The Allstate Corporation (NYSE:ALL) Q4 2022 Earnings Call Transcript
The Allstate Corporation (NYSE:ALL) Q4 2022 Earnings Call Transcript February 2, 2023
Operator: Good day and thank you for standing by. Welcome to Allstate's Fourth 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. As a reminder, please be aware that this call is being recorded. And now I'd like to introduce your host for today's program, Mr. Mark Nogal, Head of Investor Relations. Please go ahead, sir.
Mark Nogal: Thank you, Jonathan. Good morning. Welcome to Allstate's fourth quarter 2022 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 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 there 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 2021 and other public documents for information on potential risks. And now I'll turn it over to Tom.
Tom Wilson: Well, good morning. Thank you for investing your time in Allstate today. I'll start by setting context and then Mario and Jess would provide additional perspective on operating results and the actions being taken to improve auto profitability and increase shareholder value. So let's begin on Slide 2. So as you know, Allstate strategy has two components: increase personal Property-Liability market share and expand Protection Services, which is shown in the two ovals on the left. On the right hand side, you can see our results for the year. Earnings were disappointing with a net loss of $1.4 billion, largely reflecting an underwriting loss on auto insurance and mark-to-market losses on the equity portfolio. Strong results from homeowners insurance, protection services and fixed income investments were not enough to offset the losses on auto and commercial insurance.
The most important driver of near-term shareholder value will be successfully executing our comprehensive plan to improve auto profitability. That includes broadly raising auto insurance rates, reducing expenses including temporary moves such as less advertising and permanent reductions including digitizing and outsourcing work and lowering distribution costs. Underwriting restrictions have been implemented to reduce new business volume until profitability is acceptable. Claims operating processes are also being modified to manage our loss costs. This plan is being implemented, but earned premiums from auto insurance rates have not increased enough to offset higher loss costs. And while the number one priority is to improve auto insurance margins, implementation of the transformative growth strategies make great progress in 2022, and we validated that this will drive personal Property-Liability market share growth.
Proactive investment risk and return management mitigated approximately $2 billion of loss this year. And while the total return on the portfolio was a negative 4%, that compares very favorably to the performance of the S&P 500 and intermediate bond indices. We also had another great year at Allstate Protection Plans. Moving to Slide 3, let's discuss financial results. Starting at the top, revenues of $13.6 billion in the fourth quarter were 4.9% higher than the prior year quarter, increasing the full year total to $51.4 billion. Property-Liability premiums earned increased by 9.5% in the fourth quarter compared to the prior year and 8.5% for the full year due to higher average premiums in auto and homeowners insurance. Moving down the table, an adjusted net loss of $359 million was incurred in the fourth quarter reflecting an auto insurance underwriting loss, which is impacted by reserve increases for the current and prior years.
Now let me turn it over to Mario to discuss our Property-Liability results and then Jess will cover the other components of earnings.
Mario Rizzo: Thanks, Tom. Let's start by reviewing underwriting profitability for the Property-Liability business in total on Slide 4. The overall message is that the underwriting loss was a result of auto insurance operating at a combined ratio above our targets, but homeowners insurance continued to be a strong source of profit. On the left chart, the recorded combined ratio of 109.1 in the fourth quarter was primarily driven by higher auto loss costs, unfavorable reserve development and higher catastrophes. This led to a full year recorded combined ratio of 106.6, which was 10.7 points higher than the prior year. The table on the right shows the combined ratio and underwriting income by line of business for the quarter and the year.
Auto insurance had a combined ratio of 112.6 in the quarter and 110.1 for the year, substantially worse than our targets given rapidly increasing loss costs throughout the year. This result was an underwriting loss of $974 million in the quarter and over $3 billion for the year. Hence, you can see why Tom has said executing our auto profit improvement plan is the number one priority going forward. Homeowners insurance, on the other hand, had excellent results with the combined with combined ratios in the low 90s, which generated $681 million of underwriting income for the year. This reflects industry-leading underwriting and risk management in this line of business. Commercial insurance was negatively impacted by the same auto insurance cost pressures, along with inadequate pricing for the coverage provided to the large transportation network companies.
The result was an underwriting loss for the year of $464 million. This led to the decision discussed last quarter to not provide insurance to transportation network companies unless telematics-based pricing is implemented and to exit five states in the Allstate traditional commercial business. These actions are expected to reduce commercial business premiums by over 50% in 2023. Now let's move to Slide 5 and discuss auto margin in more detail. As you can see from the chart on the left, which shows the auto insurance combined ratio and underlying combined ratio from 2017 through the current year, we have a long history of sustained profitability in auto insurance due to pricing sophistication, underwriting and claims expertise and expense management.
In 2020, the combined ratio dropped to 86 even though we provided customers with over $1 billion of shelter-in-place payments. This was due to historically low accident frequency in the early stages of the pandemic. In 2021, frequency increased as mileage driven increased, but it did not reach pre-pandemic levels. Claims severity, however, increased above historical levels because of more severe increasing costs to settle claims with third parties, who are injured in accidents with our customers. In addition, used car prices were increasing at unprecedented levels, eventually peaking in December, reflecting an approximate 50% increase over the prior year. We had a reported combined ratio of 95 for the year despite all these pressures. This year, the combined ratio increased 14.7 points to 110.1, the drivers of which are shown in the right-hand chart.
The red bars reflect the impact of increasing loss costs, including a 3.6 point impact from prior year reserve additions and a 16.7 point impact from current year underlying losses, excluding catastrophes, which include increases in both frequency and more significantly, severity compared to last year. As we discussed, the core component of the profit improvement plan is to raise auto insurance rates and substantial progress was made on this front starting in the fourth quarter of 2021 and throughout last year. In 2022, the impact of higher average earned premium drove a benefit of 3.6 points, which is shown in green. As I will cover in a minute, there is much more benefit to be realized in earned premiums based on what was implemented in 2022.
Another part of the profit improvement plan is to reduce expenses and this contributed a favorable 2 point benefit this year. Moving to Slide 6. Let's discuss prior year reserve re-estimates before we look forward. Our loss estimates and reserve liabilities use consistent practices, multiple analytical methods and two external actuarial reviews to ensure reserve adequacy. These processes led us to increase the reserve liability for prior years throughout 2022 by amounts that are larger than recent years. Property-Liability prior year reserve strengthening, excluding catastrophes totaled $1.7 billion or 3.9 points on the combined ratio for the full year 2022. The pie chart on the left breaks down the impact by line and coverage with $1.1 billion driven by Allstate Brand personal auto largely related to bodily injury claims.
In addition $295 million was related to Allstate Brand commercial insurance, also mostly related to auto. The table on the right breaks down the Allstate Brand auto prior year reserve strengthening of $1.1 billion in 2022 by report year. Let me orient you to the table. Reserve increases are shown by coverage in total and then for the report here to which they apply. The reserve liability for physical damage coverages was increased by $211 million, which was entirely attributable to 2021. This primarily related to adverse development and elongated repair time frames, which were primarily addressed in the first and second quarter. Injury reserves were the largest component at $676 million, which was spread across many report years. Incurred but not reported was increased by $226 million as late reported claim counts have exceeded prior estimates.
This reserve balance was increased in each of the first three quarters of 2022, but a larger amount was recorded in the fourth quarter. In total for all coverages about 63% of the increases were for 2021 and 2020. At the bottom of the table, the reported combined ratio for the calendar year is shown and compared to the reserve changes. For example in 2021, the reported combined ratios for Allstate Brand auto insurance was 95. The reserve additions indicate that costs were 2.1 points above this reported number. Estimating reserve liability utilizes multiple reserving techniques, but is always subject to strengthening or releasing reserves over time. This variability increases with changes in the underlying data, such as claim counts, settlement times, or cost increases and as has been the case over the past three years.
While reserves could change going forward, based on the 2022 claim statistics and data, reserves are appropriately established at year-end 2022. Moving to Slide 7. Let's provide some clarity on what the auto insurance combined ratio trend was by quarter in 2022. As you can see on the left-hand chart, the recorded combined ratio peaked in the third quarter at 117.4, largely reflecting prior year reserve changes and catastrophe losses shown in light blue. The dark blue bars are the underlying combined ratio, as reported, which increased each quarter. Included in this dark blue bar is the impact of increasing claim severities within the year. We update the forecast on claim severities as the year progresses. As 2022 developed, loss cost trends resulted in increases to current report year ultimate severity expectations.
As shown in the call out on the left chart, 2022 incurred severities for collision, property damage and bodily injury was 17%, 21% and 14%, respectively, above the full report year 2021 level. This estimate, however, increased throughout the year. The impact of increasing current report year on incurred severities as the year progressed influences the quarter underlying combined ratio trend. This impact from increasing full year severities from claims occurring in prior quarters is reflected in the financial results of the period where severities were increased. For example, the fourth quarter of 2022 reflects the impact of higher severity expectations in the auto physical damage coverage, not just for claims reported in Q4 but also for claims that were reported throughout the prior three quarters as well.
The chart on the right adjusts the quarterly underlying combined ratio to reflect full year average severity levels, which removes the influence of intra-year severity changes. As you can see, after adjusting for the timing of severity increases in the current year, the quarterly underlying combined ratio trend was essentially flat throughout 2022 and close to the full year level of 103.6. Slide 8 outlines our comprehensive approach to restore auto margins. There are four areas of focus: raising rates; a continued focus on reducing expenses; implementing stricter underwriting requirements; and modifying claim practices to manage loss costs. Starting with rates, since the beginning of this year, we've implemented rate increases of 16.9% in the Allstate Brand, including 6.1% in the fourth quarter, which significantly increased written premium.
Photo by Blake Wisz on Unsplash
We expect to continue to pursue significant rate increases into 2023 to improve auto insurance margins to target levels. We are also reducing operating expenses as part of transformative growth and have temporarily reduced advertising spend to manage new business volume. We are implementing more restrictive underwriting actions on new business in locations or risk segments where we cannot achieve adequate prices for the risk. Increased restrictions have been implemented in 37 states including California, New York and New Jersey, which account for a large portion of underwriting losses. Claim practices have been modified to deal with the higher loss cost environment. For example, we have strategic partnerships with part suppliers and repair facilities to mitigate the cost of repair and use predictive modeling to optimize repair versus total loss decisions and likelihood of injury and attorney representation.
Moving to Slide 9, let's discuss a key component of our multifaceted plan raising auto insurance prices. Growth in average premium per policy is accelerating due to implemented rate increases, but the impact to average earned premium per policy is on a lag due to the six-month policy term. The chart on the left depicts the year-over-year growth in auto average gross written premium in orange, reaching 14.4% in the fourth quarter of 2022. The auto average earned premium growth of 9.7% in the fourth quarter, represented in blue, continues to increase, but on a lag due to the six-month policy term. The chart on the right is an estimation of when the rate increase is implemented will be earned into premiums. Of course, actual earned premium growth will be influenced by changes in the number of policies in force and absolute levels of new business and retention.
This illustrative example assumes 85% of the annualized written premium will be earned since customers modify policy terms such as deductibles or limits where they may not renew. Starting on the left, over the last 15 months, we've implemented Allstate brand auto rate increases of 19.8% for an estimated annualized written premium impact of approximately $4.8 billion. Using the historical 85% effectiveness assumption nets a total of $4.1 billion in expected earned premium, represented by the second blue bar. Approximately $1.2 billion has been earned through the fourth quarter. Of the remaining $2.9 billion of premium yet to be earned, roughly $2.6 billion will be earned in 2023 and $300 million in 2024 as shown in green. As I mentioned earlier, we expect to implement additional rate increases in 2023, which will be additive to the figures shown on this chart.
Slide 10 illustrates the drivers that will determine the timing of improved auto profitability. The chart on this page is an illustrative view we've shown in the past on our path to target profitability along with the magnitude of actions already taken and required prospectively. Starting on the left, the first blue bar shows the year-end 2022 auto insurance reported combined ratio 110.1. To start with the normalized base, we removed the impact of prior year reserve increases and normalized the catastrophe loss ratio for our five-year historical average. This improves the combined ratio by roughly 4.5 points. The second green bar reflects the estimated impact of rate actions already implemented when fully earned into premium, which we discussed on the prior slide.
The impact on the combined ratio is approximately 10.5 points when combining the Allstate brand and the National General brand actions. Those two adjustments would improve the combined ratio to target levels. Now of course, we know that loss costs will increase, whether from severity or accident frequency, which would increase the combined ratio. So prospective rate increases and other margin improvement actions must meet or exceed loss cost increases to achieve historical returns. We continue to manage the auto insurance business with the expectation to achieve an auto insurance combined ratio target in the mid-90s. Moving to Slide 11, the table shows Allstate brand auto results in three major states: California, New York and New Jersey combined contributed approximately a quarter of the Allstate brand auto written premiums in 2022 but accounted for approximately 45% of the underwriting loss.
While rates were increased in 2022 by 7% to 10%, this is not enough to achieve target margins. As a result, we have more work to do, some of which is listed on the right-hand side. The right-hand side of the slide is a list of actions we are taking in each of these states to improve margins. In California, we filed for an additional 6.9% rate increase in January after getting approval for an initial 6.9% rate increase and are significantly increasing down payment requirements. In New York, while multiple rate filings were requested, only partial approval of the increases requires us to make additional rate filings in early 2023, increased down payment requirements, allowable prior incidents and channel restrictions means fewer choices for consumers until an adequate rate is approved.
In New Jersey, additional rate filings will also be made and similar underwriting actions will be implemented as those taken in New York. Moving to Slide 12. Let's look at a continued good performance story in homeowners insurance. As you know a significant portion of our customers bundle home and auto insurance, which improves retention and the overall economics of both product lines. We have a differentiated homeowners product, underwriting, reinsurance and claims ecosystem that is unique in the industry. Net written premium has increased significantly throughout 2021 and into 2022, increasing 9.3% from the prior year quarter and 12% for the full year, predominantly driven by higher average gross written premium per policy and a 1.4% increase in policies in force.
National general written premiums also increased as we improved underwriting margins closer to targeted levels. The fourth quarter combined ratio for homeowners of 92.6 increased by 5.5 points compared to the prior year quarter, while full year combined ratio of 93.8 and declined by 3 points compared to 2021. For the year, this line generated $681 million of underwriting income. The increase in the fourth quarter is shown on the right side. The increased combined ratio was driven by elevated catastrophe losses, primarily due to winter storm Elliot. Homeowners insurance was also impacted by the higher loss cost environment as we continue to experience higher severities due to increasing labor and material costs. To address the inflationary environment, our products have sophisticated pricing features that respond to changes in home replacement values.
And now I'll turn it over to Jess to discuss the remainder of our results.
Jess Merten: All right. Thank you, Mario. Well, property liability is a core business for us. There are other important drivers of financial performance to discuss, starting with investment income on Slide 13. As shown in the table at the bottom left, the total return of our portfolio is 2.5% in the fourth quarter and negative 4% for the year. These returns for our broadly diversified portfolio compare favorably to the full year performance for the S&P 500 of negative 18%, and to the Bloomberg Intermediate Bond Index return of negative 9%. Net investment income shown in the chart on the left totaled $557 million in the quarter, which is $290 million below fourth quarter last year. Market-based income of $464 million, which is shown in blue, was $101 million above the prior year quarter.
This is the third consecutive quarter of increase as we benefit from reinvestment at higher market yields. Performance-based income of $147 million shown in black was $369 million below a strong prior year quarter. Income this quarter included in negative contribution from valuation of private equity fund investments that was more than offset by positive contributions from direct investments along with positive returns for infrastructure in real estate. The chart on the right shows the fixed income yield is rising and was 3.2% at quarter end, but is still below the current intermediate corporate bond yield at 5.3%. Also shown is that duration increased modestly to 3.4 in the fourth quarter, primarily by removing approximately half of our duration shortening interest rate derivatives.
The migration of the portfolio to higher yield and the corresponding increase in income will happen over time as we reinvest portfolio cash flows into higher interest rates. With the portfolio in unrealized loss positions accelerating this shift by selling bonds to generate capital losses but will be pursued if it optimizes enterprise risk and return. Now let's turn to Slide 14 and talk more about how enterprise risk and return management impacts investment allocations and results. Proactive investment management is highly integrated with risk adjusted return opportunities across the enterprise. We discussed this in detail on our September 1 Special Topic call on investments. In 2021, we decided to lower overall risk levels given the declines in auto insurance profitability.
We also expected that sustained inflation would lead to higher interest rates. As a result, the economic capital deployed to investments was reduced. This led to a shortening of the bond portfolio through the sale of long corporate and municipal bonds and the use of derivatives. While adverse market conditions negatively impacted our portfolio, these actions mitigated losses by approximately $2 billion. In 2022, giving continued auto insurance losses, we decided to lower the potential for investment losses as the U.S. economy went into recession. At the same time, interest rates were increasing, offering a better risk adjusted return from fixed income. Consequently, holdings and below investment grade bonds were cut almost in half, and public equity holdings were lowered by 40%.
Late in the year, interest rates had increased in the duration of the bond portfolio was extended as shown on the previous slide. About half the duration shortening derivative position was removed in the fourth quarter, at the same time, this lowered the amount of economic capital deployed to investments. These actions optimize enterprise risk and return and provide flexibility to take advantage of investment opportunities as economic conditions evolve. The Protection Services businesses also create shareholder value, as shown on Slide 15. Revenues, excluding the impact of net gains and losses on investments and derivatives, increased 6.1% to $643 million in the quarter and 8.7% to $2.5 billion for the full year 2022. The increase in revenue for the fourth quarter and full year was primarily driven by Allstate Protection Plans growth of 16.9% and 15.7% respectively.
As you can see from the table on the right, Allstate Protection Plans continues to rapidly expand with written premium of $1.9 billion for the year. Allstate Protection Plans expansion in 2022 is primarily driven by our investment in appliance and furniture product coverages. We continue to believe there's a significant growth opportunity in these areas and in our continued expansion of European consumer electronics and other international growth. Given, the longer policy term compared to auto and homeowner's insurance products, the unearned premium balance continues to significantly grow as well, reaching $2.6 billion at the end of the year. For the segment, adjusted net income of $38 million in the quarter, increased $9 million compared to the prior year due to a one-time net tax benefit in Allstate Protection Plans.
Full year adjusted net income of $169 million, decreased $10 million compared to the prior year, primarily due to the lower revenue in Arity as a result of decreased insurer client advertising. We'll continue to invest in growing these businesses as they provide an attractive opportunity to meet customers' needs and create economic value for our shareholders. Moving on to Slide 16, Allstate Health and Benefits is growing an attractive set of businesses that protects more than 4 million policy holders. The acquisition of National General in 2021 added both group and individual products to our portfolio as you can see on the left. Revenues of $579 million in the fourth quarter of 2022, excluding the impact of net gains and losses on investments and derivatives, decreased 1.5% to the prior year quarter as a reduction in individual health was partially offset by an increase in group health and other revenue.
Adjusted net income of $50 million, increased $2 million compared to the prior year quarter, resulting in a full year 2022 income of $222 million. The full year 2022 result was $14 million above prior year and reflects increases in group health revenues partially offset by higher operating costs and expenses on group health contract benefits. Let's close by highlighting Allstate's strong financial condition and proactive approach to capital management, which you can see on Slide 17. We ended the year with $4 billion in holding company assets, which represents an increase of $700 million compared to year end 2021. We believe holding company assets and capital resources available from statutory operating companies provide financial flexibility as we continue to implement profit proven actions, invest in Transformative Growth and return capital to shareholders.
As you can see, our adjusted net loss in 2022 resulted in a negative adjusted net income return on equity. Executing our comprehensive plan in achieving target combined ratios for auto and homeowners insurance will bring adjusted net income returns and equity back to our long-term target range of 14% to 17%. In 2022, we returned $3.4 billion to shareholders through $2.5 billion in share repurchases and $926 million in common shareholder dividends. This resulted in common shares outstanding being reduced by 6.1%, reflecting the repurchase of 19.7 million shares in 2022. With that as context, let's open the line for your questions.
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