavily in that, but we want to make sure that we balance that with the economics and the reported results on a current basis.

Thanks for the thoughtful answers.

Thank you. Our next question comes from the line of Kaypaghian from Morgan Stanley. Your question, please.

Good morning, thank you. First question on capital management. And it looks -- [Audio Gap].

So, if we look back over the last couple of years, we set up our share buyback program really in a basis of as you put a capital that we have available. We sold Lincoln Benefit Life which we'd both on capital and also the proceeds from the sale. So, we move that up to the parent company $1.2 billion in 2013 and 2014. So, in 2015 we used a fair amount of backup, increased that buyback program but what may normally had been to a $3 billion level we're talking about. In addition, as I mentioned in my prepared remarks, we've done a fair amount of work at kind of bringing our risk profile down in the corporation which once again has freed up some capital. We do need to grow the business at the moment as we said I like that we are going to pool in more money into our investment portfolio to back that into the equity type investment. We will need some to put some money aside, it should grow the business and will also we have to pay our dividend obviously and what we free up essentially from net income, we pay out on a year lag generally in and our share buyback.

Okay. So, we're looking more probably like payout ratio run 100% levels?

Well, we don't do it that way, then of course where the banks do it, but we do it with [indiscernible] which is so we look at how much capital we need, then we say how much do we earn, how much do we have, and so we don't do it as a percentage of earnings.

Okay. It's great. And second question for Tom, it looks the change on Slide 4 of your operating priority seems to be down 16. Two thing, one is the number one is better serve a customer through innovation, in fact, in efficiency. Could you give some example of that and then the [indiscernible] item, basically the long term gross platform now you mentioned about acquiring. I just wonder what platform Allstate current lack that you would like to grow into and what's the [indiscernible] of your acquisition?

Okay. So, let me answer the last one in there, let Matt answer the first one. So, first, in terms of priorities, they are all important. So, they are not like we don't fight over which order they are in. And so Matt will talk about the customer which is obviously very important to us, but as important as all the other ones. We did add, was good catching [indiscernible]. We added the acquired to the bill long-term growth platforms. Long-term growth platforms are [Audio Gap] to acquire something to help accelerate those efforts where we would do that. Secondly, we believe that there is additional propensity in particularly the Allstate agency channel but also some in insurance to pick up adjacent products and services which are consistent with protecting and preparing people particularly as Matt makes progress on the trusted adviser model in the Allstate agency channel. We think there are other things we could sell in. We could either decide we want to get into the business, do filings, [indiscernible] and that kind of stuff, it's unique. Or if somebody has a platform that we can buy and we can bolt it onto ours, we would do that. So, that's the concept behind acquisitions. We didn’t put it in there because we have some specific target and I think will not talk about. Matt, you want to go through the customer piece?

Sure, Kay. So, you correctly pointed out that its customer base. So, it's all that customer centricity and using innovation effectiveness and efficiency not just to manage financials and manage margins but to better serve our customers. And there is three primary tracks of work going on under that category. The first is Tom just mentioned just trusted adviser and trusted adviser is all the work we have underway to help our agency owners and their staff and our exclusive financial specialists better serve our customers through personalized customized tailored solutions geographically based, that are advised based, not product push, that are solutions as opposed to transactions and based on long-term value relationships. And so, we have a lot of work underway there. And that goes to both the effectiveness of our agency system as a distribution model and the efficiency with which we put through product. The second major line of work that we have underway, is we refer to it as our continuous improvement, others refer to it as lean engineering. And we have installed continuous improvement in a good portion of the company already. It's a set of management principles and practices that empower frontline employees, get them involved in root cause problem solving, create flow of information, creating environment where they are engaged in their work and we have seen dramatic increases in productivity and efficiency of those operations that we've installed continuous improvement. We've also seen customer satisfaction and employee engagement in those areas. The third, and this is on really the innovation side the track of work we have underway, we refer to it as integrated digital enterprise but you've also heard me refer to it as a set of projects that take data predictive analytics and emerging technologies and combine those capabilities to better serve customers. And that includes a range of things that both use internal sources of data as well as external sources of data to provide more predictive guidance to our agency owners in serving their customers to help them better serve those customers, tell them what the next logical product for them might be. And to use those emerging technologies to deliver that in a way that's more accepted by the customer, more intuitive to the customer, and is more respectful of the customers time and energy. And so, you will continue to see a lot of focus there. As Tom referred to in his opening remarks, as he explained why the expense ratio may float up a little bit, we will continue to invest in all these core initiatives because they are all about long-term value creation. If we're able to better serve our customers through innovation effectiveness and efficiency, we will create a more valuable organization and we are all about that. And so, I thank you for asking the question.

Thank you, very much.

Hey, Jonathan, we'll take one more quick one.

Certainly, our final question comes from the line of Alison Jacobowitz from Bank of America Merrill Lynch. Your question please.

It's actually Jay Cowan as you could probably tell by the voice. Two questions. One is, you're obviously taking action as you've talked at length about to improve the auto profitability and you suggested that certainly the effect will depend partly on what your competitors do. Question is, what are your competitors doing, what are you seeing out there. And then secondly, relative to miles driven, arguably one of the reasons is lower fuel prices, would you suspect that oil going from 100 down to 40 has a bigger effect than oil going from 40 to 30, in other words the effect one might suggest would be declining over time.

Jay, its Matt. Those are two really good questions. First of all, what we are seeing part of our competitors, some of our competitors is a significant rate action in the filings that we're reviewing. As we make our filings, we see competitor rate filings as well. Some of them are quite significant, some of them are more moderate, most of it depends upon if you look back three or four years the level of rates they started this period. And so those who had a greater GAAP to cover in order to deal with the frequency and severity pressure are taking greater rates. So, we expect that to generate some increased turmoil in the environment and it will certainly generate shopping behavior in the industry and shopping behavior can be a positive or negative depending upon how you approach it, where you positioned and its all part of competition. So, we believe we are well positioned. We believe we are prepared for it. We believe we are monitoring their actions, but we are mostly focused on what we need to do to earn appropriate returns and serve our customers. And so, I would say our primary focus is always on managing our own business with an eye towards what the competitors are doing as opposed to trying to react the competitors all the time which I find can just drive you crazy. On your second question, it's a great point. There is a point of diminishing impact with gas prices on miles driven. We've always said that we thought the unemployment rate and economic activity had even a greater impact than the gas prices because economic activity impacts employment driving and gas prices typically impact only discretionary driving activities because if you have to go to work you have to go to work and you're going to pay $3 a gallon or you're going to pay $1.90 a gallon. If you are thinking about a vacation this summer and you're deciding whether to stay at home or drive down to Florida, if gases are a $1.60, it's probably going to influence you differently than if gas was at $3.50 a gallon. Now, there is a point at which though it's just plain cheap and it's no longer a question and I think we're probably at that point. So, I think you are correct in that from what we look at we think the biggest influence of the drop in gas prices has already occurred and it's unlikely that that will drive much further increase in miles driven. But that being said, we also don't know what economic activity is going to look like and what all the other influences on frequency will look like.

So, thank you all. I will leave you with a couple of thoughts. Allstate has been extremely strong operating platform. First, that enables us to react quickly to whatever peers in the world. Secondly, we proactively manage our risk and return on a consolidated basis, whether it's catastrophes, auto margins, investment returns or our capital structure; we look at it in total. And thirdly, we are focused on long-term value. We pay attention to current earnings because it is set along the way, but we will not give up long-term value equation [secured to earnings] [ph] because we believe that's what shareholders want which is creating long-term economic cash value. Thank you very much. We will talk to you next quarter.