Operator: Good day, and thank you for standing by. Welcome to Allstate’s Second Quarter Investor Call. At this time, all participants are in a listen-only mode. After the prepared remarks, there will be a question-and-answer session. [Operator Instructions] Please limit your enquiry to one question and one follow-up. As a reminder, please be aware that today’s call is being recorded. And now, I’d like to introduce your host for today’s program, Brent Vandermause, Head of Investor Relations. Please go ahead, sir.
Brent Vandermause: Thank you, Jonathan. Good morning. Welcome to Allstate’s second quarter 2023 earnings conference call. After prepared remarks, we’ll have a question-and-answer session. Yesterday, following the close of the market, we issued our news release and investor supplement, filed our 10-Q and posted related material on our website at allstateinvestors.com. Our management team is here to provide perspective on these results. As noted on the first slide of the presentation, our discussion will contain non-GAAP measures for which are reconciliations in the news release and investor supplement, and forward-looking statements about Allstate’s operations. Allstate’s results may differ materially from these statements, so please refer to our 10-K for 2022 and other public documents for information on potential risks. And now, I’ll turn it over to Tom.
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Tom Wilson: Good morning. We appreciate you investing your time in Allstate. Let’s start with an overview of results and then Mario and Jesse will walk through operating results and the actions being taken to increase shareholder value. Let’s begin on Slide 2. Allstate’s strategy has two components; increase personal profit liability market share, and expand protection services, which are shown in the two with on the left. On the right-hand side, you can see a summary of results for the second quarter. Progress is being made on the comprehensive plan to improve auto insurance profitability, which includes raising rates, reducing expenses, limiting growth and enhancing claim processes. While auto insurance margins are not at target levels, the proportion of premium associated with states operating and that underlying — underwriting profit has gone from just under 30% in 2022 to 50% for the first half of this year.
Mario will discuss the actions being taken to continue this trend and importantly, improved results in New York, New Jersey and California. Severe weather in the quarter contributed to a net loss of $1.4 billion, 42 catastrophe events impacted 160,000 customers and resulted in $2.7 billion of catastrophe losses and a property liability underwriting loss of $2.1 billion. Strong fixed income results from higher bond yields generated $610 million of investment income and Protection Services and Health and Benefits generated $98 million of profits in the quarter. The transformative growth plan to become the lowest cost protection provider is making continued progress. This both helps current results with lower costs and positions Allstate for sustainable growth when auto margins return to acceptable levels.
Affordable, simple and connected property liability products with sophisticated telematics pricing and differentiated direct-to-consumer capabilities are being introduced under the Allstate brand through a new technology platform. National General was growing, which will also increase market share. Specialty auto expertise, along with leveraging auto’s Allstate strength in preferred auto and homeowners insurance products are expected to drive sustainable growth. Allstate Protection Plans is expanding its embedded protection through new products and retail relationships and in international markets. Allstate has a strong capital position with $16.9 billion of statutory surplus and holding company assets, as Jesse will discuss later. And as you know, we have a long history of providing cash returns to shareholders through dividends and share repurchases.
Over the last 12 months, we’ve repurchased 3.9% of outstanding shares for $1.3 billion. We suspended this is repurchase program in July, as we had a net loss for the six months of the year. Improving profitability, increasing property liability, organic growth and broadening protection offered to customers through an extensive distribution platform will increase shareholder value. Let’s review financial results on Slide 3. Revenues of $14 billion in the second quarter increased 14.4% above the prior year quarter of $1.8 billion. The increase was driven by higher average premiums in auto and homeowners insurance from rates taken in 2022 and 2023, resulting in property-liability earned premium growth of 9.6%. Net investment income of $610 million reflects the impact of higher fixed income yields and extended duration, which will substantially increase income.
This growth more than offset a decline from performance-based investments in the quarter. The net loss of $1.4 billion and an adjusted net loss of $1.2 billion reflects a profit liability underwriting loss of $2.1 billion due to the $2.7 billion in catastrophe losses and increased auto insurance loss costs. In auto insurance, higher insurance pros and lower expenses were largely offset by higher catastrophe losses and increased claim frequency and severity. The underlying auto insurance combined ratio did improve slightly for the first six months of 2023 compared to the year-end 2022. Auto insurance had an underwriting loss of $678 million. In homeowners insurance, catastrophe losses were substantially over the 15-year average, resulting in a combined ratio of 145, generating an underwriting loss of $1.3 billion.
The underlying combined ratio on homeowners improved 1.9 points to 67.6% as higher average premiums more than offset increased severity. Adjusted net income of $98 million from protection services and health and benefits when combined with the $610 million of investment income offset a portion of the underwriting loss. The target for enterprise adjusted net income return on equity remains at 14% to 17%. I’ll now turn it over to Mario to discuss profit liability results.
Mario Rizzo: Thanks, Tom. Let’s turn to Slide 4. We are seeing the impact of our comprehensive auto profit improvement plan in our financial results, starting with the rate increases we have implemented to date. The chart on the left shows Property-Liability earned premium increased 9.6% above the prior year quarter, driven by higher average premiums in auto and homeowners insurance, which were partially offset by a decline in policies in force. Price increases and cost reductions were largely offset by severe weather events and increased accident frequency and claim severity. The underwriting loss of $2.1 billion in the quarter was $1.2 billion worse than the prior year quarter due to the $1.6 billion increase in catastrophe losses.
The chart on the right highlights the components of the combined ratio, including 22.6 points from catastrophe losses. Prior year reserve reestimates, excluding catastrophes, had a 1.6 point adverse impact on the combined ratio in the quarter. Of the $182 million of strengthening in the second quarter, $148 million was in National General, primarily driven by personal auto injury coverages in the 2022 accident year. In addition, prior years were strengthened by approximately $31 million for litigation activity in the state of Florida related to torque reform that was passed in March of this year. We’ve been closely monitoring the increase in filed suits on existing claims and the charge reflects a combination of higher legal defense costs and a modest loss reserve adjustment.
Despite continuing pressure on the loss side, the underlying combined ratio of 92.9 improved modestly by 0.5 points compared to the prior year quarter and 0.4 points sequentially versus the first quarter of 2023. Now, let’s move to slide five to discuss Allstate’s auto insurance profitability in more detail. The second quarter recorded auto insurance combined ratio of 108.3% was 0.4 points higher than the prior year quarter, reflecting higher catastrophe losses and increased current report year accident frequency and severity, which were largely offset by higher earned premium, expense reductions, and lower adverse non-catastrophe prior year reserve re-estimates. We continue to raise rates, reduce expenses, restrict growth, and enhanced claim processes as part of our comprehensive plan to improve auto insurance margins.
This slide depicts the impact of our profit improvement actions on underlying auto insurance profitability trends. As a reminder, we continually assess claim severities as the year progresses. And last year, as 2022 developed, we continue to increase report year ultimate severity expectations. The chart on the left shows the quarterly underlying combined ratios from 2022 through the current quarter with 2022 quarters adjusted to account for full year average severity assumptions, which removes the effect that intra-year severity changes had on recorded quarterly results. After adjusting for the timing of higher severity expectations, the quarterly underlying combined ratio trend was essentially flat throughout 2022. As we move into 2023, the underlying combined ratio has improved modestly in each of the first two quarters, reflecting both the impact of our profitability actions and the continued persistently high levels of loss cost inflation.
The chart on the right depicts the percent change at annualized average earned premium shown by the blue line and the average underlying loss and expense per policy shown by the light blue bars compared to prior year-end. Rapid increases in claim severity and higher accident frequency since mid-2021, resulted in significant increases in the underlying loss and expense per policy which outpaced the change in average earned premium and drove a higher underlying combined ratio in both 2021 and 2022. As we’ve implemented rate increases, the annualized earned premium trend line continues to increase and has begun to outpace the still elevated underlying cost per policy in the first two quarters of 2023, resulting in a modest improvement in the underlying combined ratio.
Slide six provides an update on the execution of our comprehensive approach to increase returns in auto insurance. There are four areas of focus; raising rates, reducing expenses, implementing underwriting actions, and enhancing claim practices to manage loss costs. Starting with rates, you remember the Allstate brand implemented 16.9% of rate in 2022. In the first six months of 2023, we have implemented an additional 7.5% across the book, including 5.8% in the second quarter. National General implemented rate increases of 10% in 2022, an additional 5.5% through the first six months of 2023. We will continue to pursue rate increases in 2023 to restore auto insurance margins back to the mid-90s target levels. Reducing operating expenses is core to transformative growth, and we also temporarily reduced advertising to reflect the lower appetite for new business.
We continue to have more restrictive underwriting actions on new business in locations and risk segments where we have not yet achieved adequate prices for the risk, but are beginning to selectively remove these restrictions in states and segments that are achieving target margins. To this point, the number of states achieving an underlying combined ratio better than 100 increased from 23 states, which represented just under 30% of Allstate brand auto insurance premium at the end of 2022 and to 36 states, representing approximately 50% of premium at the end of the second quarter. Ensuring that our claim practices are operating effectively and enhancing those practices where necessary, is key to delivering customer value, particularly in this high inflation environment.
This includes modifying claim processes in both physical damage and injury coverages by doing things like increasing resources, expanding reinspections and accelerating the settlement of injury claims to mitigate the risk of continued loss development. We are also negotiating improved vendor service and parts agreements to offset some of the inflation associated with repairing vehicles. Slide 7 provides an update on progress in three large states with a disproportionate impact on profitability. The table on the left provides rate increases either implemented so far this year are currently pending with the respective insurance department in California, New York and New Jersey. Because our current prices are not adequate to cover our costs in these states, we have had to take actions to restrict new business volumes.
As a result, new issued applications from the combination of California, New York and New Jersey declined by approximately 62% compared to the prior year quarter. In California, we implemented a second 6.9% rate increase in April and also filed for a 35% increase in the second quarter that is currently pending with the Department of Insurance. We continue to work closely with the California Department to secure approval of this filing and restore auto rates to an adequate level. In New York, we implemented approximately three points of weighted rate in June, driven by approved increases in two closed companies. And subsequently received approval for a 6.7% increase in the larger open companies, which was implemented in July, we will continue to make further filings in 2023 that will be additive to their — to the rates approved so far this year.
In New Jersey, we received approval for a 6.9% rate increase in the first quarter and filed a subsequent 29% increase in the second quarter. As mentioned earlier, we anticipate implementing additional rate increases for the balance of 2023 to counteract persistent loss cost increases. Slide 8 dives deeper into how we are improving customer value through expense reductions. The chart on the left shows the property liability underwriting expense ratio and highlights drivers of the 2.5 point improvement in the second quarter compared to the prior year quarter. The first green bar shows the 1.4 point impact from advertising spend, which has been temporarily reduced, given a more limited appetite for new business. The second green bar shows the decline in operating costs, mainly driven by lower agent and employee-related costs and the impact of higher premiums relative to fixed costs.
Shifting to our longer-term trend on the right, we remain committed to reducing the adjusted expense ratio as part of transformative growth. This metric starts with our underwriting expense ratio, excluding restructuring, coronavirus-related expenses, amortization and impairment of purchased intangibles and advertising. It then adds in our claims expense ratio, excluding costs associated with settling catastrophe claims because catastrophe-related costs tend to fluctuate. Through innovation and strong execution, we’ve driven significant improvement with a second quarter adjusted expense ratio of 24.7%. We expect to drive additional improvement, achieving an adjusted expense ratio of approximately 23 by year-end 2024, which represents a 6-point reduction compared to our starting point in 2018.
While increasing average premiums certainly represent a tailwind, our intent in establishing the goal is to become more price competitive. This requires a sustainable improvement in our cost structure with our future focus on three primary areas, including enhancing digitization and automation capabilities, improving operating efficiency through outsourcing, business model rationalization and centralized support and enabling higher growth distribution at lower cost through changes in agency compensation structure and new agent models. Now, let’s move to slide 9 to review homeowner insurance results, which despite improving underlying performance, incurred an underwriting loss in the quarter driven by elevated catastrophe losses. Our business model incorporates a differentiated product, underwriting, reinsurance and claims ecosystem that is unique in the industry.
Our approach has consistently generated industry-leading underwriting results despite quarterly or yearly fluctuations in catastrophe losses. Our homeowners insurance combined ratio, including the impact of catastrophes, has outperformed the industry by 12 points from 2017 through 2022. During that same time period, we generated annual average underwriting income of approximately $650 million. The chart on the left shows key Allstate Protection homeowners insurance operating statistics for the quarter. Net written premium increased 12.4% from the prior year quarter, predominantly driven by higher average gross premium per policy in both the Allstate and National General brands and a 1% increase in policies in force. Allstate brand average gross written premium per policy increased by 13.2% compared to the prior year quarter driven by implemented rate increases throughout 2022 and an additional 7.4 points implemented through the first six months of 2023 as well as inflation in insured home replacement costs.
While the second quarter homeowners combined ratio is typically higher than full year results, primarily due to seasonally high severe weather-related catastrophe losses, the second quarter of 2023 combined ratio of 145.3% was among the highest in Allstate’s history and increased by 37.8 points compared to last year’s second quarter due to a 40.3 point increase in the catastrophe loss ratio. The underlying combined ratio of 67.6% improved by 1.9 points compared to the prior year quarter, driven by higher earned premium, lower frequency and a lower expense ratio, partially offset by higher severity. The chart on the right provides a historical perspective on the second quarter property liability catastrophe loss ratio of 75.9 points, which was elevated compared to historical experience, reflecting an increased number of catastrophe events and larger losses per event.
While the second quarter result was 33.9 points above the 15-year second quarter average of 42 points, it is not unprecedented and filled within modeled outcomes contemplated in our economic capital framework. We remain confident in our ability to generate attractive risk-adjusted returns in the homeowners business and continue to respond to loss trends by implementing rate increases to address higher repair costs and limiting exposures in geographies where we cannot achieve adequate returns for our shareholders. And now I’ll hand it over to Jesse to discuss the remainder of our results.
Jesse Merten: Thank you, Mario. I’d like to start on Slide 10, which covers results for our Protection Services and Health and Benefits businesses. The chart on the left shows Protection Services where we continue to broaden the protection provided to an increasing number of customers largely through embedded distribution programs. Revenues in these businesses, excluding the impact of net gains and losses on investments and derivatives increased 9.1% to $686 million in the second quarter compared to the prior year quarter. Increase reflects growth in Allstate Protection Plans and Allstate Dealer Services, partially offset by a decline in parity. By leveraging the Allstate brand, excellent customer service and expanded products and partnerships with leading retailers, Allstate Protection Plans continues to generate profitable growth, resulting in an 18% increase in the second quarter compared to the prior year quarter.
In the table below the chart, you will see that adjusted net income of $41 million in the second quarter decreased $2 million compared to the prior year quarter, primarily due to higher appliance and furniture claims severity and a higher mix of lower-margin business as we invest in growth at Allstate Protection Plans. We’ll continue to invest in these businesses, which provide an attractive opportunity to broaden distribution protection offerings that meet customers’ needs and create value for shareholders. Shifting to the chart on the right, Health and Benefits continues to provide stable revenues while protecting more than four million policyholders. Revenues of $575 million in the second quarter of 2023 increased by $2 million compared to the prior year quarter, driven by an increase in premiums, contract charges and other revenues in group health, which was partially offset by a reduction in individual health and employer voluntary benefits.
Health and Benefits continues to make progress on rebuilding core operating systems to drive down costs, improve the customer experience and support growth that generates shareholder value. Adjusted net income of $57 million in the second quarter of 2023 decreased $10 million, compared to the prior year quarter, primarily due to the decline in employer voluntary benefits, individual health and higher expenses related to system investments. Now let’s move to Slide 11 to discuss investment results and portfolio positioning. Active portfolio management includes comprehensive monitoring of economic conditions, market opportunities, enterprise risk and return and capital, as well as interest rates and credit spreads by rating, sector and individual name.
As you’ll recall, last year, exposure to below investment grade bonds in public equity was reduced. We maintained this portfolio allocation in the second quarter, which enabled us to extend duration of the fixed income portfolio and increased market-based income levels. As shown in the chart on the left, net investment income totaled $610 million in the quarter, which was $48 million above the second quarter of last year. Market-based income of $536 million, shown in blue was $168 million above the prior year quarter, reflecting repositioning of the fixed income portfolio into longer duration and higher yielding assets that sustainably increased income. Market-based income has also benefited from higher yields for short-term investments in floating rate assets, such as bank loans.
Performance-based income of $127 million shown in black, was $109 million below the prior year quarter due to lower valuation increases and fewer sales of underlying assets. Our performance-based portfolio is expected to enhance long-term returns and volatility on these assets from quarter-to-quarter as expected. The chart on the right shows the fixed income earned yield continues to rise and was 3.6% at quarter end compared to 2.8% for the prior year quarter and 3.4% in the first quarter of 2023. This chart also shows that from the fourth quarter of 2021 through the third quarter of 2022, lowering fixed income duration mitigated losses as rates rose. Beginning in Q4 of 2022, we began to extend duration, which locks in higher yields for longer.
In the second quarter, we further extended duration to 4.4 years, increasing from 4 years in the first quarter. Our fixed income portfolio yield is still below the current intermediate corporate bond yield of approximately 5.5%, reflecting an additional opportunity to increase yields. To close, I’d like to turn to Slide 12 to discuss how Allstate proactively manages capital to provide the financial flexibility, liquidity and capital resources necessary to navigate the challenging operating environment. Capital management is based on a sophisticated framework that quantifies capital targets by business, product, geography, investment type and for the overall enterprise. Targets include a base level of capital for expected volatility and earnings as well as additional capital for stress events, situations where correlations between risks are higher than modeled and other contingencies.
This model enables us to proactively manage capital in a dynamic and uncertain environment. Utilization of reinsurance, both by event and in aggregate is assessed relative to overall enterprise risk levels. A robust reinsurance program is in place with multiyear contracts to mitigate losses from large catastrophes. Homeowners insurance geographic exposures are managed to generate appropriate risk-adjusted returns, including lowering exposure to California and Florida property markets. This framework was used to decide to purchase additional aggregate program coverage this year. Reducing high-yield bonds and public equities in the investment portfolio significantly reduced the amount of enterprise capital required for investments. This decision was based on market conditions and the decline in auto profitability as well as the desire to reduce volatility and statutory results.
It also provides a sustainable source of increased income in capital generation. The decline in auto insurance profitability is also captured by our framework, which increased capital requirements for auto insurance from pre-pandemic levels to reflect recent results. The capital management framework ensures Allstate has the financial flexibility, liquidity and capital resources necessary to operate in challenging environments and be positioned for growth. Allstate’s capital position is sound with estimated statutory surplus and holding company assets totaling $16.9 billion at the end of the second quarter, as shown on the table to the left. Holding company assets of $3.3 billion represent approximately 2.5x our annual fixed charges with no debt maturities for the remainder of 2023 and a modest amount maturing in 2024.
Senior debt and preferred stock refinancing in the first and second quarters of this year demonstrate our ability to readily access capital markets to address maturities as they arise. In response to the loss this quarter, we have suspended share repurchases under the $5 billion authorization, which is 90% complete. This authorization expires in March of 2024. In addition to having a strong capital base, Allstate has a history of generating capital and statutory net income in our largest underwriting company, Allstate Insurance Company, as you can see on the chart on the right. Statutory net income averaged $1.9 billion annually in the 10 years prior to the onset of COVID. You can also see the impact of the rapid increase in auto insurance claim severity and recent catastrophe loss experience on 2022 and 2023 statutory net income.
We’re confident that the auto insurance profit improvement plan will restore profitability. The homeowner’s insurance business is designed to generate underwriting profits, and proactive investment management will create additional capital to grow market share, expand protection offerings and provide cash return to shareholders. Allstate will continue to proactively manage capital to navigate the current operating environment and be well positioned for growth to increase its shareholder value. With that as context, let’s open up the line for your questions.
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Q&A Session
Operator: Certainly, one moment for our first question. [Operator Instructions] Our first question comes from the line of Gregory Peters from Raymond James. Your question, please.
Gregory Peters: Well, good morning, everyone. I guess, I’m going to focus on auto insurance profitability for my first question. And obviously, there’s a bunch of slides in your presentation, the one where you identified the three states. I guess from a bigger picture perspective, though, — do you have updated views on frequency and severity for the second half of this year or for next year versus what you were thinking at the beginning of the year I guess what I’m ultimately getting is how much more rate do we need to get that underlying combined ratio number that you use on the slide 6 — excuse me, slide 5 to get it down to the low to mid-90s.
Tom Wilson: Greg, this is Tom. Let me start, and then Mario can jump in. First, as it relates to frequency and severity, of course, it’s hard to predict what’s going to happen in the second half of the year. What we do know is that the severity was increased in the second — first half of this year from what we thought it would be when we looked at it last year. So we’re really glad we took the rates that we did, and we’ve been accelerating rates, as Mario talked about. I think when you look at it, it’s really — of course, it’s hard to predict, right? What you’re really looking at is that slide that Mario showed that had the line with the average premiums going up and then the bar with the severities and you want that line to be above the bar, of course.
What you know going forward is that the line is going to keep going up, right? Like we filed those rates, we’ve got those rates. We put them in the computer, we’re collecting the cash. And so you know that’s going to happen. What you don’t know is whether severity will go up from the 11% or whether it will be down from the 11%. It’s come down this year from last year. We’d like to think that all the work we’re doing will have it come down even further. And so that gap will get you back to the mid-90s that we talked about in terms of targeted combined ratio. When that exactly happens, of course, is dependent on what happens to the second bar, which is not known. What we do know is we’ll continue to take increased rates and make that line continue to go up.
Mario, any specifics you want to add on the three states that you mentioned or?
Mario Rizzo: I think, Greg, the thing I’d add is less about to Tom’s point, what we expect going forward and more about what we’re seeing and maybe just give you a little more color underneath the loss cost trend. So as you remember, last quarter, we started giving you pure premium trends as opposed to coverage specific frequency and severity because we just think it’s a better way for you to evaluate where overall profitability is going. And the point I’d make is if you look on Slide 5, as Tom pointed out, for the first couple of quarters this year, we’ve seen the average earned premium trend begin to outpace the increases in loss and expense. It’s hard to predict what the future will hold, but that’s an encouraging development.
Underneath that loss trend, if you look at where we’re at in the second quarter compared to where we were for the full year last year, the increase in pure premium is about 12.5%, and we told you that severity is up on average across all coverages by about 11%. So what we’re seeing still is persistently high severity across coverages with a lesser impact from overall frequency increases. The point being we’re going to continue to aggressively implement our profit improvement plan, you’ve seen what we’ve done with rates. We’ve done 7.5 points through the first half of this year in the Allstate brand, 5.5 points on National General. We’re going to continue to do that. You see the benefit that the cost reductions is having on the combined ratio while that rate earns in.
And we’ve talked a lot about those three states, which make up about one-quarter of our book, California, New York and New Jersey. We want to keep pushing on continuing to drive rate increases into the book. We’ve gotten some approvals so far this year, but there’s rates pending, pretty significant rates pending in California and New Jersey, and we’re prepared to file another rate in New York. So we’re going to keep pushing really hard on that. And in the meantime, we’ve scaled way back on new business production in those states. And while it’s having a reasonably small impact on the loss ratio so far this year, because new business just tends to be a smaller proportion of our overall book, it will continue to have a favorable impact on our loss ratio going forward.
And until we get to adequate rates in those three states, we’re going to keep restricting the volume of business we’re willing to write.