The Allstate Corporation (ALL) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to Allstate's Special Topic Investor Call. [Operator Instructions] 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.

Thank you, Jonathan. Good morning, and welcome to Allstate's Third Quarter Special Topic Investor Call. This morning, we will discuss Allstate's proactive approach to managing our investment portfolio. After prepared remarks, we'll have a question-and-answer session. Jesse Merten, our CFO; and John Dugenske, our Chief Investment and Strategy Officer, are here with Tom to discuss investments. We will not be covering third quarter operating results or trends within our other lines of business. So please hold those questions until the third quarter earnings call in November. The slide presentation webcast can be found on our website at allstateinvestors.com. As noted on the first slide of the presentation, our discussion will contain non-GAAP measures 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. We are recording this call 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 I'll turn it over to Tom.

Well, good morning. Thank you for joining us today, particularly as you all get ready to blast off of Labor Day. Let's start on Slide 2, which reiterates our Allstate strategy to increase shareholder value. So our strategy has 2 components: increasing personal profit liability market share and expanding protection solutions, which are shown in the 2 ovals on the left. On the right-hand panel, we'll focus on both near-term performance and longer-term value creation. As you know, we're working hard to improve returns on capital by returning auto insurance margins to historically attractive combined ratios. And we covered this in detail in our special topic call in March and continue to make progress in implementing that plan. Our transformative growth is the initiative to increase market share in personal property liability. It is by building a low-cost digital insurer with broad distribution. That will make significant progress there as well especially on improving customer value through expense reductions and expanding customer access to the direct and independent agent channels. Shareholder value has also been increased by broadening the protection we offer to include electronic devices, appliances, furniture and entities [indiscernible] can see for our higher-growth businesses. In total, we have almost $190 million [indiscernible]. Today, we'll discuss how proactively managing investments is also a significant contributor to enterprise level. So let's move to Slide 3 and summarize how investment results do that. And there's really 3 main points here. First, Allstate's strong capital position and risk diversification enables us to proactively manage our investments. So as you know, we use our capital and funds from insurance reserve to invest for income and capital appreciation. And given the predictability of our cash flows and by investing a large part of the portfolio and investment-grade fixed income securities, we're able to invest in performance-based assets such as private equity, real estate, agriculture, infrastructure, and those generate higher returns because those investments have higher short-term volatility. Diversification of risk within the investment portfolio and across the enterprise also creates covariance, which enables us to increase overall return on equity. Secondly, our investment results are excellent relative to external benchmarks, and it reflects the system of people, processes and relationships. We have a $61 billion portfolio at the corporate level, which is 80% fixed income, 6% index public equity and 14% in the 14% main categories of performance-based assets. This has generated $11 billion in value over the last 5 years. Our comprehensive risk and return system that links goes from the granular CUSIP-level assessment, then into a portfolio view and ultimately to the enterprise, and what that does is it quantifies decision-making, establishes risk parameters and insurers accountability. Thirdly, we are proactive in our management, and that considers both the investment alternatives within the investment portfolio and the overall enterprise risk return conditions. That begins with comparing investment risk to underwriting and business risks. So today, we allocate about 30% of our total required capital investments and 70% to other risks. We proactively allocate between asset classes based on that 30%, based on a medium-term assessment of expected results. So John is going to give you an example of that by discussing a reduction in public equities we did in early 2020. Our investment allocations though are also changed based on the overall enterprise risk return. And so to highlight how we approach that, we'll discuss a reduction in inflation-related risk that we put in place late last year. Let's move to Slide 4 to put the pieces together, enterprise risk and return is usually look across the company to optimize risk and returns. So as I mentioned, today, we're at 30% of total capital allocated investments, but it's been higher. Pre-pandemic was up around 40%. From there, we created an investment strategy, which includes additional capital allocation and risk management and significant quantitative analytics. People, both internal and external are also key to our success. So as you see in the middle of the left page, our investment team is 125 front office professionals, most of whom are either CFH or have advanced to grade, a tremendous amount of successful experience in investment. And they're supported by 200 professionals in areas like IT, operations, finance, accounts, legal. We also use third-party managers to leverage their people processes and relationships while expanding our asset-type exposure. This team has value through dynamic asset allocation, active management of public assets and capturing the illiquidity premiums in idiosyncratic returns on the private markets. In total, this team oversees $71 billion of assets in both public and private markets. And now I'll turn it over to Jesse. And while Jesse has been on our team for a decade, today is his first day as CFO. As Mario has moved over to lead our Property-Liability business. Jesse, all yours.

All right. Thank you, Tom. Let's start by discussing the portfolio composition and how this adds shareholder value. Moving to Slide 5. The chart on the left highlights our investment teams, assets under management. As you can see, the significant majority back Allstate's insurance reserves and capital. We also manage investments for the company's pension plan and create collateralized loan obligations that generate fee income. The middle chart shows the $61 billion corporate portfolio by asset class with fixed income as the largest category. This portfolio is highly liquid, and gives us the capacity to capture value for shareholders with higher return assets that allow us to take advantage of short-term volatility and provide us the ability to reposition the portfolio. The chart on the right shows total investment returns in blue, which includes net investment income, realized gains and changes in unrealized gains. Underwriting income is shown in orange. Net investment income is a portion of adjusted net income, and was $7.6 billion over the last 5 years. The light blue portion of the bar represents net realized gains and losses on investments, and unrealized gains or losses, which were recorded in net income or directly to shareholders' equity, respectively. When combined, these increased book value by $3.5 billion over the 5-year period. The total value contribution from 2017 to 2021 from investments was $11.1 billion on this basis, which was slightly more than the $10.2 billion property liability underwriting income. On Slide 6, let's delve deeper into the fixed income portfolio. The left chart highlights the range of asset classes within our interest-bearing portfolio. We add value by allocating across these asset classes as market opportunities present themselves. Our credit research team has deep expertise in identifying opportunities across these sectors that allows us to add value through individual asset selection while managing downgrade risk. The middle chart shows the ratings profile of the fixed income portfolio. As you can see, about 89% of the portfolio is investment-grade, with about 1/3 in BBB bonds, which offer an opportunity to use our credit expertise to earn an attractive return for the higher risk. The allocation to below investment-grade is concentrated at the higher end of the rating scale. The fixed income portfolio provides significant liquidity and cash flow. As you see in the right chart, we are concentrated in the shorter end of fixed income market, which in part reflects our view on interest rates. Now let's turn to Slide 7 to discuss performance-based investing, which is our term for a broad group of liquid alternative investment categories. We have core capabilities, and actively invest in private equity, real estate, infrastructure and energy, timber and agriculture. On the left-hand bar chart, you can see that private equity at $5.3 billion is 60% of the total $8.9 billion, with the remainder diversified between the other categories. The large increase in performance-based assets between 2020 and 2021 was due to our decision to retain investments that are owned by our life company rather than transfer them in the disposition transaction. We retain these assets because we had the capacity to increase equity allocations like the specific investments, and provide a good diversification to the portfolio. The categories you see on the page provide risk diversification against public equity and fixed income markets, allowing for a more efficient risk and return profile. The long-term returns are driven more by the actions of managers, fundamentally changing and improving the operating and financial performance of a given asset, whether that's a company, a building, a toll road or an agricultural holding. In addition to the diversification by investment type, this portfolio is diversified by manner in which the investment is made, and the vintage year as shown in the 2 right-hand pie charts. We invest either through funds as a limited partnership, co-investing with the fund managers or directly. Through decades of relationship building, we've been able to invest with world-class partners whose economic incentives are aligned with our own in funds that represent 55% of the total portfolio. We negotiate co-investment rights of many funds to enable us to leverage our investment capabilities and allocating more to specific deals and reduce costs without taking on the responsibility to manage the investment. To a lesser extent, we made direct investments outside of fund investments. The right chart shows over the last decade, a broad diversified portfolio has been built with more than 400 investments in a wide range of vintage years. With that, I'll turn it over to John.

Thanks, Jesse, and good morning, everyone. Let's turn to Slide 8, which discusses how we add and measure value creation. Foundational to our value creation is the establishment strategic asset allocation, which optimizes long-term return for a given level of risk capital across several asset classes. While the strategic asset allocation is designed to be optimal over the long run, it isn't necessarily optimal as economic and market conditions change. Drawing from our extensive internal and external resources, we dynamically adjust portfolio exposures considering current and expected near-term conditions with the objective of adding value above long-term strategic allocation. Portfolio returns are also enhanced by leveraging Allstate's investment research capabilities and portfolio managers to actively manage individual public asset selections and identify attractive performance-based fund managers and assets. Moving to Slide 9 provides detail on how and why this adds value. Our investment processes are tailored to each asset class, utilizing an overarching philosophy, a deep fundamental analysis supported by quantitative tools can identify opportunities for performance enhancement within and between asset classes. A disciplined portfolio construction and market monitoring process is necessary to convert these insights and to enhance returns. The dynamic asset allocation process is outlined on the left-hand side of this page. We started by bringing together a diverse set of thinking that includes views of internal and external investors, economists, and economists to forecast risk-adjusted market returns across asset classes, formulating an overall opportunity set. Investors from across our teams debate additional qualitative factors to refine our expectations and calibrate expected returns and risk by asset class. Rigorous macroeconomic and fundamental analysis is used to test these views and identify portfolio modifications to optimize risk-adjusted return per unit of economic capital. We combined proprietary in-house analytics with external tools, including, for instance, BlackRock's [ land ] platform and others to manage the portfolio accurately and nimbly. This nimbleness is a key component of our ability to add value within both public and private markets. Trades are executed, and we monitor ongoing pricing will shift our positioning as opportunities evolve. On the bottom right-hand side of the slide, the chart shows 1 example of how analytics better, result in better risk-adjusted return profile. This chart shows the correlation of various performance-based asset types to S&P 500 since these have equity-like risk profiles. As you can see, these are not highly correlated, which as Tom mentioned at the start, enables us to benefit from the covariance of returns. This is 1 simplified illustration of the type of analysis that our portfolio managers leverage to assess risk and return decisions across all of our fixed income and equity asset classes. In practice, our day-to-day processes utilize hundreds of decision support tools, allowing us to consider multiple factors that drive markets, including economic relationships, market valuations, asset risk factors, market positioning and execution efficiency. Now let's move to Slide 10 to discuss our diversity, equity and inclusion initiatives. Promoting a diverse and equitable society is aligned with Allstate's shared purpose, and it improves our investment decisions and execution. This is a broad-based approach where we focus on how we invest, who we transact with, and who we hire and develop. Examples include allocating investment dollars to low-income housing initiatives, allocating funds to diverse owned asset managers and increasing trading with minority, women and veteran business enterprises. We're also using our position in the market to foster a more diverse range of talent entering the asset managed industry in the future. Moving to Slide 11. Allstate has chosen a customized investment strategy informed by enterprise capital allocation and investment portfolio construction that's differentiated from our peers. The chart shows the investment allocations for 6 insurance competitors broken out between investment grade, low investment grade credit, public equity and performance-based assets. Starting with the Allstate box in red, you can see our diversified mix of highly liquid fixed income and growth-oriented equity like investments with more idiosyncratic risk. This portfolio has a significant allocation to high-quality fixed income, which provides a stable income, earns attractive credit risk premiums and is highly liquid. This solid base enables us to invest in public equity and alternatives to capture long-run risk premiums. In comparison to the right, State Farm and GEICO has significantly more public equity exposure. To the left, the companies have a higher portion of investment-grade credit investments. This is not to imply that these are -- that any of these are right or wrong. They're just different based on a company's capital position, leverage, reserve duration and investment capabilities. This construct also enables us to proactively manage allocations, which I'll explain with a couple of examples, starting with the reduction in public equity holdings on Slide 12. In early 2020, COVID infections were rising rapidly, but there was not as much impact on financial markets. Our capital allocation process identified an increasing concern that equity valuations remains high, unsupported by S&P earnings potential, and the macroeconomic environment was weakening. As a result, we saw less value in public equities relative to investment-grade bonds on a risk-adjusted basis. As a result, our objective in this case, was to optimize risk-adjusted returns over the next several years by leveraging the capital efficiency of investment-grade bonds. We did this despite potentially missing capital appreciation and equity valuations by having lower risk. Our actions were to sell $4 billion of public equity, increased our investment in investment-grade bonds. As you can see in the lower right chart, we caught a wave and sold at 3,281 right before the market [indiscernible] temporarily. To be clear, we didn't predict the market fall, but we did proactively assess that we weren't getting enough adequate compensation for the increase of the event. The resulting stability of investment valuations supported our proactive decision to provide customers with approximately $1 billion of shelter-in-place paybacks. In addition, we continuously evaluate our portfolio to take well-informed actions throughout the year. For instance, we purchased $9 billion of investment-grade bonds as valuations became more attractive after markets adjusted to the uncertain environment. Allstate purchase intermediate bond yields declined by 160 basis points over the next 12 months increasing the value of our fixed income portfolio meaningfully. We did miss some of the subsequent run-up in equities, but our objective is to get the best balance risk-adjusted returns, not just to maximize total return. Now let's turn to Slide 13 for a second example. This more recent example highlights how enterprise risk and return influences proactive allocation. In early 2021, fiscal stimulus supply chain disruptions led to dramatic increases in used car prices, which dramatically reduced auto insurance margins. Our economic assessment was that this inflation was not transitory, but it was like a pig going through a python. With deals remaining close to multi-decade lows and the Fed [indiscernible] turning more hawkish, our internal assessment of various economic scenarios anticipated a longer and more severe inflationary trend which would lead to higher interest rates. The theory of fool me once, shame on you, fool me twice, shame on us, we decided to reduce the risk that continued inflation would have on the enterprise, primarily through the bond portfolio. We're willing to accept lower investment income to reduce the risk that higher interest rates would negatively impact on valuations. Another objective was to increase flexibility to take advantage of reinvesting in higher interest rates when they materialize. We took actions by reducing the fixed income portfolio from a duration of 4.6 to 3.2 which meaningfully reduced our interest rate risk. This did have a negative impact on investment income of about $50 million per year. That said, we avoided losses of about $800 million in the bond portfolio, and the futures position we put on also increased in value by another $470 million. If interest rates remain at current levels, investment income is expected to increase by an estimated $125 million to $150 million in 2023 relative to 2022, and this assumes normal portfolio turnover. For every 100 basis points increase in book yield, net investment income will increase by $400 million annually on our approximately $40 billion fixed income portfolio. Now let's review results in comparison to external benchmarks on Slide 14 before moving to questions. We focus our talent and asset classes where we believe proactive management can generate excess returns over passive investments. Within public markets, this means building credit research and portfolio management capabilities across sectors that we highlighted earlier. Similarly, we've built a private markets team with both direct deal and fund allocation experience across different asset types. To allow these market professionals to focus on identifying return opportunities, we've also resourced a variety of other functions, including risk managers, autonomous, quantitative analysts that provide insights to broader portfolio allocation decisions. Market savvy investors are necessary but not sufficient condition for a strong performance-focused culture. Let's turn this talent into excess returns, we execute deliberately, focused on asset class specific investment processes. All our processes start with fundamental insights such as how and why do we think a specific market opportunity exists. Then where possible, we look to augment that with quantitative analysis to increase the traction of these insights. We believe in rigorous performance measurement and comparing our results to others to other ways that Allstate could have investment. This is necessary that it creates a feedback loop for continuously refining our process. We know we can't do everything ourselves in isolation. Consequently, we actively seek and leverage relationships with other world-class investors. We use external managers for asset classes so they can deliver broader exposure, and potential for excess returns. We also leveraged economic and market insights of others. We use our relationships across private asset industry to gain access to high-quality funds, and to source co-investment deals with strong expected returns. You can see the outcome below. We hold ourselves accountable to our investment performance by measuring against various benchmarks and an internally defined set of external managers. As you can see on the right, our performance compares favorably against this external view. For the fixed income portfolio, we're also -- we are in the first and second quartile of external managers. Our public equity holdings are largely indexed. The private equity portfolio has had returns far in excess of public equities, and is in the second quartile of performance when compared to a fund of funds benchmark. Real estate returns are in the first quartile. This year's negative results, and obviously reduced overall returns for the longer time periods, but we have the capital, liquidity, risk profile and capabilities to proactively manage as part of the cycle. We believe this approach to management adds value to Allstate and our shareholders. And with that context, let's open it up the line for questions.

[Operator Instructions] And our first question comes from the line of Charles Peters from Raymond James.

I guess congratulations, Jesse, on your promotion. I wanted to start off with Slide 9 and -- where you run through the correlation of performance-based strategies with the S&P 500. And I guess what I'm trying to do is reconcile what looks to be a favorably uncorrelated investment strategy to the market with what happened in the first and second quarters of '20. And I know you remember how the limited partnership portion of your portfolio, when we get to the second quarter, generated some losses. So just trying to reconcile that slide with what happened in the first and second quarter of '20? And then also what we're thinking about for the third and fourth quarter this year, given the market volatility.

First, Greg, I'm assuming you didn't change your name.

No, I do not.

No, you never know. But let me go way up a minute, and then I'll get John to talk about it. Obviously, there is some relationship between equities and you see that in the number. That's part of the reason why we invest because they are growth-related assets. So that's -- you do -- you would want no correlation to the public equity markets because there's those will look the equity market. As it relates to third and fourth quarter, we're going to stay away from that one as to what it means. But you do know that there's a lag between the performance-based assets, and what happens in the public markets because the [ GPs ] report on a 90-day lag. But John, do you want to talk about correlations, and maybe you can think about how you the correlation around the whole portfolio?

Yes. Yes, Greg, thanks for the question. And we think about this a lot. If I could expand this conversation, we have pages of correlations across all asset classes. And we also think about correlations and covers about how it fits with the rest of the enterprise in itself. And that's an important way that we achieve capital efficiency. With the case that you pointed out, when I look at these correlations, I would say that there's a lot of ways that you can calculate these. These tend to be true over longer periods of time. They tend to be true in most instances, but there's any specific period of time where they could deviate or they could become a little bit more or a little bit less correlated. If you go back to the beginning of 2022, you may recall that, that -- obviously, you recall that it was a really special time in the course of human events, but we also took special precautions in the portfolio at that point in time to be somewhat extra conservative given that the situation that was going on. And we wrote down prices and didn't take price increases from the previous quarter out of this, what was really a very specific onetime event. I would also say that when you think about correlations sometimes it's hard to be overly precise on private investments. We're really made up of a lot of little investments at any 1 point in time, we may have M&A activity where we have a realization of a particular deal or things go through a little bit slower. So correlations in a particular period can bounce around a little bit. We believe that these are generally true. But we don't take it as gospel, that if you look at the first number on the page, 0.65 is precise, it's meant to be a general indication over time.

And maybe, Greg, just add on to that. The performance base, I think sometimes the creation of the performance-based category to which we get to add up infrastructure real estate now. Sometimes people think PD equals PE. And as Jesse pointed out, it's only about 60% of it. When you look at the PE piece, it is very well diversified between industrials are like 19%. Healthcare is 12%. Info and technologies is like 12%. So you do get you get obviously a correlation to what -- that net allocation impacts [indiscernible]. Then of course, it's mostly North America. So when you're thinking about equity correlation, there's lots of different ways as John pointed out to think about it.

Yes. Greg, Tom brings up a good point. Some of our -- some of the sectors that you see on the page there, has some nice characteristics as it comes to inflation protection, too, that whether it's real estate rising rents or what can happen in timber and ag infrastructure, they have nice characteristics that if -- what's driving the marketplace might be 1 factor or another -- growth or value or inflation or what have you, we believe that this mix of assets and the growing parity of other things relative to private equity in the portfolio, provides a real nice mix, not only within the rest of the portfolio, but even within the performance-based portfolio, there is some correlation benefits.

Got it. The second question was on Slide 11, which I really like because it provided some perspective of how you're positioned relative to your peers. I don't want to put words in your mouth, but in time, I'm pretty sure you're ultimately focused on this targeted ROE. And your results compare favorably with most of those peers except for maybe progressive. I guess -- yet your valuation is sort of lagging. So I guess my question to you is, do you think this investment mix is the right mix to get you to a better stock valuation considering what's transpired at least this year?

Well, I too am would prefer that our multiples be higher and more reflective of ROE. And if you put it through our quantitative machine, I think we would spit out and pay off a [indiscernible], which is why we keep doing share buybacks. But as it relates to this mix and our overall results. Yes, I think it's right in total. So let me -- you start with enterprise capital and just how much money do we need as a company. And then -- and that's how we do our economic capital stuff. And then we have what we think we need in the insurance companies then we keep the strategic trucker. Once you get below that -- and obviously, the money that we don't need -- or don't think we need, we buyback shares. When you go below that, then you're like, okay, how do you allocate what you have to your various risk? How much you can't risk, how much auto underwriting risk, and we're managing through that all the time. So when we look at -- as I said, we're 30% now. We've been at 40%. We have ranges on where we think we'll go there. This portfolio mix is the right mix for the range we look at in terms of how we allocate overall capital. We do like the fact that it's got this nice blend of lot of fixed income, a lot of cash generated from a pretty stable returns and lots of liquidity, which gives us the ability to invest in less liquid. When you saw the we put the number in there. We are still really long liquidity. And when we measure liquidity, we don't say what could we sell. We say, what could we sell at a certain price without changing the market like in it's down in the basis points that were like -- and I'm interested if we could sell some, but we take a big hit on it. So we still have plenty of activity. So we like where we're at in total in terms of our capital level in terms of how we're allocating that capital to investments. We're comfortable being below what we were before in capital investments. But at some point, when we think the markets are turning, and we're back to I don't know if such a thing as normal economic growth, but I think you would expect to see our percentage of capital allocated to investments go up -- and we have the -- by having this portfolio, we have the capacity to do that. I mean you can't just decide you want a [ BNP ] within [indiscernible] and his team been working on PE for over a decade. You don't just -- you can't just turn that up on I'm comfortable or at.

Greg, I might just add 1 thing, too. What you see on the page there, that's kind of a static of course, representation of what people own. There's also how you manage it and how you own it. And I just give you a couple of examples. You look at the fixed income exposure there, and it still looks reasonably stable over time. What we've taken, as you saw or as you heard in the presentation, the interest rate exposure of that roughly in half of the portfolio during the year. So as market yields moved up, we just didn't feel that hit much as we would like to. So there's a story behind the story here. And just using some rough numbers here, in the last year ending June 2022, our portfolio was down about 3.7%. And we feel bad about that. We don't like losing money. However, during that same period of time, the corporate bond index, the Bloomberg Intermediate corporate bond mix was down 9%, and the S&P was down 11%. So if you just had a simple average of those, you get something like down 10%. Our portfolio was down 3.7%. So it's also how you own it, how you move around in the portfolio.

Our next question comes from the line of Tracy Benguigui from Barclays.

First, congrats to Mario and Jesse on your new role. As you know, ERM is near and dear to my heart given my background, I do like this presentation a lot. And a very fitting one for Jesse, given your prior roles as CRO. So I also have a question on correlation. I'm struck by the reference that investments consume only 30% of total economic capital on a diversified basis. I'm curious how you're able to hold on to high levels of diversification credit post your life sale. It might be helpful context just for comparison purposes to understand what the prior proportion of capital for investments when you used to own ALIC?

Okay. Going to get Mark Prindiville who's our Chief Risk Officer now to think about that. Let me maybe give you just a sense for overall. When we look at overall enterprise, we were longer interest rate exposure when we own the life company. And 1 of the reasons we thought about and decided to sell it was reducing our overall financial market risk because of that the -- when we sold the Life company, we reduced not only the interest rate risk but a bunch of other risks. And we still had, just call it, about the same amount of capital. And so when you take that risk off, then you have the ability to redeploy that capital in your percentage change. So Mark, maybe you want to -- can you address that perhaps with more specialties.

Sure. Glad to -- good morning, everyone, and it's a pleasure to hear from someone fellow colleagues with an interesting enterprise risk retire management. So as referenced several times on the call here the way we proactively shape the enterprise risk fund. We do that based on 3 risk and return principle. We maintain a strong foundation of capital and liquidity, and I -- making use of the investment portfolio to supplement the returns that we expect on the insurance side. We use risk capacity to build strategic value. That means higher returns on the investment portfolio allow lower insurance prices. And then we optimize risk-adjusted return what's the best overall portfolio, and that's why we like being in the middle of this diagram, as was referenced in the previous call. So you make a big corporate transactions such as selling your life and annuity businesses. You open up the whiteboard and you say, what do I view with my investment portfolio to get me back to an [indiscernible] mix because we did lose a lot of investment risk associated with that transaction. But as was mentioned earlier, we retained performance-based assets, which are high long-run sources of return they fit really well into our P&C portfolio as well. We like those assets. We targeted to extend the duration of the P&C portfolio that makes up for some of the interest rate risk that was lost in the Life annuities transaction. Now we didn't execute all of that because of market conditions at the time. But over the long run, we will run a longer duration in the portfolio to have a balanced mix, both within investments and the life annuities portfolio. And then we also customize our fixed income portfolios given that we have lost a lot of credit risk through the life and annuities transaction. So we use our risk and return principles to optimize holistically across liabilities and the investment portfolio, and we have made some pretty major shifts within investments as part of that transaction in order to maintain that balance.

Tracy, the other thing we do is we work hard on covariant. And so -- and how that will actually get used. So obviously, auto insurance returns are not as correlated to investment returns and home insurance returns aren't as correlated to either of those. And so that creates covariance. And Mark and his team actively work to make sure we allocate that covariance in a way that makes us competitive in the market. So to the extent auto and home are bundled together with most customers we leave that covariance down at the property liability business for them to manage that covariance. We said there's covariance between investments in auto insurance, we keep it at the top of the house. and we don't give it to either of them. We say, you got to still make the right return on your capital on a stand-alone basis. And then we get to decide what we want to do with that covariance they either reposition the portfolio or make other states. So I would say we've -- it's a -- we're probably -- I don't know which generation of risk management rent, but we're pretty maniacal about splitting up the numbers.

Okay. So it sounds like you're able to get to the same spot to own ALIC in terms of how much pull investments were on capital. That was a very helpful context. And I'm just wondering about the other 70%. Is there anything you could say about the proportion of capital consumed by prod-cat risk? Is that fair to say that's the majority.

No. I don't think it's a majority. I don't -- I mean, we do it a bunch of different ways. We have -- there's base capital, which is normal earnings. There's stress capital for 1 in 100 event we slice it I don't think I would say that -- I don't have the specific number maybe Mark -- how much just straight up cap risk takes of the overall capital account -- but we -- and it changes by year. So auto is going to come up with a little more. They get more capital now because of profits of them, which we think works to maintain overall long-term returns. So Mark, I don't know if you -- I don't know that I've seen the numbers, but that way [indiscernible] cap.

Yes. You have to remember that we think of our risk post reinsurance that we have on...

[indiscernible]

We didn't have that reinsurance, we would be fairly highly allocated to property risk. You're absolutely right. But again, this is part of shaping the overall enterprise risk profile, and we use levers in each conventional and they use derivatives on the investment side, the way we talked about earlier with interest rate futures. We'll use reinsurance on the liability side. And if you think about our enterprise risk profile, this isn't precise, but you can almost think of it bore experience is pretty evenly divided between auto and property. Once you're bringing into account of reinsurance we have on the property and the investment risk splits across fixed income and equity, it's almost a 4-quadrant approach. And again, that's where you get to that balance in the middle of Page 11 there, that gives you -- that over the long run, there can be short-term periods where correlations different from what you expect over the long run, you maximize diversification. You maximize your ROE and you build book value through time.

Our next question comes from the line of Paul Newsome from Piper.

I was hoping to get a little bit more color on the asset liability matching process. And it looks like -- and tell me if I'm wrong, all is by design in essentially a middle ground between having some sort of boundaries on duration match and cash flow matching but -- and some other companies that basically take a completely total return approach to the investment through kind of growing liabilities. If that's the case, can you talk about those boundaries a little bit more, about sort of how much of an interest rate that you'd be willing to make from a duration perspective, for example, or how much of an equity that you make based upon the market environment -- anti-match and cash flow matching and some other companies that basically take a completely total return approach to the investments in kind of growing the liabilities. If that's the case, can you talk about those boundaries a little bit more about sort of how much of an interest rate bet you'd be willing to make from a duration perspective, for example, or how much of equity bet you make based upon the market environment and what's going on with your liabilities performance?

I'll let Mark take the asset liability matching. And I think the answer on the -- how big a duration that John can talk about, but whatever decisions made would be embedded into how much capital the investments have. They don't have 30%, there's only so much you can -- they got to work between duration and [indiscernible] manage within that. I would say back to Page 11. The other thing I noted, and John mentioned it, but some of those numbers are based on the amount of capital people have. So State Farm runs a huge equity portfolio, but they got boatloads of equity. If we had that amount of equity, we wouldn't trade anywhere near some kind of multiple book value now because the return on is lower in total. GEICO, of course, is embedded inside the Berkshire Hathaway. And I would say, on a stand-alone basis, GEICO would not be able to run that level of equity in just the auto insurance business. If you go to the other side, it really depends, I think, in part on what people's exposure is. And we have relatively short tail as the liabilities of reserves. If you have a longer tail reserves that you have greater volatility, you might not want the kind of volatility that comes with owning PE. I don't know why they chose what they did. But I'm just saying everyone is different. Like as we said, like we're not right along because we're in the middle. We're just comparing where we are, so you have a sense for -- by investing in Allstate, what you get from us versus what you get from other people. Mark, do you want to jump on as liability? And then John, you can jump in the [indiscernible]

Well, I think that was exactly the right answer. If you look at Page 5, you can see our fixed income allocation by tenure and is clustered on the left side of the page. That's really the 2 reasons. Number one, [indiscernible] where the reserves are for the P&C business. And secondly, that's embedded in our market view at the moment. If you think about the rest of -- beyond reserve you thinking to surplus, we have equities that we think are a really good match for a long horizon. We can take the short-term volatility, as John mentioned, and convert that into long-run equity returns. And so we have deep experience in terms of asset liability managing, holding on 3 years of owning life annuities business. We think about that on the P&C side as well, and we think this profile appropriately matches us to the short-term nature of P&C liabilities while giving us flexibility to invest well in higher returning performance base and public.

Maybe just adding a little bit to what both Tom and Mark both said. If you take a look behind the scenes, we all sit around the same table and have these discussions. And the common currency by which we think about risk across the firm is this concept of economic capital that we're all extremely well versed in. It's not just people that sit at the table. It's people that populate all the teams. And it's very ingrained across the culture. So when it comes to how do you think about putting on a position in investment portfolio, there's probably more than 1 answer to that. The 1 answer is what delegated authority do we have in terms of economic capital to make movements in the portfolio on a regular basis. I would say, we have appropriate amount of latitude and that appropriate amount of latitude is what shows up in our ability to compete relative to peers and competitors outside of the firm. It's being able to move and react to markets as need be. The types of things that we're going to look at -- we look at a lot of things. We're not -- we're really a multifaceted investment platform. We're going to look at valuations. We're going to look at what we think the Fed is going to do. We're going to look at what we think macroeconomic indicators are going to do, how we are positioned, technical indicators. We're going to talk about traders that are trading the markets each day and just asking us what's the pulse of the market feel like right now. So when we look at a lot of different things when you come up with a very informed view supported by great proprietary quantitative tools to gauge what the magnitude of an interest rate movement could be. And then we apply the appropriate amount of portfolio positioning relative to that interest rate movement to figure out, is that within our delegated risk authority? And we do upside, downside analysis, all the normal things that you do. We look at it on a trade-by-trade basis. But importantly, we look at it in the portfolio context of the investment portfolio and the portfolio context of the overall firm, what does this mean. If we think we have a really good opportunity or if the enterprise has a particular need, like you saw in the interest rate trade that we did earlier this year, we may work together at our Enterprise Risk and return forum to expand that latitude even more in a very known and open manner. And that was kind of the beauty of what we did earlier in the year. We have views on both sides of the house, frankly, but it came together in a positioning that cut our interest rate exposure roughly in half in the investment portfolio and had a bigger impact on the overall firm results than if we would have just done it independently.

Our next question comes from the line of Elyse Greenspan from Wells Fargo.

My first question is on the low investment-grade corporate portfolio. It seems like you guys trimmed that to around 11% of the portfolio from 18% at the end of last year. So I was hoping if you could get more color on what you guys cut within the below investment-grade portfolio, are there certain sectors that you're concerned about within the corporate market? And it did look like you cut a bunch in consumers [ cyclical ] corporate. Is that in advance of a recession? And if you can give us color on what you might be rotating into?

I'll let John talk about the trade that we're making insight how you. Let me just start again though, at least with 30% total economic capital, gross investments, we allocate that between things like PE and other, in real estate some of which are not that flexible getting in and out of. It's like once we're in, we're in for a while. And so they then have to work with inside that to allocate how they want to do that. and then they make obviously trades inside that piece as well. We do play, I want to just reiterate I just covered it. We tend to play in the BB space rather than the B or C space for a variety of reasons. But John, you might want to cover as well?

Yes. Yes. Thanks, Tom, and thanks for the question, Elyse. Look, we think is appropriate asset allocation used in an effective way. If you think of the whole continuum of you've got cash and treasuries and municipal bonds kind of on the safer side. You work your way out into public equity, private equity, high yield is somewhere in between. And there's a -- what I would say is there's kind of a really nice efficiency of returns per unit capital used. So we like it. It doesn't mean we love it. there are times when we reduce it. Right now, we're carrying -- by my count, somewhere around 9% of the overall portfolio and below investment grade. And that was a conscious choice, just like we've reduced public equity because it's a growth asset and times are a little bit less certain. We feel the same way on the overall beta or the overall market exposure of high yield right now. So we've reduced that. In terms of individual sector, I'm not going to go through each one, and each deal. But yes, we do sculp the portfolio based on our views of the economy and what may play through, whether it's a particular consumer behavior, whether it's a troubled industry. And we really do. We've got a team of analysts. We've got a team of portfolio managers, and a lot of credit experience in the shop here that help us think through that. And we challenge it from a lot of different directions. Tom mentioned the idea of -- our focus is on primarily BB with some amount of B, that's really intentional. And that's a strategy that we put forth a number of years ago. We think it fits really well with what we're trying to accomplish portfolio and believe that it's kind of a nice risk arbitrage that if you look at yield less default rates over longer periods of time, what you'll find is, in our opinion, when you look at that BB range and somewhat in B, you're going to find that, that's the sweet spot in B. That's the crunchy part on the efficient frontier where you want to be because you get, in our opinion, more than compensated for potential downgrade or default risk by the additional yield that you have. It becomes a little less true as you move down into triple season and below. So we like where we're at. The question might be, why don't you own more of this? Well, we had a lot of tools in the toolkit. And we think that as we stated in the presentation, investment-grade credit is really liquid, and provides really a strong base. We also have some asset classes that are even more return-oriented, but -- and some of them we have less liquidity, and we are continually thinking about rebuying the portfolio on a day-to-day basis. We come in and we look at every position, and we say, is this exactly what we want to own today and we will sculp it. So you'll see us move things around. Hopefully, they move around in a manner that is predictable and logical as you look at it from the outside, but the goal is always to find the best risk-adjusted return for the portfolio and more importantly, for the enterprise and our shareholders.

And then my second question, you guys alluded to during the presentation, right, you have taken down your duration, right, in advance of some movement in interest rates. When would you consider lengthening that duration? And what should we -- what are you guys paying attention to?

We just had that conversation, Elyse. It's just that -- before, not right now. How about that? Beyond that, it depends how the world goes, what happens. We do -- we welcome the opportunity to generate more returns from higher interest rates. And we're positioned to do that when it happens on annual basis. What I will tell you is we invest for economics. Like we don't -- we tell the investment team, like don't worry about the book value impact. Don't worry about what happens to operating income, get total return, make the right economic choice and the rest of the work itself out.

Our next question comes from the line of Mike Zaremski from BMO.

So just as a follow-up on the previous answering question. So it sounds like the objective is still to kind of limit the impact of inflation if I'm kind of thinking about Slide 13, and your comments about not increasing duration. Can you remind us, historically, in terms of duration boundaries on the fixed income portfolio? Have you gone much lower than 3. Would you be willing to go lower than 3 years?

Yes. I'm trying to think on the historically, Mike, just where it's been. Three is pretty low, particularly when it's related to the duration of our reserves and we do a duration of reserves. There's lots of different ways to do it. There's the -- what's this current $100,000 I'm holding per case that's going to be pay out next week. And then there's the rollover effect that we're always in the business, and always have something pay out some time in the future. So we kind of move between those. But I doubt you'll see us go lower. Where we are in inflation is we still haven't solved in auto insurance. So when we saw that in auto insurance, we may feel differently about -- in fact, I'm sure we will have a different set of math on where we are at inflation risk in the investment portfolio. But right now, we got a lot to do. Maybe we do 1 more question, so you can give you all on...

Yes. Can I ask a follow-up?

Yes, sure.

Just thinking kind of longer term, about the investment portfolio allocation. So I guess, a lot of talk about telematics. And if you agree that over the long-term telematics based underwriting could be more accurate? And I guess you have to tell me if you agree with that statement. I guess could Allstate take more investment portfolio risk over time?

Yes. It will be more -- will be is more accurate, and we need to make it ubiquitous in the way we, I think, in the industry price auto insurance -- what that does for the risk profile of auto insurance is based on a whole bunch of other stuff. I mean just as a single thing. I'd be like, yes, you ever better, you're going to have left the adverse selection, but you've got competitive positions. You've got capital. You've got what's happening with the transportation plan, what happens is frequency even though we're not that much severe weather and auto insurance tail and was and stuff to hit that business. So I don't think you could come to a conclusion that telematics in and of itself would reduce the risk profile of auto insurance, so that, that would give us the freedom to the hold less capital in total, which is also a choice or allocate more sites.

Our final question for today comes from the line of Yaron Kinar from Jefferies.

I guess maybe following up on Elyse's question on the shift in the portfolio somewhat away from below investment grade. I did also notice that at the same time, the BBB portfolio grew a little bit. And I think it's probably the other side of that coin. Maybe you can talk a little bit about -- you do a similar analysis of the risk-adjusted turn that you see in BBBs, and how you think about the risk or potential of credit migration and impairments in that portfolio in that credit cycle.

Yes. Thanks, Yaron. I think you're thinking about it the right way. It's a continuum across all asset classes earlier I mentioned, from cash to private equity, they all have different factors that react to the market. And it's not necessarily when you move from one to another, it's a completely different thing. And that's the way that we think about it in the investment group. BBB In some ways, first, it's investment grade. When you think about bonds as they're classified, I think below BBB is high yield, anything above is investment grade. So it's a really safe and stable asset. We also find it to be a really good candidate to add additional value to the portfolio, for a couple of reasons. One, it has some of the characteristics that you see in BBs and Bs that we think relative to when you look at a Moody's default study or we have our own data streams on this. It's not likely you're going to get much bad activity in that area. And you do receive additional compensation in the marketplace versus A, AA and AAA bonds and government bonds to own it. So it fits in a really nice part of asset allocation. It remains liquid. So it's something that we can move around and express our views in pretty regularly. Three, it's really a good place for our analysts and portfolio managers to play because there's a lot of opportunities to look at something that might be rated BBB, but we really think internally, it looks more like A asset, and we anticipate that it might be upgraded at some point in time. There's also times when things get upgraded from high yield to end up in the BBB bucket. And if we're nimble, and it was a big part of our investment process, we can add those before that's fully priced into the marketplace. Over time, that BBB bucket has just grown in the industry. as a percentage of overall outstanding investment-grade bonds. If you look back -- and I don't know the specifics in front of me, but part of what you're picking up on, if you go back 10, 15 years, that bucket was a lot smaller, and it's a lot bigger. Just as the [indiscernible] corporations in America have changed the way that they want to structure their finances. So part of it is an intentional view of us is where we think the sweet spot is. Part of it is also just what's the makeup of the index that we can invest into.

And Yaron, let me maybe add is an enterprise top of that. So we give investments at 30%. Let me put that in bond that comes with both interest rate risk and credit risk in both interest rate return and credit return. When we shorten duration and you sell a bond, you lose book. And so John's team is trying to make sure that we wanted to reduce the interest rate exposure, but we weren't necessarily trying to reduce the credit spread returns we're getting. So they get to and to modulate between those. Okay. Thank you all for participating and investing in Allstate. That's a triple on both your time, your money and your interest level. So we have both a capital risk diversification processes. They have the analytics, we have people to earn additional returns for our shareholders to what you've heard about as proactive -- much time to talk about that on the quarterly opportunity. So this was a good opportunity for us to share with you how we do what we do we don't purport to make every trade correctly or to be -- have every decision right, but we do try to balance enterprise risk and return and make the appropriate decision to increase shareholder value, and we have a great track doing that. So thank you for your time, and we'll talk to you in the third quarter.

Thank you. This concludes the Special Topic Investor Call. You may now disconnect.