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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS I (1)(a)
AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED
DISCLOSURE FORMAT.
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-31248
ALLSTATE LIFE INSURANCE COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
ILLINOIS 36-2554642
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
3100 SANDERS ROAD 60062
NORTHBROOK, ILLINOIS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (847) 402-5000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE SECURITIES EXCHANGE ACT
OF 1934: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE SECURITIES EXCHANGE ACT
OF 1934: COMMON STOCK, PAR VALUE $227.00 PER SHARE
INDICATE BY CHECK MARK IF THE REGISTRANT IS A WELL-KNOWN SEASONED ISSUER, AS
DEFINED IN RULE 405 OF THE SECURITIES ACT.
YES /X/ NO / /
INDICATE BY CHECK MARK IF THE REGISTRANT IS NOT REQUIRED TO FILE REPORTS
PURSUANT TO SECTION 13 OR SECTION 15(d) OF THE SECURITIES ACT.
YES / / NO /X/
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES /X/ NO / /
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. /X/
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A LARGE ACCELERATED FILER, AN
ACCELERATED FILER, A NON-ACCELERATED FILER, OR A SMALLER REPORTING COMPANY. SEE
THE DEFINITIONS OF "LARGE ACCELERATED FILER," "ACCELERATED FILER," AND "SMALLER
REPORTING COMPANY" IN RULE 12b-2 OF THE EXCHANGE ACT. (CHECK ONE):
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LARGE ACCELERATED FILER ACCELERATED FILER NON-ACCELERATED FILER SMALLER REPORTING COMPANY
/ / / / /X/ / /
(DO NOT CHECK IF A SMALLER REPORTING COMPANY)
</Table>
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN
RULE 12b-2 OF THE EXCHANGE ACT).
YES / / NO /X/
NONE OF THE COMMON EQUITY OF THE REGISTRANT IS HELD BY NON-AFFILIATES.
THEREFORE, THE AGGREGATE MARKET VALUE OF THE COMMON EQUITY HELD BY
NON-AFFILIATES OF THE REGISTRANT IS ZERO.
AS OF MARCH 14, 2008, THE REGISTRANT HAD 23,800 COMMON SHARES, $227 PAR VALUE,
OUTSTANDING, ALL OF WHICH ARE HELD BY ALLSTATE INSURANCE COMPANY.
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ALLSTATE LIFE INSURANCE COMPANY
INDEX TO ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 2007
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<Caption>
PAGE
PART I
Item 1. Business 1
Item 1A. Risk Factors 5
Item 1B. Unresolved Staff Comments 9
Item 2. Properties 9
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders * N/A
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities 11
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 52
Item 8. Financial Statements and Supplementary Data 53
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 98
Item 9A. Controls and Procedures 98
Item 9B. Other Information 98
PART III
Item 10. Directors, Executive Officers and Corporate Governance * N/A
Item 11. Executive Compensation * N/A
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters * N/A
Item 13. Certain Relationships and Related Transactions, and Director Independence * N/A
Item 14. Principal Accounting Fees and Services 99
PART IV
Item 15. Exhibits and Financial Statement Schedules 100
Signatures 105
Financial Statement Schedules S-1
</Table>
* Omitted pursuant to General Instruction I(2) of Form 10-K
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PART I
ITEM 1. BUSINESS
Allstate Life Insurance Company was organized in 1957 as a stock life
insurance company under the laws of the State of Illinois. Allstate Life
Insurance Company, together with its subsidiaries, provides life insurance,
retirement and investment products for individual and institutional customers.
It conducts substantially all of its operations directly or through wholly owned
United States subsidiaries. In this document, we refer to Allstate Life
Insurance Company as "Allstate Life" or "ALIC" and to Allstate Life and its
wholly owned subsidiaries as the "Allstate Life Group" or the "Company."
Allstate Life is a wholly owned subsidiary of Allstate Insurance Company, a
stock property-liability insurance company organized under the laws of the State
of Illinois. All of the outstanding stock of Allstate Insurance Company is owned
by The Allstate Corporation, a publicly owned holding company incorporated under
the laws of the State of Delaware. In this document, we refer to Allstate
Insurance Company as "AIC" and to The Allstate Corporation and its consolidated
subsidiaries as "Allstate", the "Parent Group" or the "Corporation". The
Allstate Corporation is the largest publicly held personal lines insurer in the
United States. Widely known through the "You're In Good Hands With Allstate(R)"
slogan, Allstate provides insurance products to more than 17 million households
through a distribution network that utilizes a total of approximately 14,900
exclusive agencies and exclusive financial specialists in the United States and
Canada. Allstate is the second-largest personal property and casualty insurer in
the United States on the basis of 2006 statutory premiums earned. In addition,
according to A.M. Best, it is the nation's 12th largest issuer of life insurance
business on the basis of 2006 ordinary life insurance in force and 16th largest
on the basis of 2006 statutory admitted assets.
The Parent Group has four business segments, one of which is Allstate
Financial. Allstate Financial, which is not a separate legal entity, is
comprised of the Allstate Life Group together with American Heritage Life
Insurance Company, the Allstate Bank and other Parent Group subsidiaries that
are not part of the Allstate Life Group. This document describes the Allstate
Life Group. It does not describe the entire group of companies that form the
Allstate Financial segment of the Parent Group.
In this annual report on Form 10-K, we occasionally refer to statutory
financial information that has been prepared in accordance with the National
Association of Insurance Commissioners Accounting Practices and Procedure Manual
("Manual"). All domestic United States insurance companies are required to
prepare statutory-basis financial statements in accordance with the Manual. As a
result, industry data is available that enables comparisons between insurance
companies, including competitors that are not subject to the requirement to
prepare financial statements in conformity with accounting principles generally
accepted in the United States ("GAAP"). We frequently use industry publications
containing statutory financial information to assess our competitive position.
PRODUCTS AND DISTRIBUTION
The Allstate Life Group provides life insurance, retirement and investment
products to individual and institutional customers. Our principal individual
products are fixed annuities, including deferred, immediate and indexed; and
interest-sensitive, traditional and variable life insurance. We also distribute
variable annuities through our bank distribution partners; however, this product
is fully reinsured with an unaffiliated entity. Our principal institutional
product is funding agreements backing medium-term notes. The table on page 2
lists our major distribution channels, with the associated products and targeted
customers.
As the table indicates, we sell products to individuals through multiple
intermediary distribution channels, including Allstate exclusive agencies, and
exclusive financial specialists, independent agents, banks, broker-dealers, and
specialized structured settlement brokers. We have distribution relationships
with approximately 60 percent of the 75 largest banks, most of the national
broker-dealers, a number of regional brokerage firms and many independent
broker-dealers. We sell products through independent agents affiliated with
approximately 150 master brokerage agencies. We sell funding agreements to
unaffiliated trusts used to back medium-term notes.
1
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DISTRIBUTION CHANNELS, PRODUCTS AND TARGET CUSTOMERS
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DISTRIBUTION CHANNEL PRIMARY PRODUCTS TARGET CUSTOMERS
- -------------------------------------------------------------------------------------------------------------------------
ALLSTATE EXCLUSIVE AGENCIES Term life insurance Middle market
(Allstate Exclusive Agents Interest-sensitive life insurance consumers(1) with
and Variable life insurance retirement and family
Allstate Exclusive Deferred fixed annuities (including indexed and market value financial protection needs
Financial Specialists) adjusted "MVA")
Immediate fixed annuities
INDEPENDENT AGENTS Term life insurance Mass market(2) and mass
(through master brokerage Interest-sensitive life insurance affluent consumers(3)
agencies) Variable life insurance with retirement and
Deferred fixed annuities (including indexed and MVA) financial protection needs
Immediate fixed annuities
BANKS Deferred fixed annuities (including indexed and MVA) Middle market consumers
Single premium fixed life insurance with retirement needs
Variable annuities - fully reinsured with an unaffiliated
entity
BROKER-DEALERS Deferred fixed annuities (including indexed and MVA) Mass market and mass
Single premium variable life insurance affluent consumers with
retirement needs
STRUCTURED SETTLEMENT Structured settlement annuities Typically used to fund or
ANNUITY BROKERS annuitize large claims or
litigation settlements
BROKER-DEALERS Funding agreements backing medium-term notes Institutional and
(Funding agreements) individual investors
</Table>
- ----------
(1) Consumers with $50,000 - $125,000 in household income
(2) Consumers with $50,000 - $75,000 in household income
(3) Consumers with $75,000 - $125,000 in household income
Allstate exclusive agencies and exclusive financial specialists also
sell the following non-proprietary products: mutual funds, variable
annuities and long-term care insurance.
COMPETITION
We compete principally on the basis of the scope of our distribution
systems, the breadth of our product offerings, the recognition of our brands,
our financial strength and ratings, our differentiated product features and
prices, and the level of customer service that we provide. With regard to
funding agreements, we compete principally on the basis of our financial
strength and ratings.
The market for life insurance, retirement and investment products continues
to be highly fragmented and competitive. As of December 31, 2007, there were
approximately 720 groups of life insurance companies in the United States, most
of which offered one or more similar products. According to A.M. Best, as of
December 31, 2006, the Allstate Life Group is the nation's 12th largest issuer
of life insurance and related business on the basis of 2006 ordinary life
insurance in force and 16th largest on the basis of 2006 statutory admitted
assets. In addition, because many of these products include a savings or
investment component, our competition includes domestic and foreign securities
firms, investment advisors, mutual funds, banks and other financial
institutions. Competitive pressure continues to grow due to several factors,
including cross marketing alliances between unaffiliated businesses, as well as
consolidation activity in the financial services industry.
2
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GEOGRAPHIC MARKETS
We sell life insurance, retirement and investment products throughout the
United States. The Allstate Life Group is authorized to sell various types of
these products in all 50 states, the District of Columbia, Puerto Rico, the U.S.
Virgin Islands and Guam. We sell funding agreements in the United States and in
the Cayman Islands.
The following table reflects, in percentages, the principal geographic
distribution of statutory premiums and annuity considerations for the Allstate
Life Group for the year ended December 31, 2007, based on information contained
in statements filed with state insurance departments.
<Table>
Delaware 31.3%
California 7.7%
New York 6.2%
</Table>
Approximately 99 percent of the statutory premiums and annuity
considerations generated in Delaware represent deposits received in connection
with funding agreements sold to trusts domiciled in Delaware. No other
jurisdiction accounted for more than 5 percent of the statutory premiums and
annuity considerations.
REGULATION
The Allstate Life Group is subject to extensive regulation, primarily at
the state level. The method, extent and substance of such regulation varies by
state but generally has its source in statutes that establish standards and
requirements for conducting the business of insurance and that delegate
regulatory authority to a state regulatory agency. In general, such regulation
is intended for the protection of those who purchase or use insurance products.
These rules have a substantial effect on our business and relate to a wide
variety of matters including insurance company licensing and examination, agent
and adjuster licensing, price setting, trade practices, policy forms, accounting
methods, the nature and amount of investments, claims practices, participation
in guaranty funds, reserve adequacy, insurer solvency, transactions with
affiliates, the payment of dividends, and underwriting standards. Some of these
matters are discussed in more detail below. For a discussion of statutory
financial information, see Note 14 of the Consolidated Financial Statements. For
a discussion of regulatory contingencies, see Note 11 of the Consolidated
Financial Statements. Notes 11 and 14 are incorporated in this Part I, Item 1 by
reference.
In recent years the state insurance regulatory framework has come under
increased federal scrutiny. Legislation that would provide for federal
chartering of insurance companies has been proposed. In addition, state
legislators and insurance regulators continue to examine the appropriate nature
and scope of state insurance regulation. We cannot predict whether any specific
state or federal measures will be adopted to change the nature or scope of the
regulation of the insurance business or what effect any such measures would have
on the Allstate Life Group.
AGENT AND BROKER COMPENSATION. In recent years, several states considered
new legislation or regulations regarding the compensation of agents and brokers
by insurance companies. The proposals ranged in nature from new disclosure
requirements to new duties on insurance agents and brokers in dealing with
customers. New disclosure requirements have been imposed in certain
circumstances upon some agents and brokers in several states.
LIMITATIONS ON DIVIDENDS BY INSURANCE SUBSIDIARIES. Allstate Life may
receive dividends from time to time from its subsidiaries. When received, these
dividends represent a source of cash from which Allstate Life may meet some of
its obligations. If a subsidiary is an insurance company, its ability to pay
dividends may be restricted by state laws regulating insurance companies. For
additional information regarding those restrictions, see Note 14 of the
Consolidated Financial Statements.
GUARANTY FUNDS. Under state insurance guaranty fund laws, insurers doing
business in a state can be assessed, up to prescribed limits, in order to cover
certain obligations of insolvent insurance companies.
INVESTMENT REGULATION. Our insurance subsidiaries are subject to
regulations that require investment portfolio diversification and that limit the
amount of investment in certain categories. Failure to comply with these rules
leads to the treatment of non-conforming investments as non-admitted assets for
purposes of measuring statutory surplus. Further, in some instances, these rules
require divestiture of non-conforming investments.
3
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VARIABLE LIFE INSURANCE, VARIABLE ANNUITIES AND REGISTERED FIXED ANNUITIES.
The sale and administration of variable life insurance, variable annuities and
registered fixed annuities with market value adjustment features are subject to
extensive regulatory oversight at the federal and state level, including
regulation and supervision by the Securities and Exchange Commission and the
Financial Industry Regulatory Authority ("FINRA").
BROKER-DEALERS, INVESTMENT ADVISORS AND INVESTMENT COMPANIES. The Allstate
Life Group entities that operate as broker-dealers, registered investment
advisors and investment companies are subject to regulation and supervision by
the Securities and Exchange Commission, FINRA and/or, in some cases, state
securities administrators.
PRIVACY REGULATION. Federal law and the laws of some states require
financial institutions to protect the security and confidentiality of customer
information and to notify customers about their policies and practices relating
to collection and disclosure of customer information and their policies relating
to protecting the security and confidentiality of that information. Federal law
and the laws of some states also regulate disclosures of customer information.
Congress, state legislatures and regulatory authorities are expected to consider
additional regulation relating to privacy and other aspects of customer
information.
EMPLOYEES AND OTHER SHARED SERVICES
The Allstate Life Group has no employees. Instead, we primarily use the
services of employees of Allstate Insurance Company, our direct parent. We also
make use of other services and facilities provided by Allstate Insurance Company
and other members of the Parent Group. These services and facilities include
space rental, utilities, building maintenance, human resources, investment
management, finance, information technology and legal services. We reimburse our
affiliates for these services and facilities under a variety of agreements.
OTHER INFORMATION
"Allstate" is one of the most recognized brand names in the United States.
We use the names "Allstate," "Lincoln Benefit Life" and variations of these
names extensively in our business, along with related logos and slogans, such as
"Goods Hands." Our rights in the United States to these names, logos and slogans
continue so long as we continue to use them in commerce. Most of these service
marks are the subject of renewable U.S. and/or foreign service mark
registrations. We believe that these service marks are important to our business
and we intend to maintain our rights to them by continued use.
4
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ITEM 1A. RISK FACTORS
This document contains "forward-looking statements" that anticipate results
based on our estimates, assumptions and plans that are subject to uncertainty.
These statements are made subject to the safe-harbor provisions of the Private
Securities Litigation Reform Act of 1995. We assume no obligation to update any
forward-looking statements as a result of new information or future events or
developments.
These forward-looking statements do not relate strictly to historical or
current facts and may be identified by their use of words like "plans," "seeks,"
"expects," "will," "should," "anticipates," "estimates," "intends," "believes,"
"likely," "targets" and other words with similar meanings. These statements may
address, among other things, our strategy for growth, product development,
regulatory approvals, market position, expenses, financial results, litigation
and reserves. We believe that these statements are based on reasonable
estimates, assumptions and plans. However, if the estimates, assumptions or
plans underlying the forward-looking statements prove inaccurate or if other
risks or uncertainties arise, actual results could differ materially from those
communicated in these forward-looking statements.
In addition to the normal risks of business, we are subject to significant
risks and uncertainties, including those listed below, which apply to us as an
insurer and a provider of other financial services. These risks constitute our
cautionary statements under the Private Securities Litigation Reform Act of 1995
and readers should carefully review such cautionary statements as they identify
certain important factors that could cause actual results to differ materially
from those in the forward-looking statements and historical trends. These
cautionary statements are not exclusive and are in addition to other factors
discussed elsewhere in this document, in our filings with the Securities and
Exchange Commission ("SEC") or in materials incorporated therein by reference.
Our business operations could also be affected by additional factors that are
not presently known to us or that we currently consider to be immaterial to our
operations.
CHANGES IN UNDERWRITING AND ACTUAL EXPERIENCE COULD MATERIALLY AFFECT
PROFITABILITY
Our product pricing includes long-term assumptions regarding investment
returns, mortality, morbidity, persistency and operating costs and expenses of
the business. Management establishes target returns for each product based upon
these factors and the average amount of capital that the company must hold to
support in-force contracts, satisfy rating agencies and meet regulatory
requirements. We monitor and manage our pricing and overall sales mix to achieve
target new business returns on a portfolio basis, which could result in the
discontinuation of products or distribution relationships and a decline in
sales. Profitability from new business emerges over a period of years depending
on the nature and life of the product and is subject to variability as actual
results may differ from pricing assumptions.
Our profitability depends on the adequacy of investment spreads, the
management of market and credit risks associated with investments, the
sufficiency of premiums and contract charges to cover mortality and morbidity
benefits, the persistency of policies to ensure recovery of acquisition
expenses, and the management of operating costs and expenses within anticipated
pricing allowances. Legislation and regulation of the insurance marketplace and
products could also affect our profitability.
CHANGES IN RESERVE ESTIMATES MAY REDUCE PROFITABILITY
Reserve for life-contingent contract benefits is computed on the basis of
long-term actuarial assumptions of future investment yields, mortality,
morbidity, policy terminations and expenses. We periodically review the adequacy
of these reserves on an aggregate basis and if future experience differs
significantly from assumptions, adjustments to reserves and deferred acquisition
costs may be required which could have a material adverse effect on our
operating results and financial condition.
CHANGES IN MARKET INTEREST RATES MAY LEAD TO A SIGNIFICANT DECREASE IN THE SALES
AND PROFITABILITY OF SPREAD-BASED PRODUCTS
Our ability to manage our spread-based products, such as fixed annuities
and institutional products, is dependent upon maintaining profitable spreads
between investment yields and interest crediting rates. When market interest
rates decrease or remain at relatively low levels, proceeds from investments
that have matured, or have been prepaid or sold may be reinvested at lower
yields, reducing investment spread. Lowering interest crediting rates in such an
environment can offset decreases in investment yield on some products. However,
these changes could be limited by market conditions, regulatory or contractual
minimum rate guarantees on many contracts and may not match the timing or
magnitude of changes in asset yields. Decreases in the rates offered on products
could make those products less attractive, leading to lower sales and/or changes
in the level of policy loans, surrenders and withdrawals and accelerating
maturities of institutional products. Non-parallel shifts in interest rates,
such as
5
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increases in short-term rates without accompanying increases in medium- and
long-term rates, can influence customer demand for fixed annuities, which could
impact the level and profitability of new customer deposits. Increases in market
interest rates can also have negative effects, for example by increasing the
attractiveness of other investments to our customers, which can lead to higher
surrenders at a time when fixed income investment asset values are lower as a
result of the increase in interest rates. For certain products, principally
fixed annuity and interest-sensitive life products, the earned rate on assets
could lag behind rising market yields. We may react to market conditions by
increasing crediting rates, which could narrow spreads and reduce profitability.
Unanticipated surrenders could result in accelerated amortization of deferred
policy acquisition costs ("DAC") or affect the recoverability of DAC and thereby
increase expenses and reduce profitability.
CHANGES IN ESTIMATES OF PROFITABILITY ON INTEREST-SENSITIVE LIFE, FIXED
ANNUITIES AND OTHER INVESTMENT PRODUCTS MAY HAVE AN ADVERSE EFFECT ON RESULTS
THROUGH INCREASED AMORTIZATION OF DAC
DAC related to interest-sensitive life, fixed annuities and other
investment contracts is amortized in proportion to actual historical gross
profits ("AGP") and estimated future gross profits ("EGP") over the estimated
lives of the contracts. Assumptions underlying EGP, including those relating to
margins from mortality, investment margin, contract administration, surrender
and other contract charges, are updated from time to time in order to reflect
actual and expected experience and its potential effect on the valuation of DAC.
Updates to these assumptions could result in amortization
acceleration/deceleration (commonly referred to as "DAC unlocking"), which in
turn could adversely affect our profitability and financial condition.
A LOSS OF KEY PRODUCT DISTRIBUTION RELATIONSHIPS COULD MATERIALLY AFFECT SALES
Certain products are distributed under agreements with other members of the
financial services industry that are not affiliated with us. Termination of one
or more of these agreements due to, for example, a change in control of one of
these distributors, could have a detrimental effect on sales.
CHANGES IN TAX LAWS MAY DECREASE SALES AND PROFITABILITY OF PRODUCTS
Under current federal and state income tax law, certain products we offer,
primarily life insurance and annuities, receive favorable tax treatment. This
favorable treatment may give certain of our products a competitive advantage
over noninsurance products. Congress from time to time considers legislation
that would reduce or eliminate the favorable policyholder tax treatment
currently applicable to life insurance and annuities. Congress also considers
proposals to reduce the taxation of certain products or investments that may
compete with life insurance and annuities. Legislation that increases the
taxation on insurance products or reduces the taxation on competing products
could lessen the advantage or create a disadvantage for certain of our products
making them less competitive. Such proposals, if adopted, could have a material
adverse effect on our financial position or ability to sell such products and
could result in the surrender of some existing contracts and policies. In
addition, changes in the federal estate tax laws could negatively affect the
demand for the types of life insurance used in estate planning.
RISKS RELATING TO INVESTMENTS
WE ARE SUBJECT TO MARKET RISK AND DECLINES IN CREDIT QUALITY
We are subject to the risk that we will incur losses due to adverse changes
in interest rates, equity prices and foreign currency exchange rates. Our
primary market risk exposures are to changes in interest rates and, to a lesser
degree, changes in equity prices and foreign currency exchange rates. In
addition, we are subject to potential declines in credit quality, either related
to issues specific to certain industries or to a weakening in the economy in
general. Although to some extent we use derivative financial instruments to
address these risks, the effectiveness of such instruments is subject to the
same risks. For additional information on market risk, see the "Market Risk"
section of Management's Discussion and Analysis.
A decline in market interest rates could have an adverse effect on our
investment income as we invest cash in new investments that may yield less than
the portfolio's average rate. In a declining interest rate environment,
borrowers may prepay or redeem securities more quickly than expected as they
seek to refinance at lower rates. A decline could also lead us to purchase
longer-term or otherwise riskier assets in order to obtain adequate investment
yields resulting in a duration gap when compared to the duration of liabilities.
An increase in market interest rates could have an adverse effect on the value
of our investment portfolio by decreasing the fair values of the fixed income
securities that comprise a substantial majority of our investment portfolio. A
decline in the quality of our investment portfolio as a result of adverse
economic conditions or otherwise could cause additional realized losses on
securities, including realized losses relating to equity and derivative
strategies.
6
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DETERIORATING FINANCIAL PERFORMANCE ON SECURITIES COLLATERALIZED BY MORTGAGE
LOANS AND COMMERCIAL MORTGAGE LOANS MAY LEAD TO WRITE-DOWNS
We continue to believe that the unrealized losses on securities
collateralized by mortgage loans and commercial mortgage loans are not
necessarily predictive of the performance of the underlying collateral, and
that, in the absence of further deterioration in the collateral relative to our
positions in the securities' respective capital structure, we expect the
unrealized losses should reverse over the remaining lives of the securities.
However, future market conditions could cause us to alter that outlook. Changes
in mortgage delinquency or recovery rates, credit rating changes by rating
agencies, bond insurer strength or rating, and the quality of service provided
by service providers on securities in our portfolios could lead us to determine
that write-downs are appropriate in the future.
CONCENTRATION OF OUR INVESTMENT PORTFOLIOS IN ANY PARTICULAR SEGMENT OF THE
ECONOMY MAY HAVE ADVERSE EFFECTS
The concentration of our investment portfolios in any particular industry,
group of related industries or geographic sector could have an adverse effect on
our investment portfolios and consequently on our results of operations and
financial position. While we seek to mitigate this risk by having a broadly
diversified portfolio, events or developments that have a negative impact on any
particular industry, group of related industries or geographic region may have a
greater adverse effect on the investment portfolios to the extent that the
portfolios are concentrated rather than diversified.
RISKS RELATING TO THE INSURANCE INDUSTRY
OUR FUTURE RESULTS ARE DEPENDENT IN PART ON OUR ABILITY TO SUCCESSFULLY OPERATE
IN AN INSURANCE INDUSTRY THAT IS HIGHLY COMPETITIVE
The insurance industry is highly competitive. Our competitors include other
insurers and, because many of our products include a savings or investment
component, securities firms, investment advisers, mutual funds, banks and other
financial institutions. Many of our competitors have well-established national
reputations and market similar products. Because of the competitive nature of
the insurance industry, including competition for producers such as exclusive
and independent agents, there can be no assurance that we will continue to
effectively compete with our industry rivals, or that competitive pressures will
not have a material adverse effect on our business, operating results or
financial condition. Furthermore, certain competitors operate using a mutual
insurance company structure and therefore, may have dissimilar profitability and
return targets. Our ability to successfully operate may also be impaired if we
are not effective in filling critical leadership positions, in developing the
talent and skills of our human resources, in assimilating new executive talent
into our organization, or in deploying human resource talent consistently with
our business goals.
WE MAY SUFFER LOSSES FROM LITIGATION
As is typical for a large company, we are involved in a substantial amount
of litigation, including class action litigation challenging a range of company
practices and coverage provided by our insurance products. In the event of an
unfavorable outcome in one or more of these matters, the ultimate liability may
be in excess of amounts currently reserved and may be material to our operating
results or cash flows for a particular quarter or annual period. For a
description of our current legal proceedings, see Note 11 of the consolidated
financial statements.
In some circumstances, we may be able to collect on third-party insurance
that we carry to recover all or part of the amounts that we may be required to
pay in judgments, settlements and litigation expenses. However, we may not be
able to resolve issues concerning the availability, if any, or the ability to
collect such insurance concurrently with the underlying litigation.
Consequently, the timing of the resolution of a particular piece of litigation
and the determination of our insurance recovery with respect to that litigation
may not coincide and, therefore, may be reflected in our financial statements in
different fiscal quarters.
WE ARE SUBJECT TO EXTENSIVE REGULATION AND POTENTIAL FURTHER RESTRICTIVE
REGULATION MAY INCREASE OUR OPERATING COSTS AND LIMIT OUR GROWTH
As insurance companies, broker-dealers, investment advisers and/or
investment companies, many of our subsidiaries are subject to extensive laws and
regulations. These laws and regulations are complex and subject to change.
Moreover, they are administered and enforced by a number of different
governmental authorities, including state insurance regulators, state securities
administrators, the SEC, Financial Industry Regulatory Authority, the U.S.
Department of Justice, and state attorneys general, each of which exercises a
degree of interpretive latitude. Consequently, we are subject to the risk that
compliance with any particular regulator's or enforcement authority's
interpretation of a legal issue may not result in compliance with another's
interpretation of the same issue,
7
<Page>
particularly when compliance is judged in hindsight. In addition, there is risk
that any particular regulator's or enforcement authority's interpretation of a
legal issue may change over time to our detriment, or that changes in the
overall legal environment may, even absent any particular regulator's or
enforcement authority's interpretation of a legal issue changing, cause us to
change our views regarding the actions we need to take from a legal risk
management perspective, thus necessitating changes to our practices that may, in
some cases, limit our ability to grow and improve the profitability of our
business. Furthermore, in some cases, these laws and regulations are designed to
protect or benefit the interests of a specific constituency rather than a range
of constituencies. For example, state insurance laws and regulations are
generally intended to protect or benefit purchasers or users of insurance
products. In many respects, these laws and regulations limit our ability to grow
and improve the profitability of our business.
In recent years, the state insurance regulatory framework has come under
public scrutiny and members of Congress have discussed proposals to provide for
optional federal chartering of insurance companies. We can make no assurances
regarding the potential impact of state or federal measures that may change the
nature or scope of insurance regulation.
REINSURANCE MAY BE UNAVAILABLE AT CURRENT LEVELS AND PRICES, WHICH MAY LIMIT OUR
ABILITY TO WRITE NEW BUSINESS
Market conditions beyond our control determine the availability and cost of
the reinsurance we purchase. No assurances can be made that reinsurance will
remain continuously available to us to the same extent and on the same terms and
rates as are currently available. If we were unable to maintain our current
level of reinsurance or purchase new reinsurance protection in amounts that we
consider sufficient and at prices that we consider acceptable, we would have to
either accept an increase in our exposure risk, reduce our insurance writings,
or develop or seek other alternatives.
REINSURANCE SUBJECTS US TO THE CREDIT RISK OF OUR REINSURERS AND MAY NOT BE
ADEQUATE TO PROTECT US AGAINST LOSSES ARISING FROM CEDED INSURANCE
The collectibility of reinsurance recoverables is subject to uncertainty
arising from a number of factors, including whether insured losses meet the
qualifying conditions of the reinsurance contract and whether reinsurers, or
their affiliates, have the financial capacity and willingness to make payments
under the terms of a reinsurance treaty or contract. Our inability to collect a
material recovery from a reinsurer could have a material adverse effect on our
operating results and financial condition.
THE CONTINUED THREAT OF TERRORISM AND ONGOING MILITARY ACTIONS MAY ADVERSELY
AFFECT THE LEVEL OF CLAIM LOSSES WE INCUR AND THE VALUE OF OUR INVESTMENT
PORTFOLIO
The continued threat of terrorism, both within the United States and
abroad, and ongoing military and other actions and heightened security measures
in response to these types of threats, may cause significant volatility and
losses from declines in the equity markets and from interest rate changes in the
United States, Europe and elsewhere, and result in loss of life, disruptions to
commerce and reduced economic activity. Some of the assets in our investment
portfolio may be adversely affected by declines in the equity markets and
reduced economic activity caused by the continued threat of terrorism. We seek
to mitigate the potential impact of terrorism on our commercial mortgage
portfolio by limiting geographical concentrations in key metropolitan areas and
by requiring terrorism insurance to the extent that it is commercially
available. Additionally, in the event that terrorist acts occur, we could be
adversely affected, depending on the nature of the event.
ANY DECREASE IN OUR FINANCIAL STRENGTH RATINGS MAY HAVE AN ADVERSE EFFECT ON OUR
COMPETITIVE POSITION
Financial strength ratings are important factors in establishing the
competitive position of insurance companies and generally have an effect on an
insurance company's business. On an ongoing basis, rating agencies review the
financial performance and condition of insurers and could downgrade or change
the outlook on an insurer's ratings due to, for example, a change in an
insurer's statutory capital; a change in a rating agency's determination of the
amount of risk-adjusted capital required to maintain a particular rating; an
increase in the perceived risk of an insurer's investment portfolio; a reduced
confidence in management or a host of other considerations that may or may not
be under the insurer's control. The insurance financial strength ratings of both
AIC and ALIC are A+, AA and Aa2 from A.M. Best, Standard & Poor's and Moody's,
respectively. Because all of these ratings are subject to continuous review, the
retention of these ratings cannot be assured. A multiple level downgrade in any
of these ratings could have a material adverse effect on our sales, our
competitiveness, the marketability of our product offerings, and our liquidity,
operating results and financial condition.
8
<Page>
CHANGES IN ACCOUNTING STANDARDS ISSUED BY THE FINANCIAL ACCOUNTING STANDARDS
BOARD ("FASB") OR OTHER STANDARD-SETTING BODIES MAY ADVERSELY AFFECT OUR
FINANCIAL STATEMENTS
Our financial statements are subject to the application of generally
accepted accounting principles, which are periodically revised and/or expanded.
Accordingly, we are required to adopt new guidance or interpretations, or could
be subject to existing guidance as we enter into new transactions, which may
have a material adverse effect on our results of operations and financial
condition that is either unexpected or has a greater impact than expected. For a
description of changes in accounting standards that are currently pending and,
if known, our estimates of their expected impact, see Note 2 of the consolidated
financial statements.
THE CHANGE IN OUR UNRECOGNIZED TAX BENEFIT DURING THE NEXT 12 MONTHS IS SUBJECT
TO UNCERTAINTY
As required by FASB Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes", which was adopted as of January 1, 2007, we have disclosed our
estimate of net unrecognized tax benefits and the reasonably possible increase
or decrease in its balance during the next 12 months. However, actual results
may differ from our estimate for reasons such as changes in our position on
specific issues, developments with respect to the governments' interpretations
of income tax laws or changes in judgment resulting from new information
obtained in audits or the appeals process.
THE OCCURRENCE OF EVENTS UNANTICIPATED IN OUR DISASTER RECOVERY SYSTEMS AND
MANAGEMENT CONTINUITY PLANNING COULD IMPAIR OUR ABILITY TO CONDUCT BUSINESS
EFFECTIVELY
In the event of a disaster such as a natural catastrophe, an industrial
accident, a terrorist attack or war, events unanticipated in our disaster
recovery systems could have an adverse impact on our ability to conduct business
and on our results of operations and financial condition, particularly if those
events affect our computer-based data processing, transmission, storage and
retrieval systems. In the event that a significant number of our managers could
be unavailable in the event of a disaster, our ability to effectively conduct
our business could be severely compromised.
CHANGING CLIMATE CONDITIONS MAY ADVERSELY AFFECT OUR FINANCIAL CONDITION,
RESULTS OF OPERATIONS OR CASH FLOWS
Allstate recognizes the scientific view that the world is getting warmer.
Climate change, to the extent it produces rising temperatures and changes in
weather patterns, could impact the frequency or severity of extreme weather
events and wildfires. To the extent that climate change impacts mortality rates
and those changes do not match the long-term mortality assumptions in our
product pricing, we would be impacted.
LOSS OF KEY VENDOR RELATIONSHIPS COULD AFFECT OUR OPERATIONS
We rely on services and products provided by many vendors in the United
States and abroad. These include, for example, vendors of computer hardware and
software and vendors of services such as human resource benefits management
services. In the event that one or more of our vendors suffers a bankruptcy or
otherwise becomes unable to continue to provide products or services, we may
suffer operational impairments and financial losses.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2. PROPERTIES
Our home office is part of the Parent Group's home office complex in
Northbrook, Illinois. As of December 31, 2007, the complex consists of several
buildings totaling approximately 2.3 million square feet of office space on a
250-acre site. In addition, we operate from various administrative, data
processing, claims handling and other support facilities.
All of the facilities from which we operate are owned or leased by our
direct parent, Allstate Insurance Company, except for office space in Lincoln,
Nebraska that is leased by Lincoln Benefit Life Company, a wholly owned
subsidiary of ALIC, for general operations, file storage and information
technology. Expenses associated with facilities owned or leased by Allstate
Insurance Company are allocated to us on both a direct and an indirect basis,
depending on the nature and use of each particular facility. We believe that
these facilities are suitable and adequate for our current operations.
The locations out of which the Parent Group exclusive agencies operate in
the U.S. are normally leased by the agencies as lessees.
9
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ITEM 3. LEGAL PROCEEDINGS
Information required for Item 3 is incorporated by reference to the
discussion under the heading "Regulation" and under the heading "Legal and
regulatory proceedings and inquiries" in Note 11 of the Consolidated Financial
Statements.
10
<Page>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
No established public trading market exists for Allstate Life's common
stock. All of its outstanding common stock is owned by its parent, Allstate
Insurance Company ("AIC"). All of the outstanding common stock of AIC is owned
by The Allstate Corporation.
In 2007 and 2006, Allstate Life paid the following amounts to AIC in the
aggregate on the dates specified as dividends on its common stock:
<Table>
<Caption>
PAYMENT DATE AGGREGATE AMOUNT
June 27, 2006 $ 125,000,000
September 21, 2006 300,000,000
December 15, 2006 250,000,000
September 24, 2007 85,000,000
December 17, 2007 250,960,134
December 21, 2007 389,039,866
</Table>
For additional information on dividends, including restrictions on the
payment of dividends by Allstate Life and its subsidiaries, see the Limitations
on Dividends by Insurance Subsidiaries subsection of the "Regulation" section of
Item 1. Business of this Form 10-K and the discussion under the heading
"Dividends" in Note 14 of our consolidated financial statements, which are
incorporated herein by reference.
11
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ITEM 6. SELECTED FINANCIAL DATA.
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
5-YEAR SUMMARY OF SELECTED FINANCIAL DATA
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005 2004 2003
------------------------------------------------------------------------
CONSOLIDATED OPERATING RESULTS
Premiums $ 502 $ 576 $ 474 $ 637 $ 959
Contract charges 942 1,009 1,079 961 872
Net investment income 4,205 4,057 3,707 3,260 3,082
Realized capital gains and losses (197) (79) 19 (11) (84)
Total revenues 5,452 5,563 5,279 4,847 4,829
Income before cumulative effect of change in
accounting principle, after-tax 412 428 417 356 291
Cumulative effect of change in accounting
principle, after-tax -- -- -- (175) (13)
Net income 412 428 417 181 278
CONSOLIDATED FINANCIAL POSITION
Investments $ 72,414 $ 74,160 $ 72,756 $ 69,689 $ 59,989
Total assets 96,117 98,758 95,022 90,401 78,812
Reserve for life-contingent contract benefits
and contractholder funds 73,062 72,769 70,071 65,142 55,394
Long-term debt 200 206 181 104 45
Shareholder's equity 4,763 5,498 6,008 6,309 6,429
</Table>
12
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
<Table>
<Caption>
PAGE
OVERVIEW........................................................................ 13
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES ................................... 14
2007 HIGHLIGHTS ................................................................ 19
OPERATIONS ..................................................................... 20
INVESTMENTS .................................................................... 30
MARKET RISK .................................................................... 43
CAPITAL RESOURCES AND LIQUIDITY ................................................ 46
REGULATION AND LEGAL PROCEEDINGS ............................................... 52
PENDING ACCOUNTING STANDARDS ................................................... 52
</Table>
OVERVIEW
The following discussion highlights significant factors influencing the
consolidated financial position and results of operations of Allstate Life
Insurance Company (referred to in this document as "we", "our", "us" or the
"Company"). It should be read in conjunction with the 5-year summary of selected
financial data, consolidated financial statements and related notes found under
Part II, Item 6 and Item 8 contained herein. We operate as a single segment
entity, based on the manner in which we use financial information to evaluate
performance and determine the allocation of resources.
Our goal is to reinvent protection and retirement for the consumer. To
achieve this goal, we are focused on the following operating priorities:
consumer focus, operational excellence, enterprise risk and return, and capital
management.
The most important factors we monitor to evaluate the financial condition
and performance of our Company include:
- For operations: premiums and deposits, benefit and investment spread,
amortization of deferred policy acquisition costs, expenses, operating
income, net income, invested assets, product returns, and profitably
growing distribution partner relationships;
- For investments: credit quality/experience, stability of long-term
returns, total returns, cash flows and asset and liability duration;
and
- For financial condition: our financial strength ratings, operating
leverage, debt leverage, and return on equity.
13
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APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP") requires
management to adopt accounting policies and make estimates and assumptions that
affect amounts reported in the consolidated financial statements. The most
critical estimates include those used in determining:
- Investment Fair Value and Impairment
- Derivative Instrument Hedge Accounting and Fair Value
- Deferred Policy Acquisition Cost ("DAC") Amortization
- Reserve for Life-Contingent Contract Benefits Estimation
In applying these policies, management makes subjective and complex
judgments that frequently require estimates about matters that are inherently
uncertain. Many of these policies, estimates and related judgments are common in
the insurance and financial services industries; others are specific to the
Company's businesses and operations. It is reasonably likely that changes in
these estimates could occur from period to period and result in a material
impact on our consolidated financial statements.
A brief summary of each of these critical accounting estimates follows. For
a more detailed discussion of the effect of these estimates on our consolidated
financial statements, and the judgments and assumptions related to these
estimates, see the referenced sections of this document. For a complete summary
of our significant accounting policies, see Note 2 of the consolidated financial
statements.
INVESTMENT FAIR VALUE AND IMPAIRMENT The fair value of our investments in fixed
income and equity securities is based on observable market quotations, other
market observable data, or is derived from such quotations and market observable
data. We utilize third party pricing servicers, brokers and internal valuation
models to determine fair value. We gain assurance of the overall reasonableness
and consistent application of the assumptions and methodologies and compliance
with accounting standards for fair value determination through our ongoing
monitoring of the fair values received or derived internally. Our exposure to
changes in market conditions is discussed more fully in the Market Risk section
of the MD&A.
We are responsible for the determination of fair value and the supporting
assumptions and methodologies. We employ independent third party pricing
servicers to gather, analyze, and interpret market information and derive fair
values based upon relevant assumptions and methodologies for each applicable
security. In situations where sufficient market observable information is not
available for a particular security through the sources as agreed to with us, no
quote is provided by the service providers. For these securities, fair value is
determined either by requesting brokers who are knowledgeable about these
securities to provide a quote or we internally determine fair values employing
widely accepted pricing valuation models. Changing market conditions in the
fourth quarter of 2007, were incorporated into valuation assumptions, and
reflected in the fair values which were validated by calibration and other
analytical techniques to available market observable data.
Third party pricing servicers consolidate market transactions and other key
valuation model inputs from multiple sources and provide pricing information in
the form of a single fair value for each security for which a fair value request
is agreed. Fair values provided are derived from their proprietary pricing
models. The sources used by these servicers include, but are not limited to,
market prices from recently completed transactions and transactions of
comparable securities, interest rate yield curves, credit spreads, currency
rates, and other market-observable information as applicable, as well as widely
accepted valuation models developed on a proprietary basis. Their proprietary
pricing models are based on discounted cashflow methodology and they may take
into account, among other things, market observable information as of the
measurement date from the sources described above; and the specific attributes
of the security being valued including its term, interest rate and credit rating
(consistent with those we use to report our holdings by credit rating); industry
sector, and where applicable, collateral quality and other issue or issuer
specific information. To operate these models effectively requires seasoned
professional judgment and experience. In cases where market transactions or
other market observable data is limited, the degree of judgment varies with the
availability of market observable information.
For approximately 7.3% of our holdings, where our third party pricing
servicers cannot provide fair value determinations for fixed income securities,
we obtain quotes from brokers familiar with the security who may consider
transactions or activity in similar securities, if any, among other information,
similar to our third party pricing servicers. The brokers providing the quotes
are generally from the brokerage divisions of leading financial institutions
with market making, underwriting and distribution expertise.
The fair value of securities, such as privately-placed securities, where
our pricing servicers or brokers cannot provide fair value determinations, is
determined using widely accepted valuation methods and models. These
14
<Page>
internally developed models are appropriate for each class of security, involve
some degree of judgment, and include inputs that may not be market observable.
Our models are based on discounted cash flow methodology and calculate a
single best estimate of fair value for each security. Our internally developed
pricing models use credit ratings and liquidity risk associated with
privately-placed securities which are difficult to independently observe and
verify. Inputs used in these fair value estimates include specific attributes of
the security being valued including; coupon rate, weighted average life, an
internal credit rating assigned by us (which is generally consistent with any
external ratings and those we use to report our holdings by credit rating),
sector of the issuer, and call provisions. Our assumptions incorporate market
information as of the measurement date that represents what we believe
independent third parties would use to determine fair value, which include:
interest rate yield curves, quoted market prices of comparable securities,
credit spreads, estimated liquidity premiums and other applicable market data.
Our assumption for liquidity risk associated with privately-placed securities
reduces the value of these securities to reflect their reduced liquidity as
compared to similar securities that are publicly traded. Additionally, no
assumption is included in the valuation of privately placed securities for an
increase to the value to reflect the generally enhanced structural features of
the securities, such as covenants or change of control protection. However,
judgment is required in developing these estimates and, as a result, the
estimated fair value of these securities may differ from amounts that would be
realized upon an orderly sale of the securities at the measurement date. The use
of different assumptions may have a material effect on the estimated fair
values.
We employ control processes to determine the reasonableness of the fair
value of our fixed income and equity securities. Our processes are designed to
assure the values provided are accurately recorded and that the data and the
valuation method utilized is appropriate and consistently applied and that the
assumptions are reasonable and representative of fair value. For example, we may
validate the reasonableness of prices by comparing the information obtained from
our pricing vendors to other third party pricing sources for certain securities.
Our control processes also include reviews, when fair value determinations are
expected to be more variable, by management with relevant expertise and
management who are independent of those charged with executing investing
transactions, of these fair value determinations to validate their
reasonableness.
The following table identifies those investments carried at fair value as
of December 31, 2007 by method of determination:
<Table>
<Caption>
INVESTMENTS
------------------------------
(IN MILLIONS) CARRYING PERCENT
VALUE TO TOTAL
---------------- ----------
Fair value based on internal sources $ 10,063 13.9%
Fair value based on external sources 48,508 67.0
---------------- ----------
Total fixed income and equity securities 58,571 80.9
---------------- ----------
Fair value of derivatives 455 0.6
Mortgage loans, policy loans, bank loans and certain
limited partnership and other investments, valued at
cost, amortized cost and the equity method 13,388 18.5
---------------- ----------
Total $ 72,414 100.0%
================ ==========
</Table>
For investments classified as available for sale, the difference between
fair value and amortized cost for fixed income securities and cost for equity
securities, net of certain other items and deferred income taxes (as disclosed
in Note 6), is reported as a component of accumulated other comprehensive income
on the Consolidated Statements of Financial Position and is not reflected in the
operating results of any period until reclassified to net income upon the
consummation of a transaction with an unrelated third party or when declines in
fair values are deemed other-than-temporary. The assessment of
other-than-temporary impairment of a security's fair value is performed on a
portfolio review as well as a case-by-case basis considering a wide range of
factors.
For our portfolio review evaluations, we ascertain whether there are any
approved programs involving the disposition of investments such as changes in
duration, revision to strategic asset allocations and liquidity actions, as well
as any dispositions anticipated by the portfolio managers. In these instances,
we recognize impairments on securities designated as subject to these approved
anticipated actions if the security is in an unrealized loss position. There are
a number of assumptions and estimates inherent in evaluating impairments and
determining if they are other-than-temporary, including: 1) our ability and
intent to hold the investment for a period of time sufficient to allow for an
anticipated recovery in value; 2) the expected recoverability of principal and
interest; 3) the length of time and extent to which the fair value has been less
than amortized cost for fixed income securities or cost for
15
<Page>
equity securities; 4) the financial condition, near-term and long-term prospects
of the issue or issuer, including relevant industry conditions and trends, and
implications of rating agency actions and offering prices; and 5) the specific
reasons that a security is in a significant unrealized loss position, including
market conditions which could affect liquidity. Additionally, once assumptions
and estimates are made, any number of changes in facts and circumstances could
cause us to subsequently determine that an impairment is other-than-temporary,
including: 1) general economic conditions that are worse than previously
forecasted or that have a greater adverse effect on a particular issuer or
industry sector than originally estimated; 2) changes in the facts and
circumstances related to a particular issue or issuer's ability to meet all of
its contractual obligations; and 3) changes in facts and circumstances or new
information obtained which causes a change in our ability or intent to hold a
security to maturity or until it recovers in value. Changes in assumptions,
facts and circumstances could result in additional charges to earnings in future
periods to the extent that losses are realized. The charge to earnings, while
potentially significant to net income, would not have a significant effect on
shareholder's equity since the majority of our portfolio is designated as
available-for-sale and carried at fair value and as a result, any related net
unrealized loss would already be reflected as a component of accumulated other
comprehensive income in shareholder's equity.
The determination of the amount of impairment is an inherently subjective
process based on periodic evaluation of the factors above. Such evaluations and
assessments are revised as conditions change and new information becomes
available. We update our evaluations regularly and reflect changes in
impairments in results of operations as such evaluations are revised. The use of
different methodologies and assumptions as to the determination of the fair
value of investments and the timing and amount of impairments may have a
material effect on the amounts presented within the consolidated financial
statements.
For a more detailed discussion of the risks relating to changes in
investment values and levels of investment impairment as well as the potential
causes of such changes, see Note 6 of the consolidated financial statements and
the Investments, Market Risk, and Forward-looking Statements and Risk Factors
sections of this document.
DERIVATIVE INSTRUMENT HEDGE ACCOUNTING AND FAIR VALUE We primarily use
derivative financial instruments to manage our exposure to market risk and in
conjunction with asset/liability management.
When derivatives meet specific criteria, they may be designated as
accounting hedges and accounted for as fair value, cash flow, foreign currency
fair value, or foreign currency cash flow hedges. When designating a derivative
as an accounting hedge, we formally document the hedging relationship and risk
management objective and strategy. The documentation identifies the hedging
instrument, the hedged item, the nature of the risk being hedged and the
methodology used to assess the effectiveness of the hedging instrument in
offsetting the exposure to changes in the hedged item's fair value attributable
to the hedged risk. In the case of a cash flow hedge, this documentation
includes the exposure to changes in the hedged transaction's variability in cash
flows attributable to the hedged risk. We do not exclude any component of the
change in fair value of the hedging instrument from the effectiveness
assessment. At each reporting date, we confirm that the hedging instrument
continues to be highly effective in offsetting the hedged risk.
The accounting for derivatives is complex and interpretations of the
applicable accounting standards continue to evolve in practice. Judgment is
applied in determining the availability and application of hedge accounting
designations and the appropriate accounting treatment under the applicable
accounting standards. If it is determined that hedge accounting designations
were not appropriately applied, reported net income could be materially
affected. Differences in judgment as to the availability and application of
hedge accounting designations and the appropriate accounting treatment may
result in differing impacts on our financial statements from those previously
reported. Measurements of ineffectiveness of hedging relationships are also
subject to evolving interpretations and estimations which may have a material
effect on net income.
The fair value of exchange traded derivative contracts is based on
observable market quotations in active markets, whereas the fair value of
non-exchange traded derivative contracts is determined using widely accepted
pricing models and other appropriate valuation methods. These techniques involve
some degree of judgment and include inputs that may not be observable in the
market. The fair value of derivatives, depending on the type of derivative, can
be affected by changes in interest rates, foreign exchange rates, financial
indices, credit spreads, market volatility and liquidity. Values can also be
affected by changes in estimates and assumptions used in pricing models. Such
assumptions include estimates of volatility, interest rates, foreign exchange
rates, other financial indices and credit ratings. Included in the analysis of
the fair value is the risk of counterparty default. The use of different
assumptions may have material effects on the estimated derivative fair value
amounts, as well as the amount of reported net income. Also, fluctuations in the
fair value of derivatives which have not been designated for hedge accounting
may result in significant volatility in net income.
16
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The following table presents the valuation of our derivatives by method of
determining fair value.
<Table>
<Caption>
FAIR VALUE OF
(IN MILLIONS) DERIVATIVE
CONTRACTS
-----------------
Fair value based on quoted market prices $ 106
Fair value based on models and other valuation methods 658
Fair value of derivatives related to the Company's products (117)
-----------------
Total fair value of derivatives $ 647
=================
</Table>
For further discussion of these policies and quantification of the impacts
of these estimates and assumptions, see Note 7 of the consolidated financial
statements and the Investments, Market Risk, and Forward-looking Statements and
Risk Factors sections of this document.
DEFERRED POLICY ACQUISITION COST AMORTIZATION We incur significant costs in
connection with acquiring business. In accordance with generally accepted
accounting principles ("GAAP"), costs that vary with and are primarily related
to acquiring business are deferred and recorded as an asset on the Consolidated
Statements of Financial Position.
DAC related to traditional life insurance is amortized over the premium
paying period of the related policies in proportion to the estimated revenues on
such business. Significant assumptions relating to estimated premiums,
investment returns, which include investment income and realized capital gains
and losses, as well as mortality, persistency and expenses to administer the
business are established at the time the policy is issued and are generally not
revised during the life of the policy. The assumptions for determining DAC
amortization and recoverability are consistent with the assumptions used to
calculate reserves for life-contingent contract benefits. Any deviations from
projected business in force resulting from actual policy terminations differing
from expected levels and any estimated premium deficiencies may result in a
change to the rate of amortization in the period such events occur. Generally,
the amortization periods for these contracts approximates the estimated lives of
the policies. The recovery of DAC is dependent upon the future profitability of
this business. We periodically review the adequacy of reserves and
recoverability of DAC for these contracts on an aggregate basis using actual
experience. In the event actual experience is significantly adverse compared to
the original assumptions any remaining unamortized DAC balance must be expensed
to the extent not recoverable and a premium deficiency reserve may be required
if the remaining DAC balance is insufficient to absorb the deficiency.
DAC related to interest-sensitive life, annuities and other investment
contracts is amortized in proportion to the incidence of the total present value
of gross profits, which includes both actual historical gross profits ("AGP")
and estimated future gross profits ("EGP") expected to be earned over the
estimated lives of the contracts. The amortization is net of interest on the
prior period DAC balance using rates established at the inception of the
contracts. Actual amortization periods generally range from 15-30 years;
however, incorporating estimates of customer surrender rates, partial
withdrawals and deaths generally results in the majority of the DAC being
amortized during the surrender charge period. The cumulative DAC amortization is
reestimated and adjusted by a cumulative charge or credit to results of
operations when there is a difference between the incidence of actual versus
expected gross profits in a reporting period or when there is a change in total
EGP.
AGP and EGP consist of the following components: benefit margins primarily
from cost of insurance contract charges less mortality, investment margin
including realized capital gains and losses; and expense margins including
surrender and other contract charges, less maintenance expenses. The amount of
EGP is principally dependent on assumptions for investment returns, including
capital gains and losses on assets supporting contract liabilities, interest
crediting rates to policyholders, the effect of any hedges, persistency,
mortality and expenses. Of these factors, we anticipate that investment returns,
credited interest, persistency, mortality, and expenses are reasonably likely to
have the greatest impact on the amount of DAC amortization. Changes in these
assumptions can be offsetting and the Company is unable to predict their future
movements or offsetting impacts over time.
Each reporting period, DAC amortization is recognized in proportion to AGP
for that period adjusted for interest on the prior period DAC balance. This
amortization process includes an assessment of AGP compared to EGP, the actual
amount of business remaining in-force and realized capital gains and losses on
investments supporting the product liability. The impact of realized capital
gains and losses on amortization of DAC depends upon which product liability is
supported by the assets that give rise to the gain or loss. If the AGP is less
than EGP in the period, but the total EGP is unchanged, the amount of DAC
amortization will generally decrease, resulting in a current period increase to
earnings. The opposite result generally occurs when the AGP exceeds the EGP in
the period, but the total EGP is unchanged.
17
<Page>
Annually we review all assumptions underlying the projections of EGP,
including investment returns, interest crediting rates, mortality, persistency,
and expenses. Management annually updates assumptions used in the calculation of
EGP. At each reporting period we assess whether any revisions to assumptions
used to determine DAC amortization are required. These reviews and updates may
result in amortization acceleration or deceleration, which are commonly referred
to as "DAC unlocking".
If the update of assumptions causes total EGP to increase, the rate of DAC
amortization will generally decrease, resulting in a current period increase to
earnings. A decrease to earnings generally occurs when the assumption update
causes the total EGP to decrease.
Over the past three years, our most significant DAC assumption updates that
resulted in a change to EGP and the amortization of DAC have been revisions to
expected future investment returns, expenses, mortality and in-force or
persistency assumptions resulting in net DAC amortization deceleration of $12
million in 2007, net DAC amortization acceleration of $2 million in 2006, and
net DAC amortization deceleration of $2 million in 2005. The 2005 amortization
deceleration included $55 million related to our subsequently disposed variable
annuity business for which we no longer have any DAC, but was largely offset by
$51 million of amortization acceleration related to investment contracts. The
amortization acceleration on fixed annuity investment contracts was primarily
due to higher than expected lapses on market value adjusted annuities and faster
than anticipated investment portfolio yield declines.
For quantification of the impact of these estimates and assumptions, see
the Forward-looking Statements and Risk Factors sections of this document and
Note 2 and 10 of the consolidated financial statements.
RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS ESTIMATION Benefits for these
contracts are payable over many years; accordingly, the reserves are calculated
as the present value of future expected benefits to be paid, reduced by the
present value of future expected net premiums. Long-term actuarial assumptions
of future investment yields, mortality, morbidity, policy terminations and
expenses are used when establishing the reserve for life-contingent contract
benefits payable under insurance policies including traditional life insurance
and life-contingent annuities. These assumptions, which for life-contingent
annuities and traditional life insurance are applied using the net level premium
method, include provisions for adverse deviation and generally vary by such
characteristics as type of annuity benefit or coverage, year of issue and policy
duration. Future investment yield assumptions are determined based upon
prevailing investment yields as well as estimated reinvestment yields.
Mortality, morbidity and policy termination assumptions are based on our
experience and industry experience. Expense assumptions include the estimated
effects of inflation and expenses to be incurred beyond the premium-paying
period. These assumptions are established at the time the policy is issued, are
consistent with assumptions for determining DAC amortization for these
contracts, and are generally not changed during the policy coverage period.
However, if actual experience emerges in a manner that is significantly adverse
relative to the original assumptions, adjustments to DAC or reserves may be
required resulting in a charge to earnings which could have a material adverse
effect on our operating results and financial condition. We periodically review
the adequacy of these reserves and recoverability of DAC for these contracts on
an aggregate basis using actual experience. In the event that actual experience
is significantly adverse compared to the original assumptions any remaining
unamortized DAC balance must be expensed to the extent not recoverable and the
establishment of a premium deficiency reserve may be required. The effects of
changes in reserve estimates are reported in the results of operations in the
period in which the changes are determined. The company has not recognized a
charge of this nature in the three years ended December 31, 2007. We anticipate
that mortality, investment and reinvestment yields, and policy terminations are
the factors that would be most likely to require adjustment to these reserves or
related DAC.
For further discussion of these policies, see Note 8 of the consolidated
financial statements and the Forward-looking Statements and Risk Factors section
of this document.
18
<Page>
2007 HIGHLIGHTS
- Net income was $412 million in 2007 compared to $428 million in 2006.
- Contractholder fund deposits totaled $7.96 billion for 2007 compared to
$9.54 billion for 2006.
- Net investment income increased 3.6% in 2007 compared to 2006 despite a
2.4% decrease in investments as of December 31, 2007 compared to December
31, 2006.
- The Company paid dividends of $725 million in 2007 to its parent, AIC.
- Return on average beginning and ending period shareholder's equity
increased 0.6 points to 8.0%.
- Effective June 1, 2006, the Company disposed of substantially all of its
variable annuity business through reinsurance with Prudential Financial
Inc. ("Prudential"). The following table presents the results of operations
attributable to our reinsured variable annuity business for the period of
2006 prior to the disposition and 2005.
<Table>
<Caption>
(IN MILLIONS) 2006 2005
---------- ----------
Contract charges $ 136 $ 276
Net investment income 17 50
Realized capital gains and losses (8) (7)
---------- ----------
Total revenues 145 319
Contract benefits (13) (64)
Interest credited to contractholder funds (24) (63)
Amortization of deferred policy acquisition costs (44) (47)
Operating costs and expenses (43) (101)
---------- ----------
Total costs and expenses (124) (275)
Loss on disposition of operations (89) --
---------- ----------
Income from operations before income
tax expense (1) $ (68) $ 44
========== ==========
</Table>
- ----------
(1) For 2006 and 2005, income from operations before income tax expense
attributable to the variable annuity business reinsured to Prudential
included investment spread of $(7) million and $(13) million,
respectively, and benefit spread of $13 million and $(24) million,
respectively.
19
<Page>
OPERATIONS
OVERVIEW AND STRATEGY We are a major provider of life insurance, retirement and
investment products to individual and institutional customers. We serve these
customers through Allstate exclusive agencies and non-proprietary distribution
channels. Our mission is to reinvent retirement and protection for the middle
market consumer.
To achieve our mission and reach our financial goals, our primary
objectives are to deepen financial services relationships with Allstate
customers and build consumer-driven innovation capabilities and culture. We will
continue to drive scale through non-proprietary distribution channel
relationships and leverage future innovations across those channels. We will
also enhance our operational excellence. In addition to focusing on higher
return markets, products, and distribution channels, we will improve our
financial performance through capital efficiency and enterprise risk and return
management capabilities and practices.
Our strategy provides a platform designed to profitably grow our business.
Based upon Allstate's strong financial position and brand, our customers look to
us to help meet their retirement and protection needs through trusted
relationships. We have unique access to potential customers through cross-sell
opportunities within the Allstate exclusive agencies. Our investment expertise,
strong operating platform and solid relationships with leading distribution
partners provide a foundation to deliver value to our customers.
We plan to continue offering a suite of products that provides financial
protection primarily to middle market consumers and help them better prepare for
retirement. Our products include fixed annuities, including deferred, immediate
and indexed; interest-sensitive, traditional and variable life insurance; and
funding agreements backing medium-term notes. Our products are sold through
several distribution channels including Allstate exclusive agencies, which
include exclusive financial specialists, independent agents (including master
brokerage agencies), and financial service firms such as banks, broker-dealers
and specialized structured settlement brokers. Our institutional product line
consists primarily of funding agreements sold to unaffiliated trusts that use
them to back medium-term notes issued to institutional and individual investors.
Summarized financial data for the years ended December 31 is presented in
the following table.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
-------------- ------------- -------------
REVENUES
Premiums $ 502 $ 576 $ 474
Contract charges 942 1,009 1,079
Net investment income 4,205 4,057 3,707
Realized capital gains and losses (197) (79) 19
-------------- ------------- -------------
Total revenues 5,452 5,563 5,279
COSTS AND EXPENSES
Contract benefits (1,364) (1,372) (1,340)
Interest credited to contractholder funds (2,628) (2,543) (2,340)
Amortization of deferred policy acquisition costs (518) (538) (568)
Operating costs and expenses (338) (374) (432)
Restructuring and related charges (2) (24) (1)
-------------- ------------- -------------
Total costs and expenses (4,850) (4,851) (4,681)
Loss on disposition of operations (10) (88) (7)
Income tax expense (180) (196) (174)
-------------- ------------- -------------
Net income $ 412 $ 428 $ 417
============== ============= =============
Investments at December 31 $ 72,414 $ 74,160 $ 72,756
</Table>
NET INCOME declined 3.7% in 2007 compared to 2006 as lower losses associated
with dispositions of operations were more than offset by a decline in total
revenues. Net income increased 2.6% in 2006 compared to 2005, due to higher
revenues, partially offset by higher total costs and expenses and the
recognition in 2006 of losses relating to the disposition of substantially all
of our variable annuity business.
20
<Page>
ANALYSIS OF REVENUES Total revenues decreased 2.0% or $111 million in 2007
compared to 2006, due to higher net realized capital losses and lower premiums
and contract charges, partially offset by higher net investment income. Total
revenues increased 5.4% or $284 million in 2006 compared to 2005 due to higher
net investment income and premiums, partially offset by net realized capital
losses in 2006 compared to net realized capital gains in 2005, and lower
contract charges.
PREMIUMS represent revenues generated from traditional life insurance, immediate
annuities with life contingencies and other insurance products that have
significant mortality or morbidity risk.
CONTRACT CHARGES are revenues generated from interest-sensitive and variable
life insurance, fixed annuities, institutional products and variable annuities
for which deposits are classified as contractholder funds or separate accounts
liabilities. Contract charges are assessed against the contractholder account
values for maintenance, administration, cost of insurance and surrender prior to
contractually specified dates. As a result, changes in contractholder funds are
considered in the evaluation of growth and as indicators of future levels of
revenues. Subsequent to the close of our reinsurance transaction with Prudential
effective June 1, 2006, variable annuity contract charges on the business
subject to the transaction are fully reinsured to Prudential and presented net
of reinsurance on the Consolidated Statements of Operations and Comprehensive
Income (see Note 3 to the Consolidated Financial Statements).
The following table summarizes premiums and contract charges by product.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
---------- ---------- ----------
PREMIUMS
Traditional life insurance $ 260 $ 257 $ 250
Immediate annuities with life contingencies 204 278 197
Other 38 41 27
---------- ---------- ----------
TOTAL PREMIUMS 502 576 474
CONTRACT CHARGES
Interest-sensitive life insurance 862 797 734
Fixed annuities 79 73 65
Variable annuities 1 139 280
---------- ---------- ----------
TOTAL CONTRACT CHARGES (1) 942 1,009 1,079
---------- ---------- ----------
TOTAL PREMIUMS AND CONTRACT CHARGES $ 1,444 $ 1,585 $ 1,553
========== ========== ==========
</Table>
- ----------
(1) Contract charges for 2007, 2006 and 2005 include contract charges
related to the cost of insurance totaling $617 million, $600 million
and $621 million, respectively.
Total premiums decreased 12.8% in 2007 compared to 2006 as a result of a
decline in sales of life contingent immediate annuities due to market
competitiveness.
Total premiums increased 21.5% in 2006 compared to 2005 due primarily to
increased premiums on immediate annuities with life contingencies, due to
certain pricing refinements and a more favorable pricing environment in 2006.
Also contributing to the increase, to a lesser extent, were higher premiums on
traditional life and other products due to increased sales.
Contract charges decreased 6.6% in 2007 compared to 2006 due to the
disposal of substantially all of our variable annuity business through
reinsurance effective June 1, 2006. Excluding contract charges on variable
annuities, substantially all of which are reinsured to Prudential effective June
1, 2006, contract charges increased 8.2% in 2007 compared to 2006. The increase
reflects growth in interest-sensitive life insurance policies in force, higher
maintenance charge rates on interest-sensitive life products and, to a lesser
extent, higher contract charges on fixed annuities. The increase in contract
charges on fixed annuities was mostly attributable to higher surrender charges.
Contract charges decreased 6.5% in 2006 compared to 2005. Excluding
contract charges on variable annuities, contract charges increased 8.9% in 2006
compared to 2005. The increase was mostly due to higher contract charges on
interest-sensitive life products resulting from growth of business in force.
Contract charges on fixed annuities were slightly higher in 2006 due to
increased surrender charges.
21
<Page>
CONTRACTHOLDER FUNDS represent interest-bearing liabilities arising from the
sale of individual and institutional products, such as interest-sensitive life
insurance, fixed annuities and funding agreements. The balance of contractholder
funds is equal to the cumulative deposits received and interest credited to the
contractholder less cumulative contract maturities, benefits, surrenders,
withdrawals and contract charges for mortality or administrative expenses.
The following table shows the changes in contractholder funds.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
------------ ------------ ------------
CONTRACTHOLDER FUNDS, BEGINNING BALANCE $ 60,565 $ 58,190 $ 53,939
DEPOSITS
Fixed annuities 3,635 6,006 5,924
Institutional products (funding agreements) 3,000 2,100 3,773
Interest-sensitive life insurance 1,324 1,336 1,318
Variable annuity and life deposits allocated to fixed accounts 1 99 395
------------ ------------ ------------
Total deposits 7,960 9,541 11,410
INTEREST CREDITED 2,635 2,600 2,340
MATURITIES, BENEFITS, WITHDRAWALS AND OTHER ADJUSTMENTS
Maturities of institutional products (3,165) (2,726) (3,090)
Benefits (1,656) (1,500) (1,336)
Surrenders and partial withdrawals (4,928) (4,627) (3,839)
Contract charges (751) (697) (649)
Net transfers from (to) separate accounts 13 (145) (339)
Fair value hedge adjustments for institutional products 34 38 (289)
Other adjustments (1) (243) (109) 43
------------ ------------ ------------
Total maturities, benefits, withdrawals and other adjustments (10,696) (9,766) (9,499)
------------ ------------ ------------
CONTRACTHOLDER FUNDS, ENDING BALANCE $ 60,464 $ 60,565 $ 58,190
============ ============ ============
</Table>
- ----------
(1) The table above illustrates the changes in contractholder funds, which are
presented gross of reinsurance recoverables on the Consolidated Statements
of Financial Position. The table above is intended to supplement our
discussion and analysis of revenues, which are presented net of reinsurance
on the Consolidated Statements of Operations and Comprehensive Income. As a
result, the net change in contractholder funds associated with products
reinsured to third parties is reflected as a component of the other
adjustments line. This includes, but is not limited to, the net change in
contractholder funds associated with the reinsured variable annuity
business subsequent to the effective date of our reinsurance agreements
with Prudential (see Note 3 to the consolidated financial statements).
Contractholder funds decreased 0.2% in 2007 and increased 4.1% and 7.9% in
2006 and 2005, respectively. Average contractholder funds increased 1.9% in 2007
compared to 2006, 5.9% in 2006 compared to 2005 and 13.9% in 2005 compared to
2004.
Contractholder deposits decreased 16.6% in 2007 compared to 2006. The
decline was primarily due to lower deposits on fixed annuities partially offset
by higher deposits on funding agreements. The decline of 39.5% in fixed annuity
deposits in 2007 compared to 2006 was due to our strategy to raise new business
returns for these products combined with lower industry-wide fixed annuity
sales. Deposits on institutional products increased 42.9% in 2007 compared to
2006. Sales of our institutional products vary from period to period based on
management's assessment of market conditions.
Contractholder deposits decreased 16.4% in 2006 compared to 2005 due to
decreased deposits on funding agreements and, to a lesser extent, the
classification of the net change in variable annuity contractholder funds as
"other adjustments" subsequent to the effective date of our reinsurance
agreements with Prudential. These items were partially offset by higher fixed
annuity deposits. The Company prioritized the allocation of fixed income
investments to support sales of retail products having the best opportunity for
sustainable growth and return while maintaining a retail market presence.
Consequently, sales of institutional products varied from period to period. In
2006, deposits on institutional products declined 44.3% compared to 2005. Higher
fixed annuity deposits in 2006 were the result of a $546 million increase in
deposits on Allstate(R) Treasury-Linked Annuity contracts. This increase was
partially offset by modest declines in deposits on traditional deferred
annuities and market value adjusted annuities. These declines were in part
impacted by our actions to improve new business returns and reduced consumer
demand. Consumer demand for fixed annuities is influenced by market interest
rates on short-term deposit products and equity market conditions, which can
increase the relative attractiveness of competing investment alternatives.
22
<Page>
Surrenders and partial withdrawals increased 6.5% in 2007 compared to 2006
due primarily to an 11.3% increase in surrenders and partial withdrawals on
fixed annuities. This increase was partially offset by lower surrenders and
partial withdrawals on interest-sensitive life insurance policies and the
classification of the net change in variable annuity contractholder funds as
"other adjustments" subsequent to the effective date of our reinsurance
agreements with Prudential. Surrenders and partial withdrawals for 2006 include
$120 million related to the reinsured variable annuity business. The surrender
and partial withdrawal rate on deferred fixed annuities and interest-sensitive
life insurance products, based on the beginning of period contractholder funds,
was 11.6% in 2007 compared to 11.3% in 2006.
Surrenders and partial withdrawals increased 20.5% in 2006 compared to
2005, while the surrender and partial withdrawal rate increased to 11.3% for
2006 from 9.9% for 2005. The increase in the surrender and partial withdrawal
rate in 2006 was influenced by multiple factors, including the relatively low
interest rate environment during the preceding years, which reduced reinvestment
opportunities and increased the number of policies with little or no surrender
charge protection. Also influencing the increase were our crediting rate
strategies related to renewal business implemented to improve investment spreads
on selected contracts.
NET INVESTMENT INCOME increased 3.6% in 2007 compared to 2006 and 9.4% in 2006
compared to 2005. The 2007 increase was primarily due to higher average
portfolio balances, increased portfolio yields and higher income from limited
partnership interests. The 2006 increase was due to increased portfolio yields
and higher average portfolio balances. Higher average portfolio balances in both
years resulted primarily from the investment of cash flows from operating
activities and, in 2006, financing activities related primarily to deposits from
fixed annuities, funding agreements and interest-sensitive life policies. The
higher portfolio yields in both periods were primarily due to increased yields
on floating rate instruments resulting from higher short-term market interest
rates and improved yields on fixed rate assets supporting fixed annuities. For
certain products, the yield changes on our floating rate instruments are
primarily offset by changes in crediting rates to holders of our floating rate
contracts, resulting in minimal impact on net income.
REALIZED CAPITAL GAINS AND LOSSES reflected net losses of $197 million and $79
million in 2007 and 2006, respectively, and net gains of $19 million in 2005.
For further discussion of realized capital gains and losses, see the Investments
section of MD&A.
ANALYSIS OF COSTS AND EXPENSES Total costs and expenses in 2007 were consistent
with 2006 as increased interest credited to contractholder funds was offset by
lower operating costs and expenses, restructuring and related charges,
amortization of DAC and contract benefits. Total costs and expenses increased
3.6% in 2006 compared to 2005 due to higher interest credited to contractholder
funds, contract benefits, and restructuring and related charges, partially
offset by lower operating costs and expenses, and amortization of DAC.
CONTRACT BENEFITS decreased 0.6% or $8 million in 2007 compared to 2006 due to
lower contract benefits on annuities, partially offset by higher contract
benefits on life insurance products. The decline in contract benefits on
annuities was mostly attributable to favorable mortality experience and lower
sales of immediate annuities with life contingencies and the absence in 2007 of
contract benefits on the reinsured variable annuity business, partially offset
by an increase in the implied interest on immediate annuities with life
contingencies. This implied interest totaled $547 million and $539 million in
2007 and 2006, respectively. Increased contract benefits on life insurance
products in 2007 were primarily due to unfavorable mortality experience and
litigation related costs recognized in 2007 in the form of additional policy
benefits on certain universal life policies written prior to 1992.
Contract benefits increased 2.4% or $32 million in 2006 compared to 2005
due primarily to growth in business in force and, to a lesser extent, an
increase in the implied interest on immediate annuities with life contingencies
to $539 million in 2006 from $529 million in 2005. These increases were
partially offset by the absence in 2006 of contract benefits related to the
reinsured variable annuity business in the period subsequent to the effective
date of the reinsurance agreement. Excluding the impact of the reinsured
variable annuity business, contract benefits increased 6.5% or $83 million in
2006 compared to 2005.
23
<Page>
We analyze our mortality and morbidity results using the difference between
premiums, contract charges earned for the cost of insurance and contract
benefits excluding the portion related to the implied interest on immediate
annuities with life contingencies ("benefit spread"). The benefit spread by
product group is disclosed in the following table.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
----------- ------------ ------------
Life insurance $ 337 $ 386 $ 364
Annuities (35) (43) (80)
----------- ------------ ------------
Total benefit spread $ 302 $ 343 $ 284
=========== ============ ============
</Table>
INTEREST CREDITED TO CONTRACTHOLDER FUNDS increased 3.3% or $85 million in 2007
compared to 2006 and 8.7% or $203 million in 2006 compared to 2005. Both
increases were due primarily to growth in average contractholder funds and, to a
lesser extent, higher weighted average interest crediting rates on institutional
products, which are detailed in the table below. These increases were partially
offset by the impact of the reinsured variable annuity business. Excluding the
impact of the reinsured variable annuity business, interest credited to
contractholder funds increased 4.3% in 2007 compared to 2006 and 10.6% in 2006
compared to 2005.
In order to analyze the impact of net investment income and interest
credited to policyholders on net income, we review the difference between net
investment income and the sum of interest credited to contractholder funds and
the implied interest on immediate annuities with life contingencies, which is
included as a component of contract benefits on the Consolidated Statements of
Operations and Comprehensive Income ("investment spread"). The investment spread
by product group is shown in the following table.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
------------ ------------ ------------
Annuities $ 504 $ 480 $ 317
Life insurance 55 49 46
Institutional products 87 88 98
Net investment income on investments supporting capital 384 358 377
------------ ------------ ------------
Total investment spread $ 1,030 $ 975 $ 838
============ ============ ============
</Table>
To further analyze investment spreads, the following table summarizes the
weighted average investment yield on assets supporting product liabilities and
capital, interest crediting rates on investment type products and investment
spreads on those products during 2007, 2006 and 2005.
<Table>
<Caption>
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
INVESTMENT YIELD INTEREST CREDITING RATE INVESTMENT SPREADS
---------------- ----------------------- ------------------
2007 2006 2005 2007 2006 2005 2007 2006 2005
---- ---- ---- ---- ---- ---- ---- ---- ----
Interest-sensitive life insurance 6.2% 6.2% 6.3% 4.6% 4.7% 4.7% 1.6% 1.5% 1.6%
Deferred fixed annuities 5.8 5.7 5.5 3.7 3.7 3.8 2.1 2.0 1.7
Immediate fixed annuities with and
without life contingencies 7.1 7.2 7.3 6.5 6.6 6.6 0.6 0.6 0.7
Institutional products 6.1 6.0 4.6 5.2 5.0 3.6 0.9 1.0 1.0
Investments supporting capital,
traditional life and other products 6.3 6.2 7.1 N/A N/A N/A N/A N/A N/A
</Table>
24
<Page>
The following table summarizes our product liabilities as of December 31
and indicates the account value of those contracts and policies for which an
investment spread is generated.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
------------ ------------ ------------
Immediate fixed annuities with life contingencies $ 8,288 $ 8,138 $ 7,888
Other life contingent contracts and other 4,310 4,066 3,993
------------ ------------ ------------
Reserve for life-contingent contract benefits $ 12,598 $ 12,204 $ 11,881
============ ============ ============
Interest-sensitive life insurance $ 8,896 $ 8,397 $ 7,917
Deferred fixed annuities 34,182 35,498 33,853
Immediate annuities without life contingencies 3,918 3,779 3,598
Institutional products 12,983 12,467 12,431
Market value adjustments related to derivative
instruments and other 485 424 391
------------ ------------ ------------
Contractholder funds $ 60,464 $ 60,565 $ 58,190
============ ============ ============
</Table>
AMORTIZATION OF DAC decreased 3.7% or $20 million in 2007 compared to 2006
and decreased 5.3% or $30 million in 2006 compared to 2005. The components of
amortization of DAC are summarized in the following table.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
----------- ------------ -----------
Amortization of DAC before amortization
relating to realized capital gains and losses
and changes in assumptions (1) $ (547) $ (586) $ (443)
Amortization relating to realized capital gains
and losses (2) 17 50 (127)
Amortization deceleration (acceleration) for
changes in assumptions ("DAC unlocking") (3) 12 (2) 2
----------- ------------ -----------
Total amortization of DAC $ (518) $ (538) $ (568)
=========== ============ ===========
</Table>
- ----------
(1) Amortization of DAC before amortization relating to realized capital
gains and losses and changes in assumptions for 2006 and 2005 includes
$(72) million and $(103) million, respectively, relating to the
reinsured variable annuity business.
(2) Amortization relating to realized capital gains and losses for 2006
and 2005 includes $28 million and $1 million, respectively, relating
to the reinsured variable annuity business.
(3) Amortization deceleration (acceleration) for changes in assumptions
("DAC unlocking") for 2005 includes $55 million relating to the
reinsured variable annuity business. There was no DAC unlocking
related to variable annuities in 2006.
The decrease in amortization of DAC in 2007 compared to 2006 was due to the
absence in 2007 of amortization on the reinsured variable annuity business.
Excluding amortization relating to the reinsured variable annuity business,
amortization of DAC increased 4.9% or $24 million in 2007 compared to 2006 due
primarily to increased amortization related to higher gross profits on fixed
annuities and a decline in the credit to income for amortization relating to
realized capital gains and losses, partially offset by a favorable impact
relating to our annual comprehensive review of DAC assumptions (commonly
referred to as "DAC unlocking").
The decline in amortization of DAC in 2006 compared to 2005 was driven
mostly by a favorable change in amortization relating to realized capital gains
and losses and a reduction in amortization on our reinsured variable annuity
business, partially offset by the impact of higher gross profits on investment
contracts.
The impact of realized capital gains and losses on amortization of DAC is
dependent upon the relationship between the assets that give rise to the gain or
loss and the product liability supported by the assets. Fluctuations result from
changes in the impact of realized capital gains and losses on actual and
expected gross profits.
The DAC asset was reduced by $726 million in 2006 as a result of the
disposition of substantially all of our variable annuity business.
25
<Page>
The changes in the DAC asset are detailed in the following tables.
<Table>
<Caption>
AMORTIZATION
BEFORE EFFECT OF
BEGINNING REALIZED CAPITAL
BALANCE IMPACT OF ACQUISITION GAINS AND LOSSES
DECEMBER 31, ADOPTION OF COSTS AND CHANGES IN
(IN MILLIONS) 2006 SOP 05-1 (1) DEFERRED ASSUMPTIONS (2)
------------ ------------ ----------- ----------------
Traditional life
and other $ 622 $ -- $ 76 $ (54)
Interest-sensitive
life 1,632 -- 249 (175)
Fixed annuities 1,217 (11) 220 (311)
Variable annuities 4 -- -- (2)
Other 10 -- 2 (5)
------------ ------------ ----------- ----------------
Total $ 3,485 $ (11) $ 547 $ (547)
============ ============ =========== ================
<Caption>
AMORTIZATION AMORTIZATION
RELATING TO (ACCELERATION) EFFECT OF ENDING
REALIZED CAPITAL DECELERATION FOR UNREALIZED BALANCE
GAINS AND CHANGES IN CAPITAL GAINS DECEMBER 31,
(IN MILLIONS) LOSSES (2) ASSUMPTIONS (2)(3) AND LOSSES 2007
---------------- ------------------ ------------- ------------
Traditional life
and other $ -- $ -- $ -- $ 644
Interest-sensitive
life 12 17 30 1,765
Fixed annuities 5 (5) 372 1,487
Variable annuities -- -- -- 2
Other -- -- -- 7
---------------- ------------------ ------------- ------------
Total 17 $ 12 $ 402 $ 3,905
================ ================== ============= ============
</Table>
<Table>
<Caption>
AMORTIZATION
BEFORE EFFECT OF
BEGINNING IMPACT OF REALIZED CAPITAL
BALANCE DISPOSAL OF ACQUISITION GAINS AND LOSSES
DECEMBER 31, VARIABLE COSTS AND CHANGES IN
(IN MILLIONS) 2005 ANNUITIES DEFERRED ASSUMPTIONS (2)
------------- ------------ ----------- ------------------
Traditional life
and other $ 603 $ -- $ 78 $ (59)
Interest-sensitive
life 1,530 -- 257 (180)
Fixed annuities 1,071 -- 359 (266)
Variable annuities 731 (726) 45 (75)
Other 13 -- 3 (6)
------------- ------------ ----------- ------------------
Total $ 3,948 $ (726) $ 742 $ (586)
============= ============ =========== ==================
<Caption>
AMORTIZATION AMORTIZATION
RELATING TO (ACCELERATION) EFFECT OF ENDING
REALIZED CAPITAL DECELERATION FOR UNREALIZED BALANCE
GAINS AND CHANGES IN CAPITAL GAINS DECEMBER 31,
(IN MILLIONS) LOSSES (2) ASSUMPTIONS (2)(3) AND LOSSES 2006
---------------- ------------------ --------------- -------------
Traditional life
and other $ -- $ -- $ -- $ 622
Interest-sensitive
life (3) (18) 46 1,632
Fixed annuities 24 16 13 1,217
Variable annuities 29 -- -- 4
Other -- -- -- 10
---------------- ------------------ --------------- -------------
Total 50 $ (2) $ 59 $ 3,485
================ ================== =============== =============
</Table>
- ----------
(1) The adoption of Statement of Position 05-1, "Accounting by Insurance
Enterprises for Deferred Acquisition Costs in Connection with Modifications
or Exchanges of Insurance Contracts" ("SOP 05-1"), resulted in a $7 million
after-tax adjustment to unamortized DAC related to the impact on future
estimated gross profits from the changes in accounting for certain costs
associated with contract continuations that no longer qualify for deferral
under SOP 05-1. The adjustment was recorded as a reduction of retained
income at January 1, 2007 and a reduction of the DAC balance of $11
million, pretax.
(2) Included as a component of amortization of DAC on the Consolidated
Statements of Operations and Comprehensive Income.
(3) Commonly referred to as "DAC unlocking".
26
<Page>
OPERATING COSTS AND EXPENSES decreased 9.6% in 2007 compared to 2006 and
decreased 13.4% in 2006 compared to 2005. The following table summarizes
operating costs and expenses.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
Non-deferrable acquisition costs $ 97 $ 118 $ 149
Other operating costs and expenses 241 256 283
----------- ----------- -----------
Total operating costs and expenses $ 338 $ 374 $ 432
=========== =========== ===========
Restructuring and related charges $ 2 $ 24 $ 1
=========== =========== ===========
</Table>
Non-deferrable acquisition costs and other operating costs and expenses
declined in 2007 compared to 2006 due primarily to expenses in 2006 related to
the reinsured variable annuity business. Subsequent to the effective date of the
reinsurance agreement for the variable annuity business, operating costs and
expenses benefited from a servicing fee paid by Prudential for the Company's
servicing of the business during a 24 month or less transition period following
the effective date of the reinsurance agreement. Non-deferrable acquisition
costs and other operating costs and expenses for 2006 included $19 million and
$24 million, respectively, related to the reinsured variable annuity business
for the period of 2006 prior to the effective date of the reinsurance agreement.
Excluding expenses associated with the impact of the reinsured variable annuity
business in the period of 2006 prior to the effective date of the reinsurance
agreement, non-deferrable acquisition expenses decreased 2.0% in 2007 compared
to 2006 due to lower premium taxes and decreased non-deferrable commissions on
certain immediate annuities and other operating costs and expenses increased
3.9% due to higher investment in technology.
Total operating costs and expenses declined in 2006 compared to 2005
primarily as a result of the reinsured variable annuity business.
Restructuring and related charges for 2006 reflect costs related to the
Voluntary Termination Offer ("VTO"). The VTO was offered to most employees
located at the Company's headquarters and was completed during 2006.
LOSS ON DISPOSITION OF OPERATIONS for 2007, 2006 and 2005 totaled $10 million,
$88 million and $7 million, respectively. In 2007, the net loss was primarily
comprised of losses associated with the anticipated disposition of our direct
response long-term care business that is currently held for sale, partially
offset by amortization of the deferred reinsurance gain and other adjustments
associated with reinsured variable annuity business. The net loss in 2006 was
almost entirely attributable to the reinsured variable annuity business. In
2005, the net loss was related to several individually insignificant gains and
losses for anticipated dispositions.
INCOME TAX EXPENSE decreased by 8.2% or $16 million in 2007 compared to 2006 and
increased by 12.6% or $22 million in 2006 compared to 2005. The decline in 2007
compared to 2006 was due to lower income from operations before income tax
expense and an energy tax credit that reduced income tax expense. The increase
in 2006 compared to 2005 was due to increased income from operations before
income tax expense and an increase in the effective tax rate related to
adjustments to prior years' tax liabilities.
The Company's effective tax rate is impacted by tax favored investment
income such as dividends qualifying for the dividends received deduction
("DRD"). In 2007, the Internal Revenue Service ("IRS") announced its intention
to issue regulations dealing with certain computational aspects of the DRD
related to separate account assets ("separate accounts DRD"). The ultimate
timing and substance of any such regulations are unknown at this time, but may
result in the elimination of some or all of the separate accounts DRD tax
benefit reflected as a component of the Company's income tax expense. The
Company recognized a tax benefit from the separate accounts DRD of $16 million,
$21 million and $18 million in 2007, 2006 and 2005, respectively.
27
<Page>
REINSURANCE CEDED We enter into reinsurance agreements with unaffiliated
reinsurers to limit our risk of mortality and morbidity losses. In addition, the
Company has used reinsurance to effect the acquisition or disposition of certain
blocks of business. We retain primary liability as a direct insurer for all
risks ceded to reinsurers.
As of December 31, 2007 and 2006, 49% and 50%, respectively, of our face
amount of life insurance in force was reinsured. As of December 31, 2007 and
2006, for certain term life insurance policies, we ceded up to 90% of the
mortality risk depending on the length of the term. Additionally, we ceded
substantially all of the risk associated with our variable annuity business and
we cede 100% of the morbidity risk on substantially all of our long-term care
contracts. Beginning in July 2007, for new life insurance contracts, we ceded
mortality risk associated with coverage in excess of $3 million per life for
contracts issued to individuals age 70 and over, and we ceded the mortality risk
associated with coverage in excess of $5 million per life for most other
contracts. Also, beginning in July 2007, for certain large contracts that meet
specific criteria, the Company's retention limit was increased to $10 million
per life. In the period prior to July 2007, but subsequent to August 1998, we
ceded the mortality risk associated with coverage in excess of $2 million per
life, except in 2006 for certain instances when specific criteria were met, we
ceded the mortality risk associated with coverage in excess of $5 million per
life. For business sold prior to October 1998, we ceded mortality risk in excess
of specific amounts up to $1 million per individual life. The changes in our
retention guidelines for new life insurance contracts did not have a significant
impact on the results of operations in 2007 or 2006.
Amounts recoverable from reinsurers by type of policy or contract at
December 31, are summarized in the following table.
<Table>
<Caption>
REINSURANCE RECOVERABLE ON
(IN MILLIONS) PAID AND UNPAID CLAIMS
--------------------------------
2007 2006
------------ ---------------
Annuities (1) $ 1,423 $ 1,654
Life insurance 1,365 1,217
Long-term care 526 427
Other 96 94
------- -------
Total $ 3,410 $ 3,392
======= =======
</Table>
- ----------
(1) Reinsurance recoverables as of December 31, 2007 and
2006 include $1.26 billion and $1.49 billion,
respectively, for general account reserves related to
variable annuities.
The estimation of reinsurance recoverables is impacted by the uncertainties
involved in the establishment of reserves.
Our reinsurance recoverables, summarized by reinsurer as of December 31,
are shown in the following table.
<Table>
<Caption>
S&P FINANCIAL REINSURANCE
STRENGTH RECOVERABLE ON PAID
(IN MILLIONS) RATING AND UNPAID CLAIMS
------ -----------------
2007 2006
---- ----
Prudential Insurance Company of America AA $ 1,261 $ 1,490
Employers Reassurance Corporation A+ 541 439
RGA Reinsurance Company AA- 325 293
Transamerica Life Group AA 288 232
Swiss Re Life and Health America, Inc. AA- 172 160
Paul Revere Life Insurance Company BBB+ 147 147
Scottish Re Group BB+ 110 127
Munich American Reassurance AA- 103 92
Security Life of Denver AA 86 73
Manulife Insurance Company AAA 78 82
Triton Insurance Company NR 73 65
Lincoln National Life Insurance AA 63 59
American Health & Life Insurance Co. NR 57 50
Other (1) 106 83
------- -------
Total $ 3,410 $ 3,392
======= =======
</Table>
- ----------
(1) As of December 31, 2007 and 2006, the other category includes $69
million and $59 million, respectively, of recoverables due from
reinsurers with an investment grade credit rating from Standard &
Poor's ("S&P").
28
<Page>
We continuously monitor the creditworthiness of reinsurers in order to
determine our risk of recoverability on an individual and aggregate basis, and a
provision for uncollectible reinsurance is recorded if needed. No amounts have
been deemed unrecoverable in the three-years ended December 31, 2007.
ALIC's insurance subsidiaries are domiciled in Illinois, New York, South
Carolina and Nebraska. Except for those domiciled in New York and South
Carolina, ALIC has 100% intercompany reinsurance agreements in place with most
of its domestic insurance subsidiaries. With the exception of Allstate Life
Insurance Company of New York, which retains substantially all of its business
up to its per life limit, and ALIC Reinsurance Company, which is a special
purpose financial captive, only invested assets supporting capital and relating
to Separate Accounts remain in ALIC's other subsidiaries. All significant
intercompany transactions have been eliminated in consolidation.
OUTLOOK
- - We plan to increase sales of our financial products by Allstate exclusive
agencies by developing and bringing to market new innovative,
consumer-driven financial products and features targeted to middle market
customers.
- - Sales of our institutional products will be impacted by management's
assessment of market liquidity, credit spreads and other market conditions.
Market conditions may also influence whether maturing contracts are
replaced with new issuances.
- - We expect operating costs and expenses to increase over the prior year as a
result of increased spending for the development of innovative products,
additional marketing and growth of our Allstate exclusive agency
distribution channel as well as a reduction in the variable annuity
servicing fee from Prudential. We expect that these expense increases will
be partially mitigated by our continuing focus on operating efficiency.
- - We plan to balance targeted new business return improvement with
investments in growth initiatives and sales. Initially, investments in
growth are expected to slow the improvement of returns and may reduce the
price competitiveness of certain products, such as our fixed annuities, and
slow or reduce the growth in sales and net income.
- - The transition of our investment objective from primarily income generation
to increased focus on increasing total returns may result in increased
volatility in net investment income and realized capital gains and losses
from period to period. Increased allocations to alternative investment
classes, such as limited partnership interests and other equity-based
assets, may also contribute to this volatility.
- - Increased levels of dividends paid in 2007, combined with the anticipated
dividends in 2008, may lead to a decline in invested assets and investment
income.
29
<Page>
INVESTMENTS
OVERVIEW AND STRATEGY An important component of our financial results is the
return on our investment portfolio. The investment portfolio is managed based
upon the nature of the business and its corresponding liability structure.
Our investment strategy has historically focused on the need for
risk-adjusted spread to support the underlying liabilities to achieve return on
capital and profitable growth. We believe investment spread is maximized by
selecting assets that perform favorably on a long-term basis and by disposing of
certain assets to minimize the effect of downgrades and defaults. We believe
this strategy maintains the investment spread necessary to sustain income over
time. The portfolio management approach employs a combination of recognized
market, analytical and proprietary modeling, including a strategic asset
allocation model, as the primary basis for the allocation of interest sensitive,
illiquid and credit assets as well as for determining overall below investment
grade exposure and diversification requirements. Within the ranges set by the
strategic asset allocation model, tactical investment decisions are made in
consideration of prevailing market conditions. We will be adding a total return
framework to the management of our assets to further enhance long-term returns
and leverage our active management capabilities.
In conjunction with our priority of optimizing the returns we realize for
the risks we accept, we will be undertaking selected new investment strategies.
We are forming an investment subsidiary to pursue investment opportunities not
efficiently held within our insurance operations. The creation of this
subsidiary improves our capital management by enabling higher return investment
strategies. As a result of these strategies and enterprise asset allocation,
there may be a different mix in the reporting of returns between investment
income, realized capital gains and losses, unrealized capital gains and losses
and higher investment expenses. Additionally, these strategies may result in
increased leverage from investing activities.
As a result of tactical decisions, we may sell securities during the period
in which fair value has declined below amortized cost for fixed income
securities or cost for equity securities. Portfolio monitoring, which includes
identifying securities that are other-than-temporarily impaired and recognizing
other-than-temporary impairments on securities in an unrealized loss position
for which we do not have the intent and ability to hold until recovery, are
conducted regularly. For more information, see the Portfolio Monitoring section
of the MD&A.
PORTFOLIO COMPOSITION The composition of the investment portfolio at December
31, 2007 is presented in the table below. Also see Notes 2 and 6 to the
consolidated financial statements for investment accounting policies and
additional information.
<Table>
<Caption>
PERCENT TO
(IN MILLIONS) INVESTMENTS TOTAL
------------------ --------------
Fixed income securities (1) $ 58,469 80.7%
Mortgage loans 9,901 13.7
Equity securities 102 0.1
Limited partnership interests 994 1.4
Short-term 386 0.5
Policy loans 770 1.1
Other 1,792 2.5
------------------ --------------
Total $ 72,414 100.0%
================== ==============
</Table>
- ----------
(1) Fixed income securities are carried at fair value. Amortized cost
basis for these securities was $58.02 billion.
Total investments decreased to $72.41 billion at December 31, 2007 from
$74.16 billion at December 31, 2006, primarily due to decreased net unrealized
gains on fixed income securities, the payment of dividends to AIC, the repayment
of an intercompany note to AIC, and lower funds associated with collateral
received in conjunction with securities lending and other activities, partially
offset by positive cash flows from operating activities.
Total investments at amortized cost related to collateral received in
connection with securities lending business activities, funds received in
connection with securities repurchase agreements and collateral posted by
counterparties related to derivative transactions decreased to $1.82 billion at
December 31, 2007, from $2.29 billion at December 31, 2006. As of December 31,
2007 and 2006, these investments were carried at fair value and classified in
fixed income securities totaling $1.57 billion and $1.53 billion, respectively,
and short-term investments totaling $219 million and $783 million, respectively.
30
<Page>
Securities lending activities are primarily used as an investment yield
enhancement, and are conducted with third parties such as brokerage firms. We
obtain collateral, typically in the form of cash, in an amount generally equal
to 102% and monitor the market value of the securities loaned on a daily basis
with additional collateral obtained as necessary. The cash we receive is
invested in short-term and fixed income investments, and an offsetting liability
to return the collateral is recorded in other liabilities and accrued expenses.
FIXED INCOME SECURITIES See Note 6 of the consolidated financial statements for
a table showing the amortized cost, unrealized gains, unrealized losses and fair
value for each type of fixed income security for the years ended December 31,
2007 and 2006.
The following table shows fixed income securities by type at December 31.
<Table>
<Caption>
(IN MILLIONS) FAIR VALUE
----------
2007 2006
---- ----
U.S. government and agencies $ 3,728 $ 3,496
Municipal 4,311 4,790
Corporate 31,735 33,327
Foreign government 2,185 2,023
Mortgage-backed securities 3,490 4,518
Commercial mortgage-backed securities 7,388 7,600
Asset-backed securities 5,603 5,681
Redeemable preferred stock 29 22
------- -------
Total fixed income securities $58,469 $61,457
======= =======
</Table>
During 2007, certain financial markets experienced decreased liquidity.
This was particularly evident in the markets for securities collateralized by
sub-prime residential mortgages. We experienced this illiquidity particularly in
our asset-backed residential mortgage-backed securities ("ABS RMBS"),
asset-backed collateralized debt obligations ("ABS CDOs"), Alt-A residential
mortgage-backed securities ("Alt-A") and commercial real estate collateralized
debt obligations ("CRE CDO") portfolios. These portfolios totaled $3.57 billion
or less than 5% of our total investments at December 31, 2007. Certain other
asset-backed and real estate-backed securities markets experienced illiquidity,
but to a lesser degree.
The fair values of securities comprising the illiquid portfolios are
obtained from our contracted third-party pricing servicers and brokers. We
evaluated the reasonableness of the fair value of these portfolios as of
December 31, 2007 by comparing vendor prices to alternative third-party pricing
and valuation servicers, both of which consider available market information
including, but not limited to, collateral quality, anticipated cash flows,
credit enhancements, default rates, loss severities, and credit ratings from
rating agencies. In addition, we also considered the reasonableness of security
values based upon the securities' relative position within their respective
capital structures in determining the reasonableness of fair values, on a
portfolio basis, for the above referenced securities as of December 31, 2007.
MUNICIPAL BONDS, including tax-exempt and taxable securities, totaled $4.31
billion and 99.8% were rated investment grade at December 31, 2007.
As of December 31, 2007, approximately $2.34 billion or 54.3% of our
municipal bond portfolio is insured by seven bond insurers and 97.3% have a
Moody's equivalent rating of Aaa or Aa. Our practices for acquiring and
monitoring municipal bonds primarily take into consideration the quality of the
underlying security. As of December 31, 2007, we believe that the valuations
already reflect a significant decline in the value of the insurance, and further
such declines, if any, are not expected to be material. While the valuation of
these holdings may be temporarily impacted by negative market developments, we
continue to have the intent and ability to hold the bonds and expect to receive
all of the contractual cash flows. As of December 31, 2007, 35.8% of our insured
municipal bond portfolio was insured by MBIA, 15.7% by AMBAC, 15.9% by FSA and
21.4% by FGIC. In total, we hold $3.20 billion of fixed income securities that
are insured by bond insurers, including $566 million of our ABS RMBS and $290
million of our other asset-backed securities discussed below. Additionally, we
hold $46 million of corporate bonds that were directly issued by these bond
insurers.
Included in our municipal bond portfolio at December 31, 2007 are $866
million of auction rate securities ("ARS") that have long-term stated
maturities, with the interest rate reset based on auctions every 7, 28 or 35
days depending on the specific security. At the auction date, if the quantity of
sell orders exceeds the quantity of purchase orders, the auction "fails" and the
issuers are forced to pay a "maximum rate" as defined for each issue. The
maximum rate is designed so that its prolonged use is an incentive to the issuer
to call and refinance the long-term
31
<Page>
bonds. The effect of this incentive may be lessened to the extent that the
maximum rate is closer to current market rates. When auctions are
successfully completed, the interest rate reset normally corresponds with the
short-term rate associated with the reset period. Our holdings primarily have
a Moody's or equivalent rating of Aaa and fair value was estimated at the
corresponding par value at December 31, 2007. We make our investment
decisions based on the underlying credit of each security, which for
approximately 95% of our holdings are pools of student loans for which at
least 85% of the collateral is insured by the U.S. Department of Education.
In 2008 through March 13, dealers were no longer supporting auctions with
their own bids as they had in the past and we experienced failed auctions for
all of our ARS holdings as of March 13, 2008 for which we are currently
receiving the maximum rate. We anticipate that failed auctions may persist.
Auctions will continue to be conducted as scheduled for each of the
securities. While these developments continue in the market, par value of
these holdings may not be representative of the fair value of these
securities. Accordingly, subsequent auctions could be more successful
resulting in interest rates being more in line with the 7, 28 or 35 day reset
periods.
CORPORATE BONDS totaled $31.74 billion and 93.0% were rated investment
grade at December 31, 2007. As of December 31, 2007, $15.57 billion or 49.1% of
the portfolio consisted of privately placed securities compared to $15.55
billion or 46.7% at December 31, 2006. Privately placed securities primarily
consist of corporate issued senior debt securities that are in unregistered form
and are directly negotiated with the borrower. All privately placed corporate
securities are rated by The National Association of Insurance Commissioners
("NAIC") based on information provided to them and are also internally rated.
Additionally, approximately 43.1% of the privately placed corporate securities
in our portfolio are rated by an independent rating agency. The following table
summarizes the privately placed corporate securities portfolio by credit quality
as of December 31, 2007.
<Table>
<Caption>
(IN MILLIONS)
NET PERCENT
MOODY'S UNREALIZED OF FAIR
NAIC EQUIVALENT FAIR GAINS AND VALUE
RATING RATING VALUE LOSSES TO TOTAL
------ ------------ --------- ----------- --------
1 Aaa/Aa/A $ 6,869 $ 95 44.1%
2 Baa 7,731 41 49.7
3 Ba 840 (24) 5.4
4 B 89 (7) 0.6
5 Caa or lower 37 (2) 0.2
6 In or near 3 -- --
---------- ----------- ---------
Total $ 15,569 $ 103 100.0%
========== =========== =========
</Table>
The Company's portfolio of privately placed securities are broadly
diversified by issuer, industry sector, and by country. The portfolio is made up
of approximately 590 issues with an average security value of approximately $26
million. Privately placed corporate obligations generally benefit from increased
yields and structural security features such as financial covenants and call
protections that provide investors greater protection against credit
deterioration, reinvestment risk or fluctuations in interest rates than those
typically found in publicly registered debt securities. Additionally,
investments in these securities are made after extensive due diligence of the
issuer, typically including direct discussions with senior management and
on-site visits to company facilities. Ongoing monitoring includes direct
periodic dialog with senior management of the issuer and continuous monitoring
of operating performance and financial position. Every issue is internally rated
with a formal rating affirmation once a year.
Hybrid securities are carried at fair value and total $2.67 billion and
$2.09 billion at December 31, 2007 and 2006, respectively. For further
discussion on hybrid securities, see Note 2 to the consolidated financial
statements.
FOREIGN GOVERNMENT securities totaled $2.19 billion and 87.8% were rated
investment grade at December 31, 2007.
MORTGAGE-BACKED SECURITIES ("MBS") totaled $3.49 billion, all of which were
rated investment grade at December 31, 2007. The credit risk associated with MBS
is mitigated due to the fact that 56.3% of the portfolio consists of securities
that were issued by, or have underlying collateral that is guaranteed by U.S.
government agencies or U.S. government sponsored entities ("U.S. Agency"). The
MBS portfolio is subject to interest rate risk since price volatility and the
ultimate realized yield are affected by the rate of prepayment of the underlying
mortgages.
32
<Page>
The following table shows MBS by type and Moody's equivalent rating at
December 31, 2007.
<Table>
<Caption>
FAIR % TO TOTAL
(IN MILLIONS) VALUE INVESTMENTS Aaa Aa A
------- ----------- --- -- -
MBS
U.S. Agency $ 1,967 2.7% 100.0% --% --%
Prime 934 1.3 96.1 3.9 --
Alt-A 589 0.8 90.3 9.7 --
------- -----
Total MBS $ 3,490 4.8%
======= =====
</Table>
The following table presents information about the collateral in our Alt-A
holdings at December 31, 2007.
<Table>
<Caption>
FAIR % TO TOTAL
(IN MILLIONS) VALUE INVESTMENTS
----- -----------
ALT-A
Fixed rate $ 423 0.6%
Variable rate 166 0.2
----- ---
Total Alt-A $ 589 0.8%
===== ===
</Table>
Alt-A mortgage-backed securities are at fixed or variable rates and include
certain securities that are collateralized by residential mortgage loans issued
to borrowers with stronger credit profiles than sub-prime borrowers, but do not
qualify for prime financing terms due to high loan-to-value ratios or limited
supporting documentation. Fair value represents 95.9% of the amortized cost of
these securities. At December 31, 2007, the Alt-A portfolio had net unrealized
losses of $25 million, which were comprised of $1 million of gross unrealized
gains and $26 million of gross unrealized losses. $362 million or 61.5% of these
securities were issued during 2005, 2006 and 2007. We acquired $136 million of
Alt-A securities during 2007, which were rated Aaa by one or more rating
agencies at the time of purchase.
COMMERCIAL MORTGAGE-BACKED SECURITIES ("CMBS") totaled $7.39 billion and
99.7% were rated investment grade at December 31, 2007. Approximately 85.7% of
the CMBS investments are pools of commercial mortgages, broadly diversified
across property types and geographical area. The CMBS portfolio is subject to
credit risk, but unlike other structured products, is generally not subject to
prepayment risk due to protections within the underlying commercial mortgages,
whereby borrowers are effectively restricted from prepaying their mortgages due
to changes in interest rates. Credit defaults can result in credit directed
prepayments. The following table shows CMBS by type and Moody's equivalent
rating at December 31, 2007.
<Table>
<Caption>
% TO TOTAL
(IN MILLIONS) FAIR VALUE INVESTMENTS Aaa Aa A Baa
---------- ----------- --- -- - ---
CMBS $ 6,822 9.4% 79.3% 13.7% 5.7% 1.3%
CRE CDO 566 0.8 33.1 31.2 25.3 10.4
-------- ----
Total CMBS $ 7,388 10.2%
======== ====
</Table>
CRE CDO are investments secured primarily by commercial mortgage-backed
securities and other commercial mortgage debt obligations. These securities are
generally less liquid and have a higher risk profile than other commercial
mortgage-backed securities. Fair value represents 78.6% of the amortized cost of
these securities. At December 31, 2007, CRE CDO had net unrealized losses of
$155 million, which were comprised of $1 million of gross unrealized gains and
$156 million of gross unrealized losses. In addition to the quality of the loans
and securities collateralizing the CRE CDOs, influential factors in our analysis
are the adequacy of subordination and strength of the CRE CDO management team.
ASSET-BACKED SECURITIES ("ABS") totaled $5.60 billion and 97.3% were rated
investment grade at December 31, 2007. Credit risk is managed by monitoring the
performance of the collateral. In addition, many of the securities in the ABS
portfolio are credit enhanced with features such as over-collateralization,
subordinated structures, reserve funds, guarantees and/or insurance. A portion
of the ABS portfolio is also subject to interest rate risk since, for example,
price volatility and ultimate realized yields are affected by the rate of
prepayment of the underlying assets.
33
<Page>
The following table shows ABS by type at December 31, 2007.
<Table>
<Caption>
FAIR % TO TOTAL Ba OR
(IN MILLIONS) VALUE INVESTMENTS Aaa Aa A Baa LOWER
------- ----------- --- -- - --- ------
ABS
ABS RMBS $ 2,382 3.3% 65.5% 28.1% 5.3% 0.1% 1.0%
ABS CDOs 36 -- 86.2 13.8 -- -- --
------- ----
Total asset-backed securities collateralized by
sub-prime residential mortgage loans 2,418 3.3
Other collateralized debt obligations 1,977 2.7 34.4 27.0 27.5 8.1 3.0
Other asset-backed securities 1,208 1.7 53.0 6.8 20.0 13.8 6.4
------- ----
Total ABS $ 5,603 7.7%
======= ====
</Table>
The following table presents additional information about our ABS RMBS
portfolio including a summary by first and second lien collateral at December
31, 2007.
<Table>
<Caption>
% TO TOTAL
(IN MILLIONS) FAIR VALUE INVESTMENTS
----------- -----------
ABS RMBS
First lien:
Fixed rate(1) $ 708 1.0%
Variable rate(1) 1,141 1.6
----------- -----------
Total first lien(2) 1,849 2.6
Second lien :
Insured 435 0.6
Other 98 0.1
----------- -----------
Total second lien(3) 533 0.7
----------- -----------
Total ABS RMBS $ 2,382 3.3%
=========== ===========
</Table>
- ----------
(1) Fixed rate and variable rate refer to the primary
interest rate characteristics of the underlying
mortgages at the time of issuance.
(2) The credit ratings of the first lien ABS RMBS were
58.2% Aaa, 35.5% Aa and 6.3% A at December 31, 2007.
(3) The credit ratings of the second lien ABS RMBS were
90.8% Aaa, 2.3% Aa, 1.9% A, 0.5% Baa and 4.5% Ba or
lower at December 31, 2007.
ABS RMBS portfolio includes securities that are collateralized by mortgage
loans issued to borrowers that cannot qualify for prime or alternative financing
terms due in part to an impaired or limited credit history. It also includes
securities that are collateralized by certain second lien mortgages regardless
of the borrower's credit history. Fair value represents 87.0% of the amortized
cost of these securities. As of December 31, 2007, the ABS RMBS portfolio had
net unrealized losses of $355 million, which were comprised of $2 million of
gross unrealized gains and $357 million of gross unrealized losses.
At December 31, 2007, $555 million or 35.6% of the total ABS RMBS
securities that are rated Aaa and Aa are insured by 4 bond insurers. $1.91
billion or 80.1% of the portfolio consisted of securities that were issued
during 2005, 2006 and 2007. At December 31, 2007, 74.6% of these securities were
rated Aaa, 22.4% rated Aa, 1.5% rated A, 0.2% rated Baa and 1.3% rated Ba or
lower.
During 2007, three second lien ABS RMBS with a value of $12 million were
downgraded within the investment grade ratings. Four second lien securities with
a fair value of $25 million were downgraded from investment grade to below
investment grade ratings.
During 2007, we sold $150 million of ABS RMBS, recognizing a loss less than
$1 million. We also collected $523 million of principal repayments consistent
with the expected cash flows. These repayments represent approximately 25.4% of
the amortized cost of our outstanding portfolio at December 31, 2006.
ABS CDOs are securities collateralized by a variety of residential
mortgage-backed and other securities, which may include sub-prime RMBS. Fair
value represents 47.4% of the amortized cost of these securities. As of December
31, 2007, this portfolio had net unrealized losses of $40 million.
34
<Page>
Writedowns during 2007, were recorded on our ABS RMBS and ABS CDOs totaling
$17 million and $62 million, respectively. We did not record any write-downs
related to our Alt-As or CRE CDOs. We continue to believe that the unrealized
losses on these securities are not necessarily predictive of the performance of
the underlying collateral. In the absence of further deterioration in the
collateral relative to our positions in the securities' respective capital
structures, which could require other-than-temporary impairments, the unrealized
losses should reverse over the remaining lives of the securities.
OTHER COLLATERALIZED DEBT OBLIGATIONS totaled $1.98 billion and 97.0% are
rated investment grade at December 31, 2007. Other collateralized debt
obligations consist primarily of obligations secured by high yield and
investment grade corporate credits including $1.15 billion of collateralized
loan obligations; $299 million of synthetic CDOs; $192 million of primarily bank
trust preferred CDOs; $113 million of market value CDOs; $58 million of CDOs
that invest in other CDOs ("CDO squared"); and $46 million of collateralized
bond obligations. The CDO squared holdings contain immaterial amounts of ABS
CDOs, ranging up to 4% of the underlying collateral. The cash flows used to
pay principle and interest are derived from the other CDOs' collateral except
for synthetic CDOs which rely on cash flows from the underlying credit default
swaps. As of December 31, 2007, net unrealized losses on the other
collateralized debt obligations were $256 million.
OTHER ASSET-BACKED SECURITIES consist primarily of investments secured by
portfolios of credit card loans, auto loans, student loans and other consumer
and corporate obligations. As of December 31, 2007, the net unrealized losses on
these securities was $19 million. Additionally, 24.0% of the other asset-backed
securities that are rated Aaa were insured by four bond insurers.
We may utilize derivative financial instruments to help manage the exposure
to interest rate risk, and to a lesser extent, currency and credit risks, from
the fixed income securities portfolio. For a more detailed discussion of
interest rate, and currency risks and our use of derivative financial
instruments, see the Net Realized Capital Gains and Losses and Market Risk
sections of MD&A and Note 7 to the consolidated financial statements.
The following table summarizes the credit quality of the fixed income
securities portfolio at December 31, 2007.
<Table>
<Caption>
(IN MILLIONS)
NAIC MOODY'S FAIR PERCENT
RATING EQUIVALENT VALUE TO TOTAL
------ ---------- ----- --------
1 Aaa/Aa/A $ 40,256 68.9%
2 Baa 15,551 26.6
-------- -----
Investment grade (1) 55,807 95.5
-------- -----
3 Ba 2,074 3.6
4 B 436 0.7
5 Caa or lower 140 0.2
6 In or near default 12 -
-------- -----
Below investment grade 2,662 4.5
-------- -----
Total $ 58,469 100.0%
======== =====
</Table>
- ----------
(1) Defined as a security having a rating from the NAIC
of 1 or 2; a rating of Aaa, Aa, A or Baa from
Moody's or a rating of AAA, AA, A or BBB from
Standard & Poor's, Fitch or Dominion or a rating of
aaa, aa, a or bbb from A.M. Best; or a comparable
internal rating if an externally provided rating is
not available.
EQUITY SECURITIES Equity securities include non-redeemable preferred stocks and
common stocks. The equity securities portfolio was $102 million at December 31,
2007 compared to $72 million at December 31, 2006. The increase is primarily
attributable to purchases of equity securities. Gross unrealized gains totaled
$5 million at December 31, 2007 compared to $11 million at December 31, 2006.
Gross unrealized losses totaled $5 million at December 31, 2007. There were no
unrealized losses at December 31, 2006.
MORTGAGE LOANS Our mortgage loan portfolio was $9.90 billion at December 31,
2007 and $8.69 billion at December 31, 2006, and comprised primarily of loans
secured by first mortgages on developed commercial real estate. Geographical and
property type diversification are key considerations used to manage our
exposure.
We closely monitor our commercial mortgage loan portfolio on a loan-by-loan
basis. Loans with an estimated collateral value less than the loan balance, as
well as loans with other characteristics indicative of higher than normal credit
risks, are reviewed by financial and investment management at least quarterly
for purposes of establishing
35
<Page>
valuation allowances and placing loans on non-accrual status when and if
necessary. The underlying collateral values are based upon either discounted
property cash flow projections or a commonly used valuation method that utilizes
a one-year projection of expected annual income divided by a market based
expected rate of return. We had no realized capital losses related to
write-downs on mortgage loans for the years ended December 31, 2007, 2006 and
2005.
LIMITED PARTNERSHIP INTERESTS Limited partnership interests totaled $994
million, or 1.4% of total investments, at December 31, 2007. Limited partnership
interests primarily have exposure to private equity, real estate and hedge
funds. This balance has increased 115.6% since December 31, 2006. Of the Limited
Partnership Interests held at December 31, 2007, 48.8% were accounted for under
the Equity Method of accounting, the remaining 51.2% were carried at cost.
SHORT-TERM INVESTMENTS Our short-term investment portfolio was $386 million and
$805 million at December 31, 2007 and 2006, respectively. We invest available
cash balances primarily in taxable short-term securities having a final maturity
date or redemption date of less than one year.
POLICY LOANS Our policy loan portfolio was $770 million and $752 million at
December 31, 2007 and 2006, respectively. Policy loans are carried at the unpaid
principal balances.
OTHER INVESTMENTS Our other investments are comprised primarily of bank loans,
which primarily include senior secured corporate loans that are carried at
amortized cost.
UNREALIZED GAINS AND LOSSES See Note 6 of the consolidated financial statements
for further disclosures regarding unrealized losses on fixed income and equity
securities and factors considered in determining whether securities are
other-than-temporarily impaired. The unrealized net capital gains on fixed
income and equity securities at December 31, 2007 totaled $449 million, a
decrease of $1.15 billion since December 31, 2006. The decrease in net
unrealized net capital gains was related primarily to increased unrealized
losses on investment grade fixed income securities, resulting from widening
credit spreads and credit exposure related to collateralized securities, which
more than offset the effects of declining interest rates.
Credit spreads are the additional yield on fixed income securities above
the risk-free rate (typically defined as the yield on U.S. treasury securities),
that market participants require to compensate them for assuming credit,
liquidity and or repayment risks for fixed income securities with consistent
terms. Credit spreads vary with the market's perception of risk and liquidity in
specific fixed income markets. Credit spreads can widen (increase) or tighten
(decrease) and may offset or add to the effects of risk-free interest rate
changes in the valuation of fixed income securities from period to period.
36
<Page>
Gross unrealized gains and losses on fixed income securities by type and
sector are provided in the table below.
<Table>
<Caption>
GROSS UNREALIZED
AMORTIZED ------------------- FAIR
(IN MILLIONS) COST GAINS LOSSES VALUE
---------- ----- ------ -----
AT DECEMBER 31, 2007
Corporate:
Banking $ 5,465 $ 70 $ (195) $ 5,340
Utilities 5,228 239 (68) 5,399
Consumer goods (cyclical and non-cyclical) 4,798 80 (95) 4,783
Financial services 3,897 47 (142) 3,802
Capital goods 3,074 69 (38) 3,105
Communications 1,902 53 (21) 1,934
Basic industry 1,806 42 (13) 1,835
Other 1,687 56 (36) 1,707
Transportation 1,586 41 (27) 1,600
Energy 1,433 45 (6) 1,472
Technology 748 15 (5) 758
--------- -------- --------- ---------
Total corporate fixed income portfolio 31,624 757 (646) 31,735
U.S. government and agencies 2,848 880 -- 3,728
Municipal 4,235 115 (39) 4,311
Foreign government 1,814 374 (3) 2,185
Mortgage-backed securities 3,499 37 (46) 3,490
Commercial mortgage-backed securities 7,698 76 (386) 7,388
Asset-backed securities 6,273 20 (690) 5,603
Redeemable preferred stock 29 1 (1) 29
--------- -------- --------- ---------
Total fixed income securities $ 58,020 $ 2,260 $ (1,811) $ 58,469
========= ======== ========= =========
</Table>
The banking, financial services, consumer goods and utilities sectors had
the highest concentration of gross unrealized losses in our corporate fixed
income securities portfolio at December 31, 2007. The gross unrealized losses in
these sectors were primarily company specific and the result of widening credit
spreads. As of December 31, 2007, $511 million or 79.1% of the gross unrealized
losses in the corporate fixed income portfolio and substantially all of the
gross unrealized losses in the remaining fixed income securities related to
securities rated investment grade. Unrealized losses on investment grade
securities are principally related to rising interest rates or changes in credit
spreads since the securities were acquired.
All securities in an unrealized loss position at December 31, 2007 were
included in our portfolio monitoring process for determining whether declines in
value are other-than-temporary.
The following table shows the composition by credit quality of the fixed
income securities with gross unrealized losses at December 31, 2007.
<Table>
<Caption>
(IN MILLIONS)
NAIC MOODY'S UNREALIZED PERCENT FAIR PERCENT
RATING EQUIVALENT LOSS TO TOTAL VALUE TO TOTAL
------ ---------- ---- -------- ----- --------
1 Aaa/Aa/A $ (1,231) 68.0% $ 16,725 66.4%
2 Baa (412) 22.7 6,835 27.2
---------- ------ -------- ------
Investment grade (1,643) 90.7 23,560 93.6
---------- ------ -------- ------
3 Ba (118) 6.5 1,189 4.7
4 B (30) 1.7 312 1.2
5 Caa or lower (20) 1.1 122 0.5
6 In or near default -- -- 1 --
---------- ------ -------- ------
Below investment grade (168) 9.3 1,624 6.4
---------- ------ -------- ------
Total $ (1,811) 100.0% $ 25,184 100.0%
========== ====== ======== ======
</Table>
37
<Page>
The table above includes 17 securities with a fair value totaling $177
million and an unrealized loss of $13 million that have not yet received an NAIC
rating, for which we have assigned a comparable internal rating. Due to lags
between the funding of an investment, execution of final legal documents, filing
with the Securities Valuation Office ("SVO") of the NAIC, and rating by the SVO,
we generally have a small number of securities that have a pending rating.
Unrealized losses on investment grade securities principally relate to
changes in interest rates or changes in credit spreads, which reflect liquidity
conditions of the related markets, since the securities were acquired. Of the
unrealized losses on below investment grade securities, there were no
significant loss positions (greater than or equal to 20% of amortized cost) for
six or more consecutive months prior to December 31, 2007. Included among the
securities rated below investment grade are high-yield bonds and securities that
were investment grade when originally acquired. We mitigate the credit risk of
investing in below investment grade fixed income securities by limiting the
percentage of our fixed income portfolio invested in such securities, through
diversification of the portfolio, active credit monitoring and portfolio
management.
The scheduled maturity dates for fixed income securities in an unrealized
loss position at December 31, 2007 are shown below. Actual maturities may differ
from those scheduled as a result of prepayments by the issuers.
<Table>
<Caption>
UNREALIZED PERCENT FAIR PERCENT
(IN MILLIONS) LOSS TO TOTAL VALUE TO TOTAL
---- -------- ----- --------
Due in one year or less $ (6) 0.3% $ 579 2.3%
Due after one year through five years (114) 6.3 2,864 11.4
Due after five years through ten years (222) 12.3 5,158 20.5
Due after ten years (733) 40.5 9,935 39.4
Mortgage- and asset- backed securities(1) (736) 40.6 6,648 26.4
---------- -------- -------- --------
Total $ (1,811) 100.0% $ 25,184 100.0%
========== ======== ======== ========
</Table>
- ----------
(1) Because of the potential for prepayment, these securities are not
categorized based on their contractual maturities.
PORTFOLIO MONITORING We have a comprehensive portfolio monitoring process to
identify and evaluate, on a case-by-case basis, fixed income and equity
securities whose carrying value may be other-than-temporarily impaired. The
process includes a quarterly review of all securities using a screening process
to identify situations where the fair value, compared to amortized cost for
fixed income securities, and cost for equity securities is below established
thresholds for certain time periods, or which are identified through other
monitoring criteria such as ratings downgrades or payment defaults. The
securities identified, in addition to other securities for which we may have a
concern, are evaluated based on facts and circumstances for inclusion on our
watch-list. We also conduct a portfolio review to recognize impairment on
securities in an unrealized loss position for which we do not have the intent
and ability to hold until recovery as a result of approved programs involving
the disposition of investments for reasons such as changes in duration,
revisions to strategic asset allocations and liquidity actions, as well as
certain dispositions anticipated by portfolio managers. All investments in an
unrealized loss position at December 31, 2007 were included in our portfolio
monitoring process for determining whether declines in value were
other-than-temporary.
38
<Page>
The following table summarizes fixed income and equity securities in a
gross unrealized loss position according to significance, aging and investment
grade classification.
<Table>
<Caption>
DECEMBER 31, 2007 DECEMBER 31, 2006
------------------------------------------- ------------------------------------------
FIXED INCOME FIXED INCOME
----------------------- -----------------------
BELOW BELOW
INVESTMENT INVESTMENT INVESTMENT INVESTMENT
(IN MILLIONS, EXCEPT NUMBER OF ISSUES) GRADE GRADE EQUITY TOTAL GRADE GRADE EQUITY TOTAL
---------- ---------- ------ -------- ---------- ---------- ------ --------
Category (I): Unrealized loss less
than 20% of cost (1)
Number of Issues 2,403 227 9 2,639 2,804 112 - 2,916
Fair Value $ 22,615 $ 1,517 $ 64 $ 24,196 $ 22,973 $ 788 $ - $ 23,761
Unrealized $ (1,129) $ (106) $ (5) $ (1,240) $ (481) $ (25) $ - $ (506)
Category (II): Unrealized loss
greater than or equal to 20% of
cost for a period of less than 6
consecutive months (1)
Number of Issues 156 18 - 174 - 2 - 2
Fair Value $ 945 $ 107 $ - $ 1,052 $ - $ 4 $ - $ 4
Unrealized $ (514) $ (62) $ - $ (576) $ - $ (1) $ - $ (1)
---------- ---------- ------ -------- ---------- ---------- ------ --------
Total Number of Issues 2,559 245 9 2,813 2,804 114 - 2,918
========== ========== ====== ======== ========== ========== ====== ========
Total Fair Value $ 23,560 $ 1,624 $ 64 $ 25,248 $ 22,973 $ 792 $ - $ 23,765
========== ========== ====== ======== ========== ========== ====== ========
Total Unrealized Losses $ (1,643) $ (168) $ (5) $ (1,816) $ (481) $ (26) $ - $ (507)
========== ========== ====== ======== ========== ========== ====== ========
</Table>
- ----------
(1) For fixed income securities, cost represents amortized cost.
The largest individual unrealized loss was $12 million for category (I) and
$26 million for category (II) as of December 31, 2007.
Categories (I) and (II) have generally been adversely affected by overall
economic conditions including interest rate increases and the market's
evaluation of certain sectors. The degree to which and/or length of time that
the securities have been in an unrealized loss position does not suggest that
these securities pose a high risk of being other-than-temporarily impaired.
Categories (III) and (IV) have primarily been adversely affected by industry and
issue specific, or issuer specific conditions. All of the securities in these
categories are monitored for other-than-temporary impairment. We expect that the
fair values of these securities will recover over time
Whenever our initial analysis indicates that a fixed income security's
unrealized loss of 20% or more for at least 36 months or any equity security's
unrealized loss of 20% or more for at least 12 months is temporary, additional
evaluations and management approvals are required to substantiate that a
write-down is not appropriate. As of December 31, 2007, no securities met these
criteria.
The following table contains the individual securities with the largest
unrealized losses as of December 31, 2007. No other fixed income or equity
security had an unrealized loss greater than $10 million or 0.6% of the total
unrealized loss on fixed income and equity securities.
<Table>
<Caption>
UNREALIZED
(IN MILLIONS) UNREALIZED FAIR NAIC LOSS
LOSS VALUE RATING CATEGORY
---------- ---------- ---------- ----------
ABS CDO $ (26) $ 19 1 II
Financial Services (12) 10 1 II
Financial Services (12) 25 3 II
ABS RMBS - 2007 - 1st Lien (12) 16 1 II
Synthetic CDO (12) 53 1 I
Synthetic CDO (12) 23 1 II
Synthetic CDO (12) 18 1 II
ABS RMBS - 2007 - 1st Lien (11) 3 1 II
---------- ----------
Total $ (109) $ 167
========== ==========
</Table>
39
<Page>
We monitor the quality of our fixed income and bank loan portfolios by
categorizing certain investments as "problem", "restructured" or "potential
problem." Problem fixed income securities and bank loans are in default with
respect to principal or interest and/or are investments issued by companies that
have gone into bankruptcy subsequent to our acquisition or loan. Restructured
fixed income and bank loan investments have rates and terms that are not
consistent with market rates or terms prevailing at the time of the
restructuring. Potential problem fixed income or bank loan investments are
current with respect to contractual principal and/or interest, but because of
other facts and circumstances, we have concerns regarding the borrower's ability
to pay future principal and interest, which causes us to believe these
investments may be classified as problem or restructured in the future.
The following table summarizes problem, restructured and potential problem
fixed income securities and bank loans at December 31.
<Table>
<Caption>
(IN MILLIONS) 2007 2006
------------------------------- -------------------------------
PERCENT OF PERCENT OF
TOTAL FIXED TOTAL FIXED
INCOME AND INCOME AND
AMORTIZED FAIR BANK LOAN AMORTIZED FAIR BANK LOAN
COST VALUE PORTFOLIOS COST VALUE PORTFOLIOS
---- ----- ---------- ---- ----- -----------
Problem $ 14 $ 14 --% $ 13 $ 16 --%
Restructured 5 6 -- 4 4 --
Potential problem 218 172 0.3 107 118 0.2
--------- ----- ----------- --------- ----- -----------
Total net carrying value $ 237 $ 192 0.3% $ 124 $ 138 0.2%
========= ===== =========== ========= ===== ===========
Cumulative write-downs
recognized (1) $ 261 $ 184
========= =========
</Table>
- ----------
(1) Cumulative write-downs recognized only reflects write-downs related to
investments within the problem, potential problem and restructured
categories.
We have experienced an increase in the amortized cost of fixed income
securities and bank loans categorized as problem, restructured and potential
problem. The increase was primarily due to the addition of certain ABS CDOs as
well as bonds issued by a prime mortgage lender.
We evaluated each of these investments through our portfolio monitoring
process at December 31, 2007 and recorded write-downs when appropriate. We
further concluded that any remaining unrealized losses on these investments were
temporary in nature and that we have the intent and ability to hold the
securities until recovery. While these balances may increase in the future,
particularly if economic conditions are unfavorable, management expects that the
total amount of investments in these categories will remain low relative to the
total fixed income securities and bank loans portfolios.
NET INVESTMENT INCOME The following table presents net investment income for the
years ended December 31.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
------- ------- -------
Fixed income securities $ 3,589 $ 3,505 $ 3,318
Equity securities 4 2 --
Mortgage loans 552 508 469
Limited partnership interests 87 42 37
Other 243 257 78
-------- -------- --------
Investment income, before expense 4,475 4,314 3,902
Investment expense (270) (257) (195)
-------- -------- --------
Net investment income $ 4,205 $ 4,057 $ 3,707
======== ======= ========
</Table>
40
<Page>
NET REALIZED CAPITAL GAINS AND LOSSES The following table presents the
components of realized capital gains and losses and the related tax effect for
the years ended December 31.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
------ ------ ------
Investment write-downs $ (118) $ (21) $ (24)
Dispositions (22) (89) 88
Valuation of derivative instruments (63) (17) (105)
Settlement of derivative instruments 6 48 60
------ ------ ------
Realized capital gains and losses, pretax (197) (79) 19
Income tax benefit (expense) 69 28 (7)
------ ------ ------
Realized capital gains and losses, after-tax $ (128) $ (51) $ 12
====== ====== ======
</Table>
Dispositions in the above table include sales, losses recognized in
anticipation of dispositions and other transactions such as calls and
prepayments. We may sell impaired fixed income or equity securities that were in
an unrealized loss position at the previous reporting date, or other investments
where the fair value has declined below the carrying value, in situations where
new factors such as negative developments, subsequent credit deterioration,
liquidity needs, and newly identified market opportunities cause a change in our
previous intent to hold a security to recovery or maturity.
Dispositions in 2007 included net realized gains on sales and other
transactions such as calls and prepayments of $70 million and losses recorded in
connection with anticipated dispositions of $92 million. The net realized gains
on sales and other transactions were comprised of gross gains of $269 million
and gross losses of $199 million. The $199 million in gross losses primarily
consisted of $186 million from sales of fixed income securities.
Dispositions in 2006 included net realized losses on sales and other
transactions such as calls and prepayments of $29 million and losses recorded in
connection with anticipated dispositions of $60 million. The net realized losses
on sales and other transactions were comprised of gross gains of $214 million
and gross losses of $243 million. The $243 million in gross losses primarily
consisted of $231 million from sales of fixed income securities.
During our comprehensive portfolio reviews, we determine whether there are
any approved programs involving the expected disposition of investments such as
changes in duration, revisions to strategic asset allocations and liquidity
actions, as well as dispositions anticipated by the portfolio managers resulting
from their on-going comprehensive reviews of the portfolios. Upon approval of
such programs, portfolio managers identify a population of suitable investments,
typically larger than needed to accomplish the objective, from which specific
securities are selected to sell. Due to our change in intent to hold until
recovery, we recognize impairments on investments within the population that are
in an unrealized loss position. When the objectives of the programs are
accomplished, any remaining securities are redesignated as intent to hold until
recovery.
For the year ended December 31, 2007, we recognized $92 million of losses
related to a change in our intent to hold certain investments with unrealized
losses until they recover in value. The change in our intent was primarily
related to strategic asset allocation decisions and ongoing comprehensive
reviews of our portfolio. At December 31, 2007, the fair value of securities for
which we did not have the intent to hold until recovery totaled $1.06 billion.
For the year ended December 31, 2006, we recognized $60 million of losses
related to a change in our intent to hold certain securities with unrealized
losses until they recover in value. The change in our intent was driven by
certain approved programs, including funding for the disposition through
reinsurance of substantially all of our variable annuity business and yield
enhancement strategies. These programs were completed during 2006. Additionally,
ongoing comprehensive reviews of our portfolio resulted in the identification of
anticipated dispositions by the portfolio managers. At December 31, 2006, the
fair value of securities for which we did not have the intent to hold until
recovery totaled $242 million.
The table below presents the realized capital gains and losses (pretax) on
the valuation and settlement of derivative instruments shown by underlying
exposure and derivative strategy for the years ended December 31.
41
<Page>
<Table>
<Caption>
(IN MILLIONS)
2007 2006 2005
---- ----- -----
INTEREST RATE EXPOSURE
Asset/liability management
Anticipatory hedging $ (30) $ 17 $ (9) Futures used to protect investment
spread from changes in interest rates
that arise from mismatches in the
timing of cash flows from our
products and the related investment
activity. Amounts primarily reflect
cash settlements.
Duration gap management (27) (51) (57) Interest rate caps, floors and swaps
are used to align interest-rate
sensitivities of assets and
liabilities. The 2007 loss resulted
from declining interest rates,
approximately $20 million related to
cash settlements.
Ineffectiveness (13) (7) (7) Represents hedge accounting
ineffectiveness, including the gains
and losses realized upon the
termination of the hedging instrument.
Hedging of interest rate exposure in (22) 1 (1) Interest rate caps used to offset the
annuity contracts effect of changing interest rates
linked to treasury rates on certain
annuity contracts, which are reported
in credited interest. The results
include cash settlements and valuation
changes. The 2007 net loss represents
approximately $50 million of losses
from changes in valuation due to the
decline in interest rates and $28
million of gain from cash settlements.
Embedded derivatives- conversion 66 72 28 Certain fixed income securities, such
options in fixed income securities and as convertible bonds and equity
equity indexed notes linked notes, contain embedded
derivatives. The changes in valuation
of the embedded derivatives are
reported in realized capital gains and
losses. The results generally track
the performance of underlying equity
indices. Valuation gains and losses
would be converted into cash for
convertible securities upon our
conversion or sale of these securities
but will be eliminated if held to
maturity; for equity indexed notes
upon sale or maturity.
CREDIT EXPOSURE
Asset replication (18) 4 2 Credit default swaps used to
replicate fixed income securities to
complement the cash market when
credit exposure to certain issuers is
not available or when the derivative
alternative is less expensive than
the cash market alternative. The
amounts primarily reflect non-cash
changes in valuation due to
fluctuating credit spreads, which
would be converted to cash upon
termination or a default on an
underlying credit obligation.
CURRENCY EXPOSURE
Foreign currency contracts (13) (5) --
OTHER
Other -- -- (1)
------ ------ ------
$ (57) $ 31 $ (45)
====== ====== ======
</Table>
A changing interest rate environment will drive changes in our portfolio
duration targets at a tactical level. A duration target and range is established
with an economic view of liabilities relative to a long-term portfolio view.
Tactical duration management is accomplished through both cash market
transactions including new purchases and derivative activities that generate
realized gains and losses. As a component of our approach to managing portfolio
duration, realized gains and losses on certain derivative instruments are most
appropriately considered in conjunction with the unrealized gains and losses on
the fixed income portfolio. This approach mitigates the impacts of general
interest rate changes to the overall financial condition of the Company as shown
in the Market Risk section of the MD&A. Approximately $48 million or 76.4% of
the losses that relate to the valuations of derivative instruments are
associated with economic hedging instruments that support investments whose
valuation changes are reported in shareholder's equity.
42
<Page>
The ten largest losses from sales of individual securities for the year
ended December 31, 2007 totaled $38 million with the largest loss being $7
million and the smallest loss being $2 million. One equity security comprising
$5 million was in an unrealized loss position greater than 20% of cost for a
period of less than six consecutive months.
Our largest aggregate loss on dispositions and writedowns are shown in the
following table by issuer and its affiliates, and issue for government
securities. No other issuer together with its affiliates had an aggregated loss
on dispositions and writedowns greater than 1.5% of the total gross loss on
disposition and writedowns on fixed income and equity securities.
<Table>
<Caption>
FAIR VALUE DECEMBER 31, NET
AT DISPOSITION LOSS ON WRITE- 2007 UNREALIZED
(IN MILLIONS) ("PROCEEDS") DISPOSITIONS(1) DOWNS HOLDINGS (2) GAIN (LOSS)
-------------- --------------- -------------- -------------- --------------
ABS CDO $ -- $ -- $ (37) $ -- $ --
Prime mortgage lender 24 (1) (14) 33 (4)
ABS RMBS - 2006 - 2nd lien -- -- (13) 4 --
ABS CDO -- -- (11) 44 (25)
ABS CDO -- -- (11) -- --
Tax advantaged investment -- -- (9) 8 --
Commercial mortgage -- (7) -- 151 7
-------------- --------------- -------------- -------------- --------------
Total $ 24 $ (8) $ (95) $ 240 $ (22)
============== =============== ============== ============== ==============
</Table>
- ----------
(1) Dispositions include losses recognized in anticipation of dispositions.
(2) Holdings include fixed income securities at amortized cost or equity
securities at cost.
The circumstances of the above losses are considered to be security
specific or issue specific and are not expected to have a material effect on
other holdings in our portfolio.
MARKET RISK
Market risk is the risk that we will incur losses due to adverse changes in
equity, interest, or currency exchange rates and prices. Adverse changes to
these rates and prices may occur due to changes in the liquidity of a market or
market segment, or to changes in market perceptions of credit worthiness and/or
risk tolerance. Our primary market risk exposures are to changes in interest
rates and equity prices, although we also have a smaller exposure to changes in
foreign currency exchange rates.
The active management of market risk is integral to our results of
operations. We may use the following approaches to manage exposure to market
risk within defined tolerance ranges: 1) rebalancing existing asset or liability
portfolios, 2) changing the character of investments purchased in the future and
3) using derivative instruments to modify the market risk characteristics of
existing assets and liabilities or assets expected to be purchased. For a more
detailed discussion of our use of derivative financial instruments, see Note 7
of the consolidated financial statements.
OVERVIEW We generate substantial investible funds from our business. In
formulating and implementing guidelines for investing funds, we seek to earn
returns that enhance our ability to offer competitive rates and prices to
customers while contributing to attractive and stable profits and long-term
capital growth. Accordingly, our investment decisions and objectives are a
function of the underlying risks and our product profiles.
Investment policies define the overall framework for managing market and
other investment risks, including accountability and controls over risk
management activities. These investment activities follow policies that have
been approved by our board of directors. These investment policies specify the
investment limits and strategies that are appropriate given our liquidity,
surplus, product profile and regulatory requirements. Executive oversight of
investment activities is conducted primarily through our board of directors and
investment committee. Asset-liability management ("ALM") policies further define
the overall framework for managing market and investment risks. ALM focuses on
strategies to enhance yields, mitigate market risks and optimize capital to
improve profitability and returns. ALM activities follow asset-liability
policies that have been approved by our board of directors. These ALM policies
specify limits, ranges and/or targets for investments that best meet our
business objectives in light of our product liabilities.
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We manage our exposure to market risk through the use of asset allocation,
duration and value-at-risk limits, simulation and, as appropriate, through the
use of stress tests. We have asset allocation limits that place restrictions on
the total funds that may be invested within an asset class. We have duration
limits on our investment portfolio and, as appropriate, on individual components
of the portfolio. These duration limits place restrictions on the amount of
interest rate risk that may be taken. Our value-at-risk limits are intended to
restrict the potential loss in fair value that could arise from adverse
movements in the fixed income, equity, and currency markets based on historical
volatilities and correlations among market risk factors. Comprehensive
day-to-day management of market risk within defined tolerance ranges occurs as
portfolio managers buy and sell within their respective markets based upon the
acceptable boundaries established by investment policies. This day-to-day
management is integrated with and informed by the activities of the ALM
organization. This integration results in a prudent, methodical and effective
adjudication of market risk and return, conditioned by the unique demands and
dynamics of our product liabilities and supported by the continuous application
of advanced risk technology and analytics.
INTEREST RATE RISK is the risk that we will incur a loss due to adverse changes
in interest rates relative to the interest rate characteristics of interest
bearing assets and liabilities. This risk arises from many of our primary
activities, as we invest substantial funds in interest sensitive assets and
issue interest rate-sensitive liabilities. Interest rate risk includes risks
related to changes in U.S. Treasury yields and other key benchmarks as well as
changes in interest rates resulting from the widening credit spreads and credit
exposure to collateralized securities.
We manage the interest rate risk in our assets relative to the interest
rate risk in our liabilities. One of the measures used to quantify this exposure
is duration. Duration measures the price sensitivity of the assets and
liabilities to changes in interest rates. For example, if interest rates
increase 100 basis points, the fair value of an asset with a duration of 5 is
expected to decrease in value by approximately 5%. At December 31, 2007, the
difference between our asset and liability duration was approximately 0.63,
compared to a 0.35 gap at December 31, 2006. A positive duration gap indicates
that the fair value of our assets is more sensitive to interest rate movements
than the fair value of our liabilities.
We seek to invest premiums, contract charges and deposits to generate
future cash flows that will fund future claims, benefits and expenses, and that
will earn stable spreads across a wide variety of interest rate and economic
scenarios. To achieve this objective and limit interest rate risk, we adhere to
a philosophy of managing the duration of assets and related liabilities within
predetermined tolerance levels. This philosophy is executed using interest rate
swaps, futures, forwards, caps, floors and swaptions to reduce the interest rate
risk resulting from mismatches between existing assets and liabilities, and
financial futures and other derivative instruments to hedge the interest rate
risk of anticipated purchases and sales of investments and product sales to
customers.
We pledge and receive collateral on certain types of derivative contracts.
For futures and option contracts traded on exchanges, we have pledged securities
as margin deposits totaling $19 million as of December 31, 2007. For
over-the-counter derivative transactions including interest rate swaps, foreign
currency swaps, interest rate caps, interest rate floor agreements, and credit
default swaps, master netting agreements are used. These agreements allow us to
net payments due for transactions covered by the agreements, and when
applicable, we are required to post collateral. As of December 31, 2007, we held
cash of $72 million and securities of $226 million pledged by counterparties as
collateral for over-the-counter instruments; we pledged cash of $1 million and
securities of $107 million as collateral to counterparties.
To calculate the duration gap between assets and liabilities, we project
asset and liability cash flows and calculate their net present value using a
risk-free market interest rate adjusted for credit quality, sector attributes,
liquidity and other specific risks. Duration is calculated by revaluing these
cash flows at alternative interest rates and determining the percentage change
in aggregate fair value. The cash flows used in this calculation include the
expected maturity and repricing characteristics of our derivative financial
instruments, all other financial instruments (as described in Note 7 of the
consolidated financial statements), and certain other items including
interest-sensitive liabilities and annuity liabilities. The projections include
assumptions (based upon historical market experience and our experience) that
reflect the effect of changing interest rates on the prepayment, lapse, leverage
and/or option features of instruments, where applicable. The preceding
assumptions relate primarily to mortgage-backed securities, collateralized
mortgage obligations, municipal housing bonds, callable municipal and corporate
obligations, and fixed rate single and flexible premium deferred annuities.
Based upon the information and assumptions used in the duration
calculation, and interest rates in effect at December 31, 2007, we estimate that
a 100 basis point immediate, parallel increase in interest rates ("rate shock")
would decrease the net fair value of the assets and liabilities by approximately
$449 million, compared to $371 million at December 31, 2006. In calculating the
impact of a 100 basis point increase on the swaption value, we have assumed
interest rate volatility remains constant. The selection of a 100 basis point
immediate parallel change in interest rates should not be construed as our
prediction of future market events, but only as an illustration of the potential
effect of such an event. There are $7.05 billion of assets supporting life
insurance products such as
44
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traditional and interest-sensitive life that are not financial instruments.
These assets and the associated liabilities have not been included in the above
estimate. The $7.05 billion of assets excluded from the calculation has
increased from the $7.04 billion reported at December 31, 2006 due to an
increase in the in-force account value of interest-sensitive life products.
Based on assumptions described above, in the event of a 100 basis point
immediate increase in interest rates, the assets supporting life insurance
products would decrease in value by $521 million, compared to a decrease of $455
million at December 31, 2006.
To the extent that conditions differ from the assumptions we used in these
calculations, duration and rate shock measures could be significantly impacted.
Additionally, our calculations assume that the current relationship between
short-term and long-term interest rates (the term structure of interest rates)
will remain constant over time. As a result, these calculations may not fully
capture the effect of non-parallel changes in the term structure of interest
rates and/or large changes in interest rates.
EQUITY PRICE RISK is the risk that we will incur losses due to adverse changes
in the general levels of the equity markets. At December 31, 2007, we held
approximately $50 million in common stocks and $1.81 billion in other securities
with equity risk (including primarily convertible securities, limited
partnership funds, non-redeemable preferred securities and equity-linked notes),
compared to $27 million in common stocks and $1.39 billion in other securities
with equity risk at December 31, 2006.
At December 31, 2007, our portfolio of securities with equity risk had a
beta of approximately 0.89, compared to a beta of approximately 0.84 at December
31, 2006. Beta represents a widely used methodology to describe, quantitatively,
an investment's market risk characteristics relative to an index such as the
Standard & Poor's 500 Composite Price Index ("S&P 500"). Based on the beta
analysis, we estimate that if the S&P 500 increases or decreases by 10%, the
fair value of our equity investments will increase or decrease by approximately
8.9%, respectively. Based upon the information and assumptions we used to
calculate beta at December 31, 2007, we estimate that an immediate decrease in
the S&P 500 of 10% would decrease the net fair value of our equity investments
identified above by approximately $164 million, compared to $117 million at
December 31, 2006. The selection of a 10% immediate decrease in the S&P 500
should not be construed as our prediction of future market events, but only as
an illustration of the potential effect of such an event.
The beta of our securities with equity risk was determined by comparing the
monthly total returns of these investments to monthly total returns of the S&P
500 over a three-year historical period. Since beta is historically based,
projecting future price volatility using this method involves an inherent
assumption that historical volatility and correlation relationships between
stocks and the composition of our portfolio will not change in the future.
Therefore, the illustrations noted above may not reflect our actual experience
if future volatility and correlation relationships differ from the historical
relationships.
At December 31, 2007 and 2006, we had separate accounts assets related to
variable annuity and variable life contracts with account values totaling $14.93
billion and $16.17 billion, respectively. Equity risk exists for contract
charges based on separate account balances and guarantees for death and/or
income benefits provided by our variable products. In 2006, we disposed of
substantially all of the variable annuity business through a reinsurance
agreement with Prudential as described in Note 3 of the consolidated financial
statements, and therefore mitigated this aspect of our risk. Equity risk of our
variable life business relates to contract charges and policyholder benefits.
Total variable life contract charges for 2007, and 2006 were $92 million and $86
million, respectively. Separate account liabilities related to variable life
contracts were $905 million and $826 million in December 31, 2007 and 2006,
respectively.
At December 31, 2007 and 2006 we had approximately $3.98 billion and $3.47
billion, respectively, in equity-indexed annuity liabilities that provide
customers with interest crediting rates based on the performance of the S&P 500.
We economically hedge the risk associated with these liabilities using
equity-indexed options and futures, interest rate swaps, and eurodollar futures,
maintaining risk within specified value-at-risk limits.
FOREIGN CURRENCY EXCHANGE RATE RISK is the risk that we will incur economic
losses due to adverse changes in foreign currency exchange rates. This risk
primarily arises from the foreign component of our limited partnership
interests. We also have certain funding agreement programs and a small amount of
fixed income securities that are denominated in foreign currencies, however,
derivatives are used to effectively hedge the foreign currency risk of these
funding agreements and approximately half of the securities. At December 31,
2007 and 2006, we had approximately $924 million and $1.02 billion,
respectively, in funding agreements denominated in foreign currencies.
At December 31, 2007, the foreign component of our limited partnership
interests totaled approximately $158 million, compared to $22 million at
December 31, 2006.
Based upon the information and assumptions we used at December 31, 2007, we
estimate that a 10% immediate unfavorable change in each of the foreign currency
exchange rates that we are exposed to would decrease the value
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of the foreign component of our limited partnership interests by approximately
$16 million, compared with an estimated $2 million decrease at December 31,
2006. The selection of a 10% immediate decrease in all currency exchange rates
should not be construed as our prediction of future market events, but only as
an illustration of the potential effect of such an event. Our currency exposure
is diversified across 27 currencies, compared to 11 currencies at December 31,
2006. Our largest individual foreign currency exposures at December 31, 2007
were to the Euro (41.1%) and the British Pound (21.7%). The largest individual
foreign currency exposures at December 31, 2006 were to the Canadian Dollar
(20.1%) and the Mexican Peso (19.5%). Our primary regional exposure is to
Western Europe, approximately 65.0% at December 31, 2007, compared to 20.4% at
December 31, 2006.
The modeling technique we use to report our currency exposure does not take
into account correlation among foreign currency exchange rates. Even though we
believe it is very unlikely that all of the foreign currency exchange rates that
we are exposed to would simultaneously decrease by 10%, we nonetheless stress
test our portfolio under this and other hypothetical extreme adverse market
scenarios. Our actual experience may differ from these results because of
assumptions we have used or because significant liquidity and market events
could occur that we did not foresee.
CAPITAL RESOURCES AND LIQUIDITY
CAPITAL RESOURCES consist of shareholder's equity and debt, representing funds
deployed or available to be deployed to support business operations. The
following table summarizes our capital resources at December 31.
<Table>
<Caption>
(IN MILLIONS) 2007 2006 2005
------- ------- -------
Redeemable preferred stock $ -- $ 5 $ 5
Common stock, retained earnings and other
shareholder's equity items 4,847 5,168 5,415
Accumulated other comprehensive income (84) 325 588
-------- -------- --------
Total shareholder's equity 4,763 5,498 6,008
Debt 200 706 181
-------- -------- --------
Total capital resources $ 4,963 $ 6,204 $ 6,189
======== ======== ========
</Table>
SHAREHOLDER'S EQUITY declined in both 2007 and 2006, due to dividends and
unrealized net capital losses on fixed income securities as of December 31, 2007
compared to unrealized net capital gains as of December 31, 2006, partially
offset by net income. The Company paid dividends of $725 million and $675
million to Allstate Insurance Company ("AIC", the Company's parent) in 2007 and
2006, respectively.
DEBT decreased $506 million in 2007 due to the repayment of a $500 million
intercompany note issued to AIC in 2006 and the redemption of mandatorily
redeemable preferred stock.
Debt increased $525 million in 2006, due to the issuance of the
intercompany note to AIC and a surplus note to an unconsolidated affiliate,
partially offset by the redemption of debt associated with a consolidated
variable interest entity ("VIE") and the redemption of mandatorily redeemable
preferred stock.
During 2006, the Company issued an intercompany note in the amount of $500
million payable to its parent, AIC, on demand and, in any event, by March 30,
2007. This note is reflected as note payable to parent on the Company's
Consolidated Statements of Financial Position. The Company used the funds to
accelerate purchases of investments based on its outlook of the availability of
acceptable investments in the beginning of 2007. The Company repaid the loan
with funds generated in the normal course of business, primarily by sales,
investment income and cash collected for investment calls and maturities.
During 2006, under an existing agreement with Kennett Capital, Inc.
("Kennett"), an unconsolidated affiliate of ALIC, ALIC sold Kennett a $100
million redeemable surplus note issued by ALIC Reinsurance Company ("ALIC Re"),
a wholly owned subsidiary of ALIC. The surplus note is due June 1, 2036 with an
initial rate of 6.18% that will reset once every ten years to the then current
ten year Constant Maturity Treasury yield ("CMT"), plus 1.14%. As payment,
Kennett issued a full recourse note due June 1, 2036 to ALIC for the same amount
with an initial interest rate of 5.98% that will reset once every ten years to
the then current ten year CMT, plus 0.94%. The note due from Kennett is
classified as other investments and the related surplus note is classified as
long-term debt in the Consolidated Statements of Financial Position.
The Company was the primary beneficiary of a consolidated structured
investment security VIE. The Company's Consolidated Statements of Financial
Position included $54 million of investments and $49 million of long-term debt
as of December 31, 2005. In 2006, the debt associated with the VIE was redeemed.
Also redeemed
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during 2006 was mandatorily redeemable preferred stock totaling $26 million (see
Note 5 to the consolidated financial statements).
FINANCIAL RATINGS AND STRENGTH The following table summarizes our financial
strength ratings at December 31, 2007.
<Table>
<Caption>
RATING AGENCY RATING
------------- ------
Moody's Investors Service, Inc. Aa2 ("Excellent")
Standard & Poor's Ratings Services AA ("Very Strong")
A.M. Best Company, Inc. A+ ("Superior")
</Table>
Our ratings are influenced by many factors including our operating and
financial performance, asset quality, liquidity, asset/liability management,
overall portfolio mix, financial leverage (i.e., debt), exposure to risks,
operating leverage, AIC's ratings and other factors. There were no changes to
the ratings listed above during 2007.
AIC entered into a capital support agreement with the Company effective
December 14, 2007. AIC also entered into an intercompany liquidity agreement
with the Company effective January 1, 2008. Under the capital support agreement,
AIC is committed to provide capital to the Company to allow for profitable
growth while maintaining financial strength ratings at or above those of AIC.
The intercompany liquidity agreement establishes a mechanism under which
short-term advances of funds may be made between AIC and the Company for
liquidity and other general corporate purposes. The maximum amount of potential
funding under each of these agreements is $1.00 billion.
State laws specify regulatory actions if an insurer's risk-based capital
("RBC"), a measure of an insurer's solvency, falls below certain levels. The
NAIC has a standard formula for annually assessing RBC. The formula for
calculating RBC for life insurance companies takes into account factors relating
to insurance, business, asset and interest rate risks. At December 31, 2007, our
RBC and the RBC for each of our insurance companies was above levels that would
require regulatory actions.
The NAIC has also developed a set of financial relationships or tests known
as the Insurance Regulatory Information System to assist state regulators in
monitoring the financial condition of insurance companies and identifying
companies that require special attention or actions by insurance regulatory
authorities. The NAIC analyzes financial data provided by insurance companies
using prescribed ratios, each with defined "usual ranges". Generally, regulators
will begin to monitor an insurance company if its ratios fall outside the usual
ranges for four or more of the ratios. If an insurance company has insufficient
capital, regulators may act to reduce the amount of insurance it can issue. The
ratios of our insurance companies are within these ranges.
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LIQUIDITY SOURCES AND USES Our potential sources of funds principally include
the activities as follows.
- Receipt of insurance premiums
- Contractholder fund deposits
- Reinsurance recoveries
- Receipts of principal, interest and dividends on investments
- Sales of investments
- Funds from investment repurchase agreements, securities lending, dollar
roll and lines of credit agreements
- Inter-company loans
- Capital contributions from parent
Our potential uses of funds principally include the activities as follows.
- Payment of contract benefits, maturities, surrenders and withdrawals
- Reinsurance cessions and payments
- Operating costs and expenses
- Purchase of investments
- Repayment of investment repurchase agreements, securities lending,
dollar roll and lines of credit agreements
- Payment or repayment of inter-company loans
- Dividends to parent
- Tax payments/settlements
- Debt service expenses and repayment
- Settlement payments of employee and agent benefit plans
As reflected in our Consolidated Statements of Cash Flows, higher operating
cash flows in 2007, compared to 2006, primarily related to lower operating
expenses and tax payments, and an increase in investment income, partially
offset by increased policy and contract benefit payments and the absence in 2007
of contract charges on the reinsured variable annuity business. Higher operating
cash flows in 2006, compared to 2005, primarily related to higher investment
income.
Cash flows from investing activities reflected a source of cash in 2007
compared to a use of cash in 2006. This change was primarily the result of the
change in net cash flows from financing activities from a source of cash in 2006
to a use of cash in 2007. Cash flows used in investing activities decreased in
2006 primarily due to decreased net cash provided by financing activities,
partially offset by the investment of higher operating cash flows. Cash flows
used in investing activities in 2006 also include the settlements related to the
disposition through reinsurance of substantially all our variable annuity
business.
Cash flows from financing activities reflected a use of cash in 2007
compared to a source of cash in 2006, primarily due to lower contractholder fund
deposits. Cash used in financing activities increased in 2006 as a result of
lower contractholder fund deposits and higher surrenders and partial
withdrawals. For quantification of the changes in contractholder funds, see the
Operations section of MD&A.
Financing cash flows were impacted by dividends paid of $725 million, $675
million and $211 million in 2007, 2006 and 2005, respectively.
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A portion of our product portfolio, including fixed annuity,
interest-sensitive life insurance and certain funding agreements, is subject to
surrender and withdrawal at the discretion of contractholders. The following
table summarizes our liabilities for these products by their contractual
withdrawal provisions at December 31, 2007.
<Table>
<Caption>
(IN MILLIONS) 2007
-----------
Not subject to discretionary withdrawal $ 11,675
Subject to discretionary withdrawal with adjustments:
Specified surrender charges (1) 25,509
Market value (2) 9,234
Subject to discretionary withdrawal without adjustments (3) 14,046
-----------
Total contractholder funds (4) $ 60,464
===========
</Table>
- ----------
(1) Includes $9.90 billion of liabilities with a contractual surrender
charge of less than 5% of the account balance.
(2) Approximately $8.26 billion of the contracts with market value
adjusted surrenders have a 30-45 day period during which there is
no surrender charge or market value adjustment including
approximately $1.45 billion with a period commencing during 2008.
(3) Includes $5.63 billion of extendible funding agreements backing
medium-term notes outstanding with an initial maturity of 13
months from the effective date of the contract that require
contractholders to elect a maturity extension each month for a
period of 5 to 10 years, depending on the contract terms, up to
the contractually specified final maturity date. The contractually
specified final maturity dates begin in 2009 and are definitive
unless the maturity dates are accelerated in accordance with the
contractholders' election to not extend the maturity date, in
which case the contracts mature 12 months thereafter. The
contracts have an annual coupon step-up feature when extended.
Based upon the elections made as of December 31, 2007,
approximately $4.20 billion will mature during 2008. In addition,
from January 31, 2008 through February 15, 2008, approximately
$827 million elected to not extend the initial maturity date.
(4) Includes $1.12 billion of contractholder funds on variable
annuities reinsured to Prudential effective June 1, 2006.
To ensure we have the appropriate level of liquidity, we perform actuarial
tests on the impact to cash flows of policy surrenders and other actions under
various scenarios. Depending upon the years in which certain policy types were
sold with specific surrender provisions, our cash flow could vary due to higher
surrender of policies exiting their surrender charge periods.
We expect to meet the cash flow requirements of the non-extended funding
agreements maturing in 2008 and 2009 primarily through a combination of cash
received from new product deposits and contractual interest and principal
receipts from our investment portfolio.
In addition to the capital and support agreement and the intercompany
liquidity agreement with AIC, which provide a maximum amount of potential
funding under each agreement of $1.00 billion, we also have an intercompany loan
agreement with The Allstate Corporation. The amount of intercompany loans
available to us under this intercompany agreement is at the discretion of The
Allstate Corporation. The maximum amount of loans The Allstate Corporation will
have outstanding to all its eligible subsidiaries at any given point in time is
limited to $1.00 billion. We had no amounts outstanding under the intercompany
loan agreement at December 31, 2007 or 2006. The Allstate Corporation uses
commercial paper borrowings and bank lines of credit to fund intercompany
borrowings.
The Allstate Corporation has established external sources of short-term
liquidity that include a commercial paper program, lines-of-credit, dollar rolls
and repurchase agreements. For additional liquidity, we can also issue new
insurance contracts, incur additional debt and sell assets from our investment
portfolio. The liquidity of our investment portfolio varies by type of
investment. For example, $15.57 billion of privately placed corporate
obligations that represent 21.5% of the investment portfolio, and $9.90 billion
of mortgage loans that represent 13.7% of the investment portfolio, generally
are considered to be less liquid than many of our other types of investments,
such as our U.S. government and agencies, municipal and
public corporate fixed income security portfolios.
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We have access to additional borrowing to support liquidity through The
Allstate Corporation as follows:
- - A commercial paper program with a borrowing limit of $1.00 billion to cover
short-term cash needs. As of December 31, 2007, there were no balances
outstanding and therefore the remaining borrowing capacity was $1.00
billion; however, the outstanding balance fluctuates daily.
- - The primary credit facility covers short-term liquidity requirements. The
$1.00 billion unsecured revolving credit facility, has an initial term of
five years expiring in 2012 with two one year extensions that can be
exercised in the first or second year of the facility upon approval of
existing or replacement lenders providing more than two thirds of the
commitments to lend. This facility contains an increase provision that would
allow up to an additional $500 million of borrowing provided the increased
portion could be fully syndicated at a later date among existing or new
lenders. Although the right to borrow under the facility is not subject to a
minimum rating requirement, the costs of maintaining the facility and
borrowing under it are based on the ratings of our senior, unsecured,
nonguaranteed long-term debt. There were no borrowings under this line of
credit during 2007. The total amount outstanding at any point in time under
the combination of the commercial paper program and the credit facility
cannot exceed the amount that can be borrowed under the credit facility.
- - A universal shelf registration statement was filed with the Securities and
Exchange Commission ("SEC") in May 2006. The Allstate Corporation can use it
to issue an unspecified amount of debt securities, common stock (including
337 million shares of treasury stock as of December 31, 2007), preferred
stock, depositary shares, warrants, stock purchase contracts, stock purchase
units and securities of subsidiaries. The specific terms of any securities
The Allstate Corporation issues under this registration statement will be
provided in the applicable prospectus supplements.
The Allstate Corporation's only financial covenant exists with respect to
its credit facility and its synthetic lease VIE obligations. The covenant
requires that The Allstate Corporation not exceed a 37.5% debt to capital
resources ratio as defined in the agreements. This ratio at December 31, 2007
was 17.0%.
We closely monitor and manage our liquidity through long- and short-term
planning that is integrated throughout our underwriting and investment
operations. We manage the duration of assets and related liabilities through
our ALM organization, using a dynamic process that addresses liquidity from
components of the investment portfolio, as appropriate, and is routinely
subjected to stress testing. We also have access to funds from The Allstate
Corporation as described above and through the intercompany liquidity
agreement with AIC that is discussed in the Financial Ratings and Strength
section of MD&A.
Certain remote events and circumstances could constrain our, The Allstate
Corporation's or AIC's liquidity. Those events and circumstances include, for
example, a catastrophe resulting in extraordinary losses, a downgrade in The
Allstate Corporation's long-term debt rating of A1, A+ and a (from Moody's,
Standard & Poor's and A.M. Best, respectively) to below Baa3/BBB-/bb, a
downgrade in AIC's financial strength rating from Aa2, AA and A+ (from
Moody's, Standard & Poor's and A.M. Best, respectively) to below Baa/BBB/A-,
or a downgrade in our financial strength ratings from Aa2, AA and A+ (from
Moody's, Standard & Poor's and A.M. Best, respectively) to below Aa3/AA-/A-.
The rating agencies also consider the interdependence of our individually
rated entities, therefore, a rating change in one entity could potentially
affect the ratings of other related entities.
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<Page>
CONTRACTUAL OBLIGATIONS AND COMMITMENTS Our contractual obligations as of
December 31, 2007 and the payments due by period are shown in the following
table.
<Table>
<Caption>
(IN MILLIONS) LESS THAN OVER 5
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
--------- --------- --------- --------- ---------
Liabilities for collateral and repurchase
agreements(1) $ 1,817 $ 1,817 $ -- $ -- $ --
Contractholder funds(2) 76,078 14,088 23,893 9,977 28,120
Reserve for life-contingent contract benefits(2) 29,367 1,109 3,345 2,219 22,694
Long-term debt(3) 498 11 22 22 443
Payable to affiliates, net 206 206 -- -- --
Other liabilities and accrued expenses(4)(5) 757 731 10 4 12
--------- --------- --------- --------- ---------
Total Contractual Cash Obligations $ 108,723 $ 17,962 $ 27,270 $ 12,222 $ 51,269
========= ========= ========= ========= =========
</Table>
- ----------
(1) Liabilities for collateral and repurchase agreements are typically fully
secured with cash. We manage our short-term liquidity position to ensure
the availability of a sufficient amount of liquid assets to extinguish
short-term liabilities as they come due in the normal course of business,
including utilizing potential sources of liquidity as disclosed previously.
(2) Contractholder funds represent interest-bearing liabilities arising from
the sale of products such as interest-sensitive life, fixed annuities,
including immediate annuities without life contingencies and institutional
products. The reserve for life-contingent contract benefits relates
primarily to traditional life and immediate annuities with life
contingencies. These amounts reflect the present value of estimated cash
payments to be made to contractholders and policyholders. Certain of these
contracts, such as immediate annuities without life contingencies and
institutional products, involve payment obligations where the amount and
timing of the payment is essentially fixed and determinable. These amounts
relate to (i) policies or contracts where we are currently making payments
and will continue to do so and (ii) contracts where the timing of a portion
or all of the payments has been determined by the contract. Extendible
funding agreements backing medium-term notes outstanding are reflected in
the table above at the contractually specified next maturity dates or the
maturity date accelerated in accordance with the contractholders' election
to not extend the initial maturity date. Other contracts, such as
interest-sensitive life, fixed deferred annuities, traditional life and
immediate annuities with life contingencies, involve payment obligations
where a portion or all of the amount and timing of future payments is
uncertain. For these contracts, the Company is not currently making
payments and will not make payments until (i) the occurrence of an
insurable event, such as death, or illness or (ii) the occurrence of a
payment triggering event such as the surrender of or partial withdrawal on
a policy or deposit contract, which is outside of the control of the
Company. We have estimated the timing of payments related to these
contracts based on historical experience and our expectation of future
payment patterns. Uncertainties relating to these liabilities include
mortality, morbidity, expenses, customer lapse and withdrawal activity,
estimated additional deposits for interest-sensitive life contracts, and
renewal premium for life policies, which may significantly impact both the
timing and amount of future payments. Such cash outflows reflect
adjustments for the estimated timing of mortality, retirement, and other
appropriate factors, but are undiscounted with respect to interest. As a
result, the sum of the cash outflows shown for all years in the table
exceeds the corresponding liabilities of $60.46 billion for contractholder
funds and $12.6 billion for reserve for life-contingent contract benefits
as included in the Consolidated Statements of Financial Position as of
December 31, 2007. The liability amount in the Consolidated Statements of
Financial Position reflects the discounting for interest as well as
adjustments for the timing of other factors as described above.
(3) Amount differs from the balance presented on the Consolidated Statements
of Financial Position as of December 31, 2007 because the long-term debt
amount above includes interest.
(4) Other liabilities primarily include accrued expenses, claim payments and
other checks outstanding.
(5) Balance sheet liabilities not included in the table above include unearned
and advanced premiums of $42 million and deferred income tax liabilities of
$101 million. These items were excluded as they do not meet the definition
of a contractual liability as we are not contractually obligated to pay
these amounts to third parties. Rather, they represent an accounting
mechanism that allows us to present our financial statements on an accrual
basis. In addition, other liabilities of $240 million were not included in
the table above because they did not represent a contractual obligation or
the amount and timing of their eventual payment was sufficiently uncertain.
The following is a distribution in U.S. Dollars of funding agreements
(non-putable) by currency at December 31. All foreign currency denominated
funding agreements have been swapped to U.S. Dollars.
<Table>
<Caption>
(IN MILLIONS)
2007 2006
------------ ------------
CURRENCY
United States Dollar $ 12,000 $ 11,300
British Pound 646 696
Swiss Franc 278 278
Singapore Dollar -- 41
------------ ------------
$ 12,924 $ 12,315
============ ============
</Table>
51
<Page>
Our contractual commitments as of December 31, 2007 and the payments due by
period are shown in the following table.
<Table>
<Caption>
(IN MILLIONS) LESS THAN OVER 5
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
----- ------ --------- --------- -----
Other Commitments - Conditional (1) $ 30 $ 30 $ -- $ -- $ --
Other Commitments - Unconditional (1) 1,211 57 692 407 55
--------- --------- --------- --------- ---------
Total Commitments $ 1,241 $ 87 $ 692 $ 407 $ 55
========= ========= ========= ========= =========
</Table>
- ----------
(1) Represents investment commitments such as private placements and mortgage
loans.
Contractual commitments represents investment commitments such as private
placements, private equities and mortgage loans.
We have agreements in place for services we conduct, generally at cost,
between subsidiaries relating to insurance, reinsurance, loans and
capitalization. All material inter-company transactions have appropriately been
eliminated in consolidation. Inter-company transactions among insurance
subsidiaries and affiliates have been approved by the appropriate departments of
insurance as required.
For a more detailed discussion of our off-balance sheet arrangements, see
Note 7 of the consolidated financial statements.
REGULATION AND LEGAL PROCEEDINGS
We are subject to extensive regulation and we are involved in various legal
and regulatory actions, all of which have an effect on specific aspects of our
business. For a detailed discussion of the legal and regulatory actions in which
we are involved, see Note 11 of the consolidated financial statements.
PENDING ACCOUNTING STANDARDS
There are several pending accounting standards that we have not implemented
either because the standard has not been finalized or the implementation date
has not yet occurred. For a discussion of these pending standards, see Note 2 of
the consolidated financial statements.
The effect of implementing certain accounting standards on our financial
results and financial condition is often based in part on market conditions at
the time of implementation of the standard and other factors we are unable to
determine prior to implementation. For this reason, we are sometimes unable to
estimate the effect of certain pending accounting standards until the relevant
authoritative body finalizes these standards or until we implement them.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required for Item 7A is incorporated by reference to the
material under caption "Market Risk" in Part II, Item 7 of this report.
52
<Page>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------------------
(IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
REVENUES
Premiums (net of reinsurance ceded of $625, $617 and $606) $ 502 $ 576 $ 474
Contract charges (net of reinsurance ceded of $315, $170 and $ -) 942 1,009 1,079
Net investment income 4,205 4,057 3,707
Realized capital gains and losses (197) (79) 19
----------- ----------- -----------
5,452 5,563 5,279
COSTS AND EXPENSES
Contract benefits (net of reinsurance recoveries of $646, $548 and $515) 1,364 1,372 1,340
Interest credited to contractholder funds (net of reinsurance recoveries
of $47, $41 and $4) 2,628 2,543 2,340
Amortization of deferred policy acquisition costs 518 538 568
Operating costs and expenses 340 398 433
----------- ----------- -----------
4,850 4,851 4,681
Loss on disposition of operations (10) (88) (7)
----------- ----------- -----------
INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE 592 624 591
----------- ----------- -----------
Income tax expense 180 196 174
----------- ----------- -----------
NET INCOME 412 428 417
----------- ----------- -----------
OTHER COMPREHENSIVE LOSS, AFTER-TAX
Change in:
Unrealized net capital gains and losses (409) (263) (425)
----------- ----------- -----------
OTHER COMPREHENSIVE LOSS, AFTER-TAX (409) (263) (425)
----------- ----------- -----------
COMPREHENSIVE INCOME (LOSS) $ 3 $ 165 $ (8)
=========== =========== ===========
</Table>
See notes to consolidated financial statements.
53
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
<Table>
<Caption>
DECEMBER 31,
-------------------------
(IN MILLIONS, EXCEPT SHARE AND PAR VALUE DATA) 2007 2006
----------- -----------
ASSETS
Investments
Fixed income securities, at fair value (amortized cost $58,020 and $59,869) $ 58,469 $ 61,457
Mortgage loans 9,901 8,690
Equity securities (cost $102 and $61) 102 72
Limited partnership interests 994 461
Short-term 386 805
Policy loans 770 752
Other 1,792 1,923
----------- -----------
Total investments 72,414 74,160
Cash 185 273
Deferred policy acquisition costs 3,905 3,485
Reinsurance recoverables 3,410 3,392
Accrued investment income 652 689
Other assets 622 585
Separate Accounts 14,929 16,174
----------- -----------
TOTAL ASSETS $ 96,117 $ 98,758
=========== ===========
LIABILITIES
Contractholder funds $ 60,464 $ 60,565
Reserve for life-contingent contract benefits 12,598 12,204
Unearned premiums 33 34
Payable to affiliates, net 206 84
Other liabilities and accrued expenses 2,823 3,235
Deferred income taxes 101 258
Note payable to parent -- 500
Long-term debt 200 206
Separate Accounts 14,929 16,174
----------- -----------
TOTAL LIABILITIES 91,354 93,260
----------- -----------
COMMITMENTS AND CONTINGENT LIABILITIES (NOTES 7 AND 11)
SHAREHOLDER'S EQUITY
Redeemable preferred stock - series A, $100 par value, 1,500,000 shares
authorized, none and 49,230 shares issued and outstanding -- 5
Redeemable preferred stock - series B, $100 par value, 1,500,000 shares
authorized, none issued -- --
Common stock, $227 par value, 23,800 shares authorized and outstanding 5 5
Additional capital paid-in 1,108 1,108
Retained income 3,734 4,055
Accumulated other comprehensive income:
Unrealized net capital gains and losses (84) 325
----------- -----------
Total accumulated other comprehensive income (84) 325
----------- -----------
TOTAL SHAREHOLDER'S EQUITY 4,763 5,498
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 96,117 $ 98,758
=========== ===========
</Table>
See notes to consolidated financial statements.
54
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------------------
(IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
REDEEMABLE PREFERRED STOCK - SERIES A
Balance, beginning of year $ 5 $ 5 $ 5
Redemption of stock (5) -- --
----------- ----------- -----------
Balance, end of year -- 5 5
----------- ----------- -----------
REDEEMABLE PREFERRED STOCK - SERIES B -- -- --
----------- ----------- -----------
COMMON STOCK 5 5 5
----------- ----------- -----------
ADDITIONAL CAPITAL PAID-IN 1,108 1,108 1,108
RETAINED INCOME
Balance, beginning of year 4,055 4,302 4,178
Net income 412 428 417
Dividends (725) (675) (293)
Cumulative effect of change in accounting principle (8) -- --
----------- ----------- -----------
Balance, end of year 3,734 4,055 4,302
----------- ----------- -----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of year 325 588 1,013
Change in unrealized net capital gains and losses (409) (263) (425)
----------- ----------- -----------
Balance, end of year (84) 325 588
----------- ----------- -----------
TOTAL SHAREHOLDER'S EQUITY $ 4,763 $ 5,498 $ 6,008
=========== =========== ===========
</Table>
See notes to consolidated financial statements.
55
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------------------
(IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 412 $ 428 $ 417
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization and other non-cash items (289) (280) (175)
Realized capital gains and losses 197 79 (19)
Loss on disposition of operations 10 88 7
Interest credited to contractholder funds 2,628 2,543 2,340
Changes in:
Policy benefit and other insurance reserves (290) (199) (200)
Unearned premiums (1) (1) 4
Deferred policy acquisition costs (29) (205) (198)
Reinsurance recoverables (276) (218) (197)
Income taxes payable 112 (122) 18
Other operating assets and liabilities 104 93 95
----------- ----------- -----------
Net cash provided by operating activities 2,578 2,206 2,092
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales
Fixed income securities 11,222 12,290 10,660
Equity securities 73 23 25
Limited partnership interests 181 114 32
Investment collections
Fixed income securities 2,981 2,727 4,076
Mortgage loans 1,506 1,618 1,172
Investment purchases
Fixed income securities (12,096) (16,246) (18,128)
Equity securities (101) (282) (37)
Limited partnership interests (673) (22) (166)
Mortgage loans (2,637) (2,159) (1,976)
Change in short-term investments, net 31 362 (352)
Change in policy loans and other investments, net (124) (33) (16)
Disposition of operations (5) (826) (2)
----------- ----------- -----------
Net cash provided by (used in) investing activities 358 (2,434) (4,712)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Note payable to parent (500) 500 -
Redemption of redeemable preferred stock (11) (26) (26)
Contractholder fund deposits 7,948 9,546 11,374
Contractholder fund withdrawals (9,736) (8,998) (8,604)
Dividends paid (725) (675) (211)
----------- ----------- -----------
Net cash (used in) provided by financing activities (3,024) 347 2,533
----------- ----------- -----------
NET (DECREASE) INCREASE IN CASH (88) 119 (87)
CASH AT BEGINNING OF YEAR 273 154 241
----------- ----------- -----------
CASH AT END OF YEAR $ 185 $ 273 $ 154
=========== =========== ===========
</Table>
See notes to consolidated financial statements.
56
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Allstate Life Insurance Company ("ALIC") and its wholly owned subsidiaries
(collectively referred to as the "Company"). ALIC is wholly owned by Allstate
Insurance Company ("AIC"), a wholly owned subsidiary of The Allstate Corporation
(the "Corporation"). These consolidated financial statements have been prepared
in conformity with accounting principles generally accepted in the United States
of America ("GAAP"). All significant intercompany accounts and transactions have
been eliminated.
To conform to the current year presentation, certain amounts in the prior
years' consolidated financial statements and notes have been reclassified.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
NATURE OF OPERATIONS
The Company sells life insurance, retirement and investment products to
individual and institutional customers. The principal individual products are
fixed annuities and interest-sensitive, traditional and variable life insurance.
The principal institutional product is funding agreements backing medium-term
notes issued to institutional and individual investors. The following table
summarizes premiums and contract charges by product.
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
PREMIUMS
Traditional life insurance $ 260 $ 257 $ 250
Immediate annuities with life contingencies 204 278 197
Other 38 41 27
----------- ----------- -----------
TOTAL PREMIUMS 502 576 474
CONTRACT CHARGES
Interest-sensitive life insurance 862 797 734
Fixed annuities 79 73 65
Variable annuities 1 139 280
----------- ----------- -----------
TOTAL CONTRACT CHARGES 942 1,009 1,079
----------- ----------- -----------
TOTAL PREMIUMS AND CONTRACT CHARGES $ 1,444 $ 1,585 $ 1,553
=========== =========== ===========
</Table>
The Company, through several subsidiaries, is authorized to sell life
insurance and retirement products in all 50 states, the District of Columbia,
Puerto Rico, the U.S. Virgin Islands and Guam. For 2007, the top geographic
locations for statutory premiums and annuity considerations were Delaware,
California and New York. No other jurisdiction accounted for more than 5% of
statutory premiums and annuity considerations. The Company distributes its
products to individuals through multiple distribution channels, including
Allstate exclusive agencies, which include exclusive financial specialists,
independent agents (including master brokerage agencies and workplace enrolling
agents), and financial service firms, such as banks, broker-dealers and
specialized structured settlement brokers.
The Company monitors economic and regulatory developments that have the
potential to impact its business. The ability of banks to affiliate with
insurers may have a material adverse effect on all of the Company's product
lines by substantially increasing the number, size and financial strength of
potential competitors. The Company currently benefits from agreements with
financial services entities that market and distribute its products; change in
control of these non-affiliated entities could negatively impact the Company's
sales. Furthermore, federal and state laws and regulations affect the taxation
of insurance companies and life insurance and annuity products. Congress and
various state legislatures have considered proposals that, if enacted, could
impose a greater tax burden on the Company or could have an adverse impact on
the tax treatment of some insurance products offered by the Company, including
favorable policyholder tax treatment currently applicable to life insurance and
annuities. Legislation that reduced the federal income tax rates applicable to
certain dividends and capital gains realized by individuals, or
57
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
other proposals if adopted, that reduce the taxation or permit the establishment
of certain products or investments that may compete with life insurance or
annuities could have an adverse effect on the Company's financial position or
ability to sell such products and could result in the surrender of some existing
contracts and policies. In addition, changes in the federal estate tax laws
could negatively affect the demand for the types of life insurance used in
estate planning.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INVESTMENTS
Fixed income securities include bonds, asset-backed securities,
mortgage-backed securities, commercial mortgage-backed securities and redeemable
preferred stocks. Fixed income securities may be sold prior to their contractual
maturity, are designated as available for sale and are carried at fair value.
The fair value of fixed income securities is based upon observable market
quotations, other market observable data or is derived from such quotations and
market observable data. The fair value of privately placed fixed income
securities is generally based on widely accepted pricing valuation models, which
are developed internally. The valuation models use security specific information
such as the credit rating of the issuer, industry sector of the issuer,
maturity, estimated duration, call provisions, sinking fund requirements, coupon
rate, quoted market prices of comparable securities and estimated liquidity
premiums to determine security specific credit spreads. These spreads are then
adjusted for illiquidity based on historical analysis and broker surveys. The
difference between amortized cost and fair value, net of deferred income taxes,
certain life and annuity deferred policy acquisition costs, certain deferred
sales inducement costs, and certain reserves for life-contingent contract
benefits, is reflected as a component of accumulated other comprehensive income.
Cash received from calls, principal payments and make-whole payments is
reflected as a component of proceeds from sales and cash received from
maturities and pay-downs is reflected as a component of investment collections
within the Consolidated Statement of Cash Flows.
Reported in fixed income securities are hybrid securities which have
characteristics of fixed income securities and equity securities. Many of these
securities have attributes most similar to those of fixed income securities such
as a stated interest rate, a mandatory redemption date or a punitive interest
rate step-up feature which, in most cases, would compel the issuer to redeem the
security at a specified call date. Hybrid securities are carried at fair value
and amounted to $2.67 billion and $2.09 billion at December 31, 2007 and 2006,
respectively.
Equity securities include common and non-redeemable preferred stocks.
Common and non-redeemable preferred stocks are classified as available for sale
and are carried at fair value. The difference between cost and fair value, net
of deferred income taxes, is reflected as a component of accumulated other
comprehensive income.
Mortgage loans are carried at outstanding principal balances, net of
unamortized premium or discount and valuation allowances. Valuation allowances
are established for impaired loans when it is probable that contractual
principal and interest will not be collected. Valuation allowances for impaired
loans reduce the carrying value to the fair value of the collateral or the
present value of the loan's expected future repayment cash flows discounted at
the loan's original effective interest rate.
Investments in limited partnership interests, including certain interests
in limited liability companies and funds, and where the Company's interest is so
minor that it exercises virtually no influence over operating and financial
policies are accounted for in accordance with the cost method of accounting;
otherwise, investments in limited partnership interests are accounted for in
accordance with the equity-method of accounting.
Short-term investments are carried at cost or amortized cost that
approximates fair value. Policy loans are carried at the unpaid principal
balances. Other investments consist primarily of bank loans. Bank loans are
comprised primarily of senior secured corporate loans which are carried at
amortized cost.
In connection with the Company's securities lending business activities,
funds received in connection with securities repurchase agreements, cash
collateral received from counterparties related to derivative transactions and
securities purchased under agreements to resell are invested and classified as
short-term investments or fixed income securities available for sale as
applicable. For the Company's securities lending business activities and
securities sold under agreements to repurchase, the Company records an
offsetting liability in other liabilities and accrued expenses for the Company's
obligation to return the collateral or funds received.
58
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investment income consists primarily of interest and dividends, income from
limited partnership interests and income from certain derivative transactions.
Interest is recognized on an accrual basis using the effective yield method and
dividends are recorded at the ex-dividend date. Interest income for asset-backed
securities, mortgage-backed securities and commercial mortgage-backed securities
is determined considering estimated principal repayments obtained from widely
accepted third party data sources and internal estimates. Interest income on
certain beneficial interests in securitized financial assets is determined using
the prospective yield method, based upon projections of expected future cash
flows. For all other asset-backed securities, mortgage-backed securities and
commercial mortgage-backed securities, the effective yield is recalculated on
the retrospective basis. Income from investments in limited partnership
interests accounted for on the cost basis is recognized upon receipt of amounts
distributed by the partnerships as income. Income from investments in limited
partnership interests accounted for utilizing the equity-method of accounting is
recognized based on the financial results of the entity and the Company's
proportionate investment interest. Accrual of income is suspended for fixed
income securities and mortgage loans that are in default or when receipt of
interest payments is in doubt.
Realized capital gains and losses include gains and losses on investment
dispositions, write-downs in value due to other-than-temporary declines in fair
value and periodic changes in the fair value and settlements of certain
derivatives including hedge ineffectiveness. Dispositions include sales, losses
recognized in anticipation of dispositions and other transactions such as calls
and prepayments. Realized capital gains and losses on investment dispositions
are determined on a specific identification basis.
The Company recognizes other-than-temporary impairment losses on fixed
income securities, equity securities and short-term investments when the decline
in fair value is deemed other-than-temporary (see Note 6).
DERIVATIVE AND EMBEDDED DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments include swaps, futures (interest rate),
options (including swaptions), interest rate caps and floors, warrants, certain
forward contracts for purchases of to-be-announced ("TBA") mortgage securities,
forward contracts to hedge foreign currency risks and certain investment risk
transfer reinsurance agreements. Derivatives that are required to be separated
from the host instrument and accounted for as derivative financial instruments
("subject to bifurcation") are embedded in convertible and equity-indexed fixed
income securities, equity-indexed life and annuity contracts, reinsured variable
annuity contracts, and certain funding agreements (see Note 7).
All derivatives are accounted for on a fair value basis and reported as
other investments, other assets, other liabilities and accrued expenses or
contractholder funds. Embedded derivative instruments subject to bifurcation are
also accounted for on a fair value basis and are reported together with the host
contract. The change in the fair value of derivatives embedded in certain fixed
income securities and subject to bifurcation is reported in realized capital
gains and losses. The change in the fair value of derivatives embedded in
liabilities and subject to bifurcation is reported in life and annuity contract
benefits, interest credited to contractholder funds or realized capital gains
and losses.
When derivatives meet specific criteria, they may be designated as
accounting hedges and accounted for as fair value, cash flow, foreign currency
fair value or foreign currency cash flow hedges. The hedged item may be either
all or a specific portion of a recognized asset, liability or an unrecognized
firm commitment attributable to a particular risk. At the inception of the
hedge, the Company formally documents the hedging relationship and risk
management objective and strategy. The documentation identifies the hedging
instrument, the hedged item, the nature of the risk being hedged and the
methodology used to assess the effectiveness of the hedging instrument in
offsetting the exposure to changes in the hedged item's fair value attributable
to the hedged risk. In the case of a cash flow hedge, this documentation
includes the exposure to changes in the hedged item's or transaction's
variability in cash flows attributable to the hedged risk. The Company does not
exclude any component of the change in fair value of the hedging instrument from
the effectiveness assessment. At each reporting date, the Company confirms that
the hedging instrument continues to be highly effective in offsetting the hedged
risk. Ineffectiveness in fair value hedges and cash flow hedges is reported in
realized capital gains and losses. The hedge ineffectiveness reported in
realized capital gains and losses amounted to losses of $13 million, $7 million
and $7 million in 2007, 2006 and 2005, respectively.
FAIR VALUE HEDGES The Company designates certain of its interest rate and
foreign currency swap contracts and certain investment risk transfer reinsurance
agreements as fair value hedges when the hedging instrument is highly effective
in offsetting the risk of changes in the fair value of the hedged item.
59
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For hedging instruments used in fair value hedges, when the hedged items
are investment assets or a portion thereof, the change in the fair value of the
derivatives is reported in net investment income, together with the change in
the fair value of the hedged items. The change in the fair value of hedging
instruments used in fair value hedges of contractholder funds liabilities or a
portion thereof is reported in interest credited to contractholder funds,
together with the change in the fair value of the hedged item. Accrued periodic
settlements on swaps are reported together with the changes in fair value of the
swaps in net investment income or interest credited to contractholder funds. The
amortized cost for fixed income securities, the carrying value for mortgage
loans or the carrying value of the hedged liability is adjusted for the change
in the fair value of the hedged risk.
CASH FLOW HEDGES The Company designates certain of its foreign currency
swap contracts as cash flow hedges when the hedging instrument is highly
effective in offsetting the exposure of variations in cash flows for the hedged
risk that could affect net income. The Company's cash flow exposure may be
associated with an existing asset, liability or a forecasted transaction.
Anticipated transactions must be probable of occurrence and their significant
terms and specific characteristics must be identified.
For hedging instruments used in cash flow hedges, the changes in fair value
of the derivatives are reported in accumulated other comprehensive income.
Amounts are reclassified to net investment income or realized capital gains and
losses as the hedged or forecasted transaction affects net income. Accrued
periodic settlements on derivatives used in cash flow hedges are reported in net
investment income. The amount reported in accumulated other comprehensive income
for a hedged transaction is limited to the lesser of the cumulative gain or loss
on the derivative less the amount reclassified to net income; or the cumulative
gain or loss on the derivative needed to offset the cumulative change in the
expected future cash flows on the hedged transaction from inception of the hedge
less the derivative gain or loss previously reclassified from accumulated other
comprehensive income to net income. If the Company expects at any time that the
loss reported in accumulated other comprehensive income would lead to a net loss
on the combination of the hedging instrument and the hedged transaction which
may not be recoverable, a loss is recognized immediately in realized capital
gains and losses. If an impairment loss is recognized on an asset or an
additional obligation is incurred on a liability involved in a hedge
transaction, any offsetting gain in accumulated other comprehensive income is
reclassified and reported together with the impairment loss or recognition of
the obligation.
TERMINATION OF HEDGE ACCOUNTING If, subsequent to entering into a hedge
transaction, the derivative becomes ineffective (including if the hedged item is
sold or otherwise extinguished, the occurrence of a hedged forecasted
transaction is no longer probable, or the hedged asset becomes
other-than-temporarily impaired), the Company may terminate the derivative
position. The Company may also terminate derivative instruments or redesignate
them as non-hedge as a result of other events or circumstances. If the
derivative financial instrument is not terminated when a fair value hedge is no
longer effective, the future gains and losses recognized on the derivative are
reported in realized capital gains and losses. When a fair value hedge is no
longer effective, is redesignated as non-hedge or when the derivative has been
terminated, the fair value gain or loss on the hedged asset, liability or
portion thereof which has already been recognized in income while the hedge was
in place and used to adjust the amortized cost for fixed income securities, the
carrying value for mortgage loans or the carrying amount for the liability, is
amortized over the remaining life of the hedged asset, liability or portion
thereof, and reflected in net investment income or interest credited to
contractholder funds beginning in the period that hedge accounting is no longer
applied. If the hedged item in a fair value hedge is an asset which has become
other-than-temporarily impaired, or is a liability which an increase has been
recognized for the obligation, the adjustment made to the amortized cost for
fixed income securities, the carrying value for mortgage loans or the carrying
amount for the liability is subject to the accounting policies applied to
other-than-temporarily impaired assets.
When a derivative financial instrument used in a cash flow hedge of an
existing asset or liability is no longer effective or is terminated, the gain or
loss recognized on the derivative is reclassified from accumulated other
comprehensive income to net income as the hedged risk impacts net income,
beginning in the period hedge accounting is no longer applied or the derivative
instrument is terminated. If the derivative financial instrument is not
terminated when a cash flow hedge is no longer effective, the future gains and
losses recognized on the derivative are reported in realized capital gains and
losses. When a derivative financial instrument used in a cash flow hedge of a
forecasted transaction is terminated because the forecasted transaction is no
longer probable, the gain or loss recognized on the derivative is immediately
reclassified from accumulated other comprehensive income to realized capital
gains and losses in the period that hedge accounting is no longer applied. If a
cash flow hedge is no longer effective, the gain or loss recognized on the
derivative during the period the hedge was effective is reclassified from
accumulated other comprehensive income to net income as the remaining hedged
item affects net income.
60
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NON-HEDGE DERIVATIVE FINANCIAL INSTRUMENTS The Company also has certain
derivatives that are used in interest rate, equity price and credit risk
management strategies for which hedge accounting is not applied. These
derivatives primarily consist of certain interest rate swap agreements, equity
and financial futures contracts, interest rate cap and floor agreements,
swaptions, foreign currency forward and option contracts, certain forward
contracts for TBA mortgage securities and credit default swaps.
The Company replicates fixed income securities using a combination of a
credit default swap and one or more highly rated fixed income securities to
synthetically replicate the economic characteristics of one or more cash market
securities. Fixed income securities are replicated when they are either
unavailable in the cash market or are more economical to acquire in synthetic
form.
Based upon the type of derivative instrument and strategy, the income
statement effects of these derivatives are reported in a single line item with
the results of the associated risk. Therefore, the derivatives' fair value gains
and losses and accrued periodic settlements are recognized together in one of
the following line items during the reporting period: net investment income,
realized capital gains and losses, operating costs and expenses, life and
annuity contract benefits or interest credited to contractholder funds. Cash
flows from embedded derivatives requiring bifurcation and derivatives receiving
hedge accounting are reported consistently with the host contracts and hedged
risks respectively within the Consolidated Statement of Cash Flows. Cash flows
from other derivatives are reported in cash flows from investing activities
within the Consolidated Statement of Cash Flows.
SECURITIES LOANED AND SECURITY REPURCHASE AND RESALE
The Company's business activities, include securities lending transactions,
securities sold under agreements to repurchase ("repurchase agreements"), and
securities purchased under agreements to resell ("resale agreements"), which are
used primarily to generate net investment income. The proceeds received from
repurchase agreements also provide a source of liquidity. For repurchase
agreements and securities lending transactions used to generate net investment
income, the proceeds received are reinvested in short-term investments or fixed
income securities. These transactions are short-term in nature, usually 30 days
or less.
The Company receives collateral for securities loaned in an amount
generally equal to 103% of the fair value of securities, and records the related
obligations to return the collateral in other liabilities and accrued expenses.
The carrying value of these obligations approximates fair value because of their
relatively short-term nature. The Company monitors the market value of
securities loaned on a daily basis and obtains additional collateral as
necessary under the terms of the agreements to mitigate counterparty credit
risk. The Company maintains the right and ability to redeem the securities
loaned on short notice. Substantially all of the Company's securities loaned are
placed with large brokerage firms.
The Company's policy is to take possession or control of securities under
resale agreements. Securities to be repurchased under repurchase agreements are
the same, or substantially the same, as the securities transferred. The
Company's obligations to return the funds received under repurchase agreements
are carried at the amount at which the securities will subsequently be
reacquired, including accrued interest, as specified in the respective
agreements and are classified as other liabilities and accrued expenses. The
carrying value of these obligations approximates fair value because of their
relatively short-term nature.
RECOGNITION OF PREMIUM REVENUES AND CONTRACT CHARGES, AND RELATED BENEFITS AND
INTEREST CREDITED
Traditional life insurance products consist principally of products with
fixed and guaranteed premiums and benefits, primarily term and whole life
insurance products. Premiums from these products are recognized as revenue when
due from policyholders. Benefits are reflected in life and annuity contract
benefits and recognized in relation to premiums so that profits are recognized
over the life of the policy.
Immediate annuities with life contingencies, including certain structured
settlement annuities, provide insurance protection over a period that extends
beyond the period during which premiums are collected. Premiums from these
products are recognized as revenue when received at the inception of the
contract. Benefits and expenses are recognized in relation to premiums so that
profits are recognized over the life of the contract.
Interest-sensitive life contracts, such as universal life, single premium
life and equity-indexed life are insurance contracts whose terms are not fixed
and guaranteed. The terms that may be changed include premiums paid by the
contractholder, interest credited to the contractholder account balance and
contract charges assessed against the contractholder account balance. Premiums
from these contracts are reported as contractholder fund deposits. Contract
charges consist of fees assessed against the contractholder account balance for
the cost of insurance (mortality risk),
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contract administration and early surrender. These contract charges are
recognized as revenue when assessed against the contractholder account balance.
Life and annuity contract benefits include life-contingent benefit payments in
excess of the contractholder account balance.
Contracts that do not subject the Company to significant risk arising from
mortality or morbidity are referred to as investment contracts. Fixed annuities,
including market value adjusted annuities, equity-indexed annuities and
immediate annuities without life contingencies, and funding agreements
(primarily backing medium-term notes) are considered investment contracts.
Consideration received for such contracts is reported as contractholder fund
deposits. Contract charges for investment contracts consist of fees assessed
against the contractholder account balance for maintenance, administration and
surrender of the contract prior to contractually specified dates, and are
recognized when assessed against the contractholder account balance.
Interest credited to contractholder funds represents interest accrued or
paid on interest-sensitive life contracts and investment contracts. Crediting
rates for certain fixed annuities and interest-sensitive life contracts are
adjusted periodically by the Company to reflect current market conditions
subject to contractually guaranteed minimum rates. Crediting rates for indexed
annuities, indexed life contracts and indexed funding agreements are generally
based on a specified interest rate index, such as LIBOR, or an equity index,
such as the S&P 500. Interest credited also includes amortization of deferred
sales inducement ("DSI") expenses. DSI is amortized into interest credited using
the same method used to amortize deferred policy acquisition costs ("DAC").
Contract charges for variable life and variable annuity products consist of
fees assessed against the contractholder account values for contract
maintenance, administration, mortality, expense and early surrender. Contract
benefits incurred include guaranteed minimum death, income, withdrawal and
accumulation benefits. Subsequent to the Company's disposal of substantially all
of its variable annuity business through reinsurance agreements with Prudential
in 2006 (see Note 3), the contract charges and contract benefits related thereto
are reported net of reinsurance ceded.
DEFERRED POLICY ACQUISITION AND SALES INDUCEMENT COSTS
Costs that vary with and are primarily related to acquiring life insurance
and investment contracts are deferred and recorded as DAC. These costs are
principally agents' and brokers' remuneration, premium taxes, inspection costs,
and certain underwriting and direct mail solicitation expenses. DSI costs, which
are deferred and recorded as other assets, relate to sales inducements offered
on sales to new customers, principally on annuities and primarily in the form of
additional credits to the customer's account value or enhancements to interest
credited for a specified period, which are in excess of the rates currently
being credited to similar contracts without sales inducements. All other
acquisition costs are expensed as incurred and included in operating costs and
expenses on the Consolidated Statements of Operations and Comprehensive Income.
Future investment income is considered in determining the recoverability of DAC.
Amortization of DAC associated with life insurance and investment contracts is
described in more detail below. All life insurance and investment contract DAC
is included in amortization of deferred policy acquisition costs on the
Consolidated Statements of Operations and Comprehensive Income. DSI is reported
in other assets and amortized to income using the same methodology and
assumptions as DAC and is included in interest credited to contractholder funds
on the Consolidated Statements of Operations and Comprehensive Income. DAC and
DSI are periodically reviewed for recoverability and adjusted if necessary.
For traditional life insurance, DAC is amortized over the premium paying
period of the related policies in proportion to the estimated revenues on such
business. Assumptions used in the amortization of DAC and reserve calculations
are established at the time the policy is issued and are generally not revised
during the life of the policy. Any deviations from projected business in force
resulting from actual policy terminations differing from expected levels and any
estimated premium deficiencies may result in a change to the rate of
amortization in the period such events occur. Generally, the amortization period
for these contracts approximates the estimated lives of the policies.
For interest-sensitive life, annuities and other investment contracts, DAC
and DSI are amortized in proportion to the incidence of the total present value
of gross profits, which includes both actual historical gross profits ("AGP")
and estimated future gross profits ("EGP") expected to be earned over the
estimated lives of the contracts. The amortization is net of interest on the
prior DAC balance and uses rates established at the inception of the contracts.
Actual amortization periods generally range from 15-30 years; however,
incorporating estimates of customer surrender rates, partial withdrawals and
deaths generally results in the majority of the DAC being amortized over the
surrender charge period. The rate of amortization during this term is matched to
the pattern of total gross profits.
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AGP and EGP consists primarily of the following components: the excess of
contract charges for the cost of insurance over mortality and other benefits;
investment income and realized capital gains and losses over interest credited;
and surrender and other contract charges over maintenance expenses. The
principal assumptions for determining the amount of EGP are investment returns,
including capital gains and losses on assets supporting contract liabilities,
interest crediting rates to policyholders, the effect of any hedges used,
persistency, mortality and expenses.
Changes in the amount or timing of EGP result in adjustments to the
cumulative amortization of DAC and DSI. All such adjustments are reflected in
the current results of operations.
The Company performs quarterly reviews of DAC and DSI recoverability for
interest-sensitive life, annuities and other investment contracts in the
aggregate using current assumptions. If a change in the amount of EGP is
significant, it could result in the unamortized DAC and DSI not being
recoverable, resulting in a charge which is included as a component of
amortization of deferred policy acquisition costs or interest credited to
contractholder funds, respectively, on the Consolidated Statements of Operations
and Comprehensive Income.
Any amortization of DAC or DSI that would result from changes in unrealized
gains or losses had those gains or losses actually been realized during the
reporting period is recorded net of tax in other comprehensive income.
The costs assigned to the right to receive future cash flows from certain
business purchased from other insurers are also classified as DAC in the
Consolidated Statements of Financial Position. The costs capitalized represent
the present value of future profits expected to be earned over the lives of the
contracts acquired. These costs are amortized as profits emerge over the lives
of the acquired business and are periodically evaluated for recoverability. The
present value of future profits was $21 million and $25 million at December 31,
2007 and 2006, respectively. Amortization expense on the present value of future
profits was $5 million, $6 million and $8 million for the years ended December
31, 2007, 2006 and 2005, respectively.
Customers of the Company may exchange one insurance policy or investment
contract for another offered by the Company, or make modifications to an
existing investment or life contract issued by the Company. These transactions
are identified as internal replacements for accounting purposes. Internal
replacement transactions that are determined to result in replacement contracts
that are substantially unchanged from the replaced contract are accounted for as
continuations of the replaced contracts. Unamortized DAC and DSI related to the
replaced contract continue to be deferred and amortized in connection with the
replacement contracts. For interest-sensitive life insurance and investment
contracts, the EGP of the replacement contract is treated as revisions to the
EGP of the replaced contract in the determination of amortization of DAC and
DSI. For traditional life insurance policies, any changes to unamortized DAC and
benefit reserves that result from the replacement contract are treated as
prospective revisions. Any costs associated with the issuance of the replacement
contract are characterized as maintenance costs and expensed as incurred.
Internal replacement transactions that are determined to result in a
substantial change to the replaced contracts are accounted for as an
extinguishment of the replaced contracts, and any unamortized DAC and DSI
related to the replaced contracts are eliminated with a corresponding charge to
the Consolidated Statements of Operations and Comprehensive Income.
REINSURANCE
In the normal course of business, the Company seeks to limit aggregate and
single exposure to losses on large risks by purchasing reinsurance (see Note 9).
The Company has also used reinsurance to effect the acquisition or disposition
of certain blocks of business. The amounts reported in the Consolidated
Statements of Financial Position as reinsurance recoverables include amounts
billed to reinsurers on losses paid as well as estimates of amounts expected to
be recovered from reinsurers on insurance liabilities and contractholder funds
that have not yet been paid. Reinsurance recoverables on unpaid losses are
estimated based upon assumptions consistent with those used in establishing the
liabilities related to the underlying reinsured contracts. Insurance liabilities
are reported gross of reinsurance recoverables. Reinsurance premiums are
generally reflected in income in a manner consistent with the recognition of
premiums on the reinsured contracts or are earned ratably over the contract
period to the extent coverage remains available. Reinsurance does not extinguish
the Company's primary liability under the policies written. Therefore, the
Company regularly evaluates the financial condition of its reinsurers including
their activities with respect to claim settlement practices and commutations,
and establishes allowances for uncollectible reinsurance recoverables as
appropriate.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GOODWILL
Goodwill represents the excess of amounts paid for acquiring businesses
over the fair value of the net assets acquired. The Company annually evaluates
goodwill for impairment using a trading multiple analysis, which is a widely
accepted valuation technique to estimate the fair value of its reporting units.
The Company also reviews its goodwill for impairment whenever events or changes
in circumstances indicate that it is more likely than not that the carrying
amount of goodwill may exceed its implied fair value. Goodwill impairment
evaluations indicated no impairment at December 31, 2007.
INCOME TAXES
The income tax provision is calculated under the liability method. Deferred
tax assets and liabilities are recorded based on the difference between the
financial statement and tax bases of assets and liabilities at the enacted tax
rates. The principal assets and liabilities giving rise to such differences are
unrealized capital gains and losses on certain investments, insurance reserves
and DAC. A deferred tax asset valuation allowance is established when there is
uncertainty that such assets would be realized (see Note 12).
RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS
The reserve for life-contingent contract benefits payable under insurance
policies including traditional life insurance, life-contingent fixed annuities
and voluntary health products is computed on the basis of long-term actuarial
assumptions of future investment yields, mortality, morbidity, policy
terminations and expenses (see Note 8). These assumptions, which for traditional
life insurance, life-contingent fixed annuities and accident and health products
are applied using the net level premium method, include provisions for adverse
deviation and generally vary by characteristics such as type of coverage, year
of issue and policy duration. To the extent that unrealized gains on fixed
income securities would result in a premium deficiency had those gains actually
been realized, the related increase in reserves for certain immediate annuities
with life contingencies is recorded net of tax as a reduction of unrealized net
capital gains included in accumulated other comprehensive income.
CONTRACTHOLDER FUNDS
Contractholder funds represent interest-bearing liabilities arising from
the sale of products, such as interest-sensitive life, fixed annuities and
funding agreements. Contractholder funds are comprised primarily of deposits
received and interest credited to the benefit of the contractholder less
surrenders and withdrawals, mortality charges and administrative expenses (see
Note 8). Contractholder funds also include reserves for secondary guarantees on
interest-sensitive life insurance and certain fixed annuity contracts and
reserves for certain guarantees on reinsured variable annuity contracts.
SEPARATE ACCOUNTS
Separate accounts assets are carried at fair value. Separate accounts
liabilities are carried at the account values, which are equal to the carrying
value of the corresponding assets. The assets of the separate accounts are
legally segregated and available only to settle separate account contract
obligations. Separate accounts liabilities represent the contractholders' claims
to the related assets. Investment income and realized capital gains and losses
of the separate accounts accrue directly to the contractholders and therefore,
are not included in the Company's Consolidated Statements of Operations and
Comprehensive Income. Deposits to and surrenders and withdrawals from the
separate accounts are reflected in separate accounts liabilities and are not
included in consolidated cash flows.
Absent any contract provision wherein the Company provides a guarantee,
variable annuity and variable life insurance contractholders bear the investment
risk that the separate accounts' funds may not meet their stated investment
objectives. Substantially all of the Company's variable annuity business was
reinsured to Prudential in 2006.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
Commitments to invest, commitments to purchase private placement
securities, commitments to extend mortgage loans, financial guarantees and
credit guarantees have off-balance-sheet risk because their contractual amounts
are not recorded in the Company's Consolidated Statements of Financial Position
(see Note 7 and Note 11).
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ADOPTED ACCOUNTING STANDARDS
STATEMENT OF POSITION 05-1, ACCOUNTING BY INSURANCE ENTERPRISES FOR DEFERRED
ACQUISITION COSTS IN CONNECTION WITH MODIFICATIONS OR EXCHANGES OF INSURANCE
CONTRACTS ("SOP 05-1")
In October 2005, the American Institute of Certified Public Accountants
("AICPA") issued SOP 05-1. SOP 05-1 provides accounting guidance for DAC
associated with internal replacements of insurance and investment contracts
other than those set forth in Statement of Financial Accounting Standards
("SFAS") No. 97, "Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and for Realized Gains and Losses from the Sale of
Investments". SOP 05-1 defines an internal replacement as a modification in
product benefits, features, rights or coverages that occurs through the exchange
of an existing contract for a new contract, or by amendment, endorsement or
rider to an existing contract, or by the election of a feature or coverage
within an existing contract. The Company adopted the provisions of SOP 05-1 on
January 1, 2007 for internal replacements occurring in fiscal years beginning
after December 15, 2006. The adoption resulted in an $8 million after-tax
reduction to retained income to reflect the impact on EGP from the changes in
accounting for certain costs associated with contract continuations that no
longer qualify for deferral under SOP 05-1 and a reduction of DAC and DSI
balances of $13 million pre-tax as of January 1, 2007.
SFAS NO. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS - AN AMENDMENT
OF FASB STATEMENTS NO. 133 AND 140 ("SFAS NO. 155")
In February 2006, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 155, which permits the fair value remeasurement at the date of adoption
of any hybrid financial instrument containing an embedded derivative that
otherwise would require bifurcation under paragraph 12 or 13 of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133");
clarifies which interest-only strips and principal-only strips are not subject
to the requirements of SFAS No. 133; establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or hybrid financial instruments that contain embedded
derivatives requiring bifurcation; and clarifies that concentrations of credit
risk in the form of subordination are not embedded derivatives. The Company
adopted the provisions of SFAS No. 155 on January 1, 2007, which were effective
for all financial instruments acquired, issued or subject to a remeasurement
event occurring after the beginning of the first fiscal year beginning after
September 15, 2006. The Company elected not to remeasure existing hybrid
financial instruments that contained embedded derivatives requiring bifurcation
at the date of adoption pursuant to paragraph 12 or 13 of SFAS No. 133. The
adoption of SFAS No. 155 did not have a material effect on the results of
operations or financial position of the Company.
FASB INTERPRETATION NO. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES - AN
INTERPRETATION OF FASB STATEMENT NO. 109 AND FASB STAFF POSITION NO. FIN 48-1,
DEFINITION OF SETTLEMENT IN FASB INTERPRETATION NO. 48 ("FIN 48")
The FASB issued the interpretation in July 2006 and the staff position in
May 2007. FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an entity's financial statements in accordance with SFAS No. 109,
"Accounting for Income Taxes". FIN 48 requires an entity to recognize the tax
benefit of uncertain tax positions only when it is more likely than not, based
on the position's technical merits, that the position would be sustained upon
examination by the respective taxing authorities. The tax benefit is measured as
the largest benefit that is more than fifty-percent likely of being realized
upon final settlement with the respective taxing authorities. On January 1,
2007, the Company adopted the provisions of FIN 48, which were effective for
fiscal years beginning after December 15, 2006. No cumulative effect of a change
in accounting principle or adjustment to the liability for unrecognized tax
benefits was recognized as a result of the adoption of FIN 48. Accordingly, the
adoption of FIN 48 did not have an effect on the results of operations or
financial position of the Company (see Note 12).
SECURITIES AND EXCHANGE COMMISSION ("SEC") STAFF ACCOUNTING BULLETIN NO. 108,
CONSIDERING THE EFFECTS OF PRIOR YEAR MISSTATEMENTS WHEN QUANTIFYING
MISSTATEMENTS IN CURRENT YEAR FINANCIAL STATEMENTS ("SAB 108")
In September 2006, the SEC issued SAB 108 to eliminate the diversity of
practice in the way misstatements are quantified for purposes of assessing their
materiality in financial statements. SAB 108 was intended to eliminate the
potential build up of improper amounts on the balance sheet due to the
limitations of certain methods of assessing materiality previously utilized by
some reporting entities. SAB 108 established a single quantification framework
wherein the significance determination is based on the effects of the
misstatements on each of the financial statements as well as the related
financial statement disclosures. On December 31, 2006, the Company adopted the
provisions of SAB 108 which were effective for the first fiscal year ending
after November 15, 2006. The adoption of SAB 108 did not have any effect on the
results of operations or financial position of the Company.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FASB STAFF POSITION NO. FAS 115-1, THE MEANING OF OTHER-THAN-TEMPORARY
IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS ("FSP FAS 115-1")
FSP FAS 115-1 nullified the guidance in paragraphs 10-18 of Emerging Issues
Task Force Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" and references existing other-than-temporary
impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize
an impairment loss no later than when the impairment is deemed
other-than-temporary, even if a decision to sell the security has not been made,
and also provides guidance on the subsequent income recognition for impaired
debt securities. The Company adopted FSP FAS 115-1 as of January 1, 2006 on a
prospective basis. The effects of adoption did not have a material effect on the
results of operations or financial position of the Company.
SFAS NO. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS - A REPLACEMENT OF APB
OPINION NO. 20 AND FASB STATEMENT NO. 3 ("SFAS NO. 154")
SFAS No. 154 replaced Accounting Principles Board ("APB") Opinion No. 20,
"Accounting Changes", and SFAS No. 3, "Reporting Accounting Changes in Interim
Financial Statements". SFAS No. 154 requires retrospective application to prior
periods' financial statements for changes in accounting principle, unless
determination of either the period specific effects or the cumulative effect of
the change is impracticable or otherwise not required. The Company adopted SFAS
No. 154 on January 1, 2006. The adoption of SFAS No. 154 did not have any effect
on the results of operations or financial position of the Company.
PENDING ACCOUNTING STANDARDS
SFAS NO. 141(R), BUSINESS COMBINATIONS ("SFAS NO. 141R")
In December 2007, the FASB issued SFAS No. 141R which replaces SFAS No.
141, "Business Combinations" ("SFAS No. 141"). Among other things, SFAS No. 141R
broadens the scope of SFAS No. 141 to include all transactions where an acquirer
obtains control of one or more other businesses; retains the guidance to
recognize intangible assets separately from goodwill; requires, with limited
exceptions, that all assets acquired and liabilities assumed, including certain
of those that arise from contractual contingencies, be measured at their
acquisition date fair values; requires most acquisition and
restructuring-related costs to be expensed as incurred; requires that step
acquisitions, once control is acquired, to be recorded at the full amounts of
the fair values of the identifiable assets, liabilities and the noncontrolling
interest in the acquiree; and replaces the reduction of asset values and
recognition of negative goodwill with a requirement to recognize a gain in
earnings. The provisions of SFAS No. 141R are effective for fiscal years
beginning after December 15, 2008 and are to be applied prospectively only.
Early adoption is not permitted. The Company will apply the provisions of SFAS
141R as required when effective.
SFAS NO. 160, NONCONTROLLING INTERESTS IN CONSOLIDATED FINANCIAL STATEMENTS - AN
AMENDMENT OF ARB NO. 51 ("SFAS NO. 160")
In December 2007, the FASB issued SFAS No. 160 which clarifies that a
noncontrolling interest in a subsidiary is that portion of the subsidiary's
equity that is attributable to owners of the subsidiary other than its parent or
parent's affiliates. Noncontrolling interests are required to be reported as
equity in the consolidated financial statements and as such net income will
include amounts attributable to both the parent and the noncontrolling interest
with disclosure of the amounts attributable to each on the face of the
consolidated statement of operations. SFAS No. 160 requires that all changes in
a parent's ownership interest in a subsidiary when control of the subsidiary is
retained, be accounted for as equity transactions. In contrast, SFAS No. 160
requires a parent to recognize a gain or loss in net income when control over a
subsidiary is relinquished and the subsidiary is deconsolidated, as well as
provide certain associated expanded disclosures. SFAS No. 160 is effective as of
the beginning of a reporting entity's first fiscal year beginning after December
15, 2008. Early adoption is prohibited. SFAS No. 160 requires prospective
application as of the beginning of the fiscal year in which the standard is
initially applied, except for the presentation and disclosure requirements which
are to be applied retrospectively for all periods presented. The Company will
apply the provisions of SFAS No. 160 as required on the effective date.
SEC STAFF ACCOUNTING BULLETIN NO. 109, WRITTEN LOAN COMMITMENTS THAT ARE
RECORDED AT FAIR VALUE THROUGH EARNINGS ("SAB 109")
In October 2007, the SEC issued SAB 109, a replacement of SAB 105,
"Application of Accounting Principles to Loan Commitments". SAB 109 is
applicable to both loan commitments accounted for under SFAS No. 133, and other
loan commitments for which the issuer elects fair value accounting under SFAS
No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities".
SAB 109 states that the expected net future cash flows related
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to the servicing of a loan should be included in the fair value measurement of a
loan commitment accounted for at fair value through earnings. The expected net
future cash flows associated with loan servicing should be determined in
accordance with the guidance in SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities", as amended by
SFAS No. 156, "Accounting for Servicing of Financial Assets". SAB 109 should be
applied on a prospective basis to loan commitments accounted for under SFAS No.
133 that were issued or modified in fiscal quarters beginning after December 15,
2007. Earlier adoption is not permitted. The adoption of SAB 109 is not expected
to have a material impact on the Company's results of operations or financial
position.
SFAS NO. 157, FAIR VALUE MEASUREMENTS ("SFAS NO. 157")
In September 2006, the FASB issued SFAS No. 157, which redefines fair value
as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date, establishes a framework for measuring fair value in GAAP, and
expands disclosures about fair value measurements. Specifically, SFAS No. 157
establishes a three-level hierarchy for fair value measurements based upon the
nature of the inputs to the valuation of an asset or liability. SFAS No. 157
applies where other accounting pronouncements require or permit fair value
measurements. Additional disclosures and modifications to current fair value
disclosures will be required upon adoption of SFAS No. 157. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007. In February 2008,
the FASB issued FASB Staff Position No. 157-2, "Effective Date of FASB Statement
No. 157", which permits the deferral of the effective date of SFAS No. 157 to
fiscal years beginning after November 15, 2008 for all non-financial assets and
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis. The Company plans to utilize the
deferral for non-financial assets and liabilities. The adoption of SFAS No. 157
is not expected to have a material effect on the Company's results of operations
or financial position.
SFAS NO. 159, THE FAIR VALUE OPTION FOR FINANCIAL ASSETS AND FINANCIAL
LIABILITIES - INCLUDING AN AMENDMENT OF FASB STATEMENT NO. 115 ("SFAS NO.
159")
In February 2007, the FASB issued SFAS No. 159 which provides reporting
entities an option to report selected financial assets, including investment
securities designated as available for sale, and financial liabilities,
including most insurance contracts, at fair value. SFAS No. 159 establishes
presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement alternatives for similar
types of financial assets and liabilities. The standard also requires additional
information to aid financial statement users' understanding of the impacts of a
reporting entity's decision to use fair value on its earnings and requires
entities to display, on the face of the statement of financial position, the
fair value of those assets and liabilities for which the reporting entity has
chosen to measure at fair value. SFAS No. 159 is effective as of the beginning
of a reporting entity's first fiscal year beginning after November 15, 2007. The
Company does not expect to apply the fair value option to any existing financial
assets or liabilities as of January 1, 2008. Consequently, the initial adoption
of SFAS No. 159 is expected to have no impact on the Company's results of
operations or financial position.
SOP 07-1, CLARIFICATION OF THE SCOPE OF THE AUDIT AND ACCOUNTING GUIDE,
INVESTMENT COMPANIES ("THE GUIDE") AND ACCOUNTING BY PARENT COMPANIES AND
EQUITY METHOD INVESTORS FOR INVESTMENTS IN INVESTMENT COMPANIES ("SOP 07-1")
In June 2007, the AICPA issued SOP 07-1 which provides guidance for
determining whether an entity falls within the scope of the Guide and whether
investment company accounting should be retained by a parent company upon
consolidation of an investment company subsidiary or by an equity-method
investor in an investment company. SOP 07-1 was to be effective for fiscal years
beginning on or after December 15, 2007, however in February 2008, the FASB
issued FASB Staff Position No. SOP 07-1-1, "Effective Date of AICPA Statement of
Position 07-1", which amends SOP 07-1 to (1) delay indefinitely the effective
date of the SOP and (2) prohibit adoption of the SOP for an entity that did not
early adopt the SOP before December 15, 2007. The Company did not early adopt
SOP 07-1. Consequently, the standard is expected to have no impact on the
Company's results of operations or financial position.
FASB STAFF POSITION NO. FIN 39-1, AMENDMENT OF FASB INTERPRETATION NO. 39 ("FSP
FIN 39-1")
In April 2007, the FASB issued FSP FIN 39-1, which amends FASB
Interpretation No. 39, "Offsetting of Amounts Related to Certain Contracts". FSP
FIN 39-1 replaces the terms "conditional contracts" and "exchange contracts"
with the term "derivative instruments" and requires a reporting entity to offset
fair value amounts recognized for the right to reclaim cash collateral or the
obligation to return cash collateral against fair value
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
amounts recognized for derivative instruments executed with the same
counterparty under the same master netting arrangement that have been offset in
the statement of financial position. FSP FIN 39-1 is effective for fiscal years
beginning after November 15, 2007, with early adoption permitted. The effects of
applying FSP FIN 39-1, if any, are to be recorded as a change in accounting
principle through retrospective application unless such application is
determined to be impractical. The adoption of FSP FIN 39-1 is not expected to
have a material impact on the Company's results of operations or financial
position based on the current level of derivative activity.
3. DISPOSITIONS
VARIABLE ANNUITY BUSINESS
On June 1, 2006, in accordance with the terms of the definitive Master
Transaction Agreement and related agreements (collectively the "Agreement")
ALIC, its subsidiary, Allstate Life Insurance Company of New York ("ALNY"), and
the Corporation completed the disposal through reinsurance of substantially all
of our variable annuity business to Prudential Financial, Inc. and its
subsidiary, The Prudential Insurance Company of America (collectively
"Prudential"). For Allstate, this disposal achieved the economic benefit of
transferring to Prudential the future rights and obligations associated with
this business.
The disposal was effected through reinsurance agreements (the "Reinsurance
Agreements") which include both coinsurance and modified coinsurance provisions.
Coinsurance and modified coinsurance provisions are commonly used in the
reinsurance of variable annuities because variable annuities generally include
both separate account and general account liabilities. When contractholders make
a variable annuity deposit, they must choose how to allocate their account
balances between a selection of variable-return mutual funds that must be held
in a separate account and fixed-return funds held in the Company's general
account. In addition, variable annuity contracts include various benefit
guarantees that are general account obligations of the Company. The Reinsurance
Agreements do not extinguish the Company's primary liability under the variable
annuity contracts.
Variable annuity balances invested in variable-return mutual funds are held
in separate accounts, which are legally segregated assets and available only to
settle separate account contract obligations. Because the separate account
assets must remain with the Company under insurance regulations, modified
coinsurance is typically used when parties wish to transfer future economic
benefits of such business. Under the modified coinsurance provisions, the
separate account assets remain on the Company's Consolidated Statements of
Financial Position, but the related results of operations are fully reinsured
and presented net of reinsurance on the Consolidated Statements of Operations
and Comprehensive Income.
The coinsurance provisions of the Reinsurance Agreements were used to
transfer the future rights and obligations related to fixed return fund options
and benefit guarantees. $1.37 billion of assets supporting general account
liabilities have been transferred to Prudential, net of consideration, under the
coinsurance reinsurance provisions as of the transaction closing date. General
account liabilities of $1.26 billion and $1.49 billion as of December 31, 2007
and 2006 respectively, however, remain on the Consolidated Statements of
Financial Position with a corresponding reinsurance recoverable.
For purposes of presentation in the Consolidated Statements of Cash Flows,
the Company treated the reinsurance of substantially all our variable annuity
business to Prudential as a disposition of operations, consistent with the
substance of the transaction which was the disposition of a block of business
accomplished through reinsurance. Accordingly, the net consideration transferred
to Prudential of $744 million (computed as $1.37 billion of general account
insurance liabilities transferred to Prudential on the closing date less
consideration of $628 million), the cost of hedging the ceding commission
received from Prudential of $69 million, pre-tax, and the costs of executing the
transaction of $13 million, pre-tax, were classified as a disposition of
operations in the cash flows from investing activities section of the
Consolidated Statements of Cash Flows.
Under the Agreement, the Company has indemnified Prudential for certain
pre-closing contingent liabilities (including extra-contractual liabilities of
the Company and liabilities specifically excluded from the transaction) that the
Company has agreed to retain. In addition, the Company will indemnify Prudential
for certain post-closing liabilities that may arise from the acts of the Company
and its agents, including in connection with the Company's provision of
transition services. The Reinsurance Agreements contain no limits or
indemnifications with regard to insurance risk transfer, and transferred all of
the future risks and responsibilities for performance on the underlying variable
annuity contracts to Prudential, including those related to benefit guarantees,
in accordance with the provisions of SFAS No. 113, "Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts".
68
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The terms of the Agreement give Prudential the right to be the exclusive
provider of its variable annuity products through the Allstate proprietary
agency force for three years and a non-exclusive preferred provider for the
following two years. During a transition period, the Company will continue to
issue new variable annuity contracts, accept additional deposits on existing
business from existing contractholders on behalf of Prudential and, for a period
of twenty-four months or less from the effective date of the transaction,
service the reinsured business while Prudential prepares for the migration of
the business onto its servicing platform.
Pursuant to the Agreement, the final market-adjusted consideration was $628
million. The disposal resulted in a gain of $83 million pre-tax for ALIC, which
was deferred as a result of the disposition being executed through reinsurance.
The deferred gain is included as a component of other liabilities and accrued
expenses on the Consolidated Statements of Financial Position, and is amortized
to gain (loss) on dispositions of operations on the Consolidated Statements of
Operations and Comprehensive Income over the life of the reinsured business
which is estimated to be approximately 18 years. For ALNY, the transaction
resulted in a loss of $9 million pre-tax. ALNY's reinsurance loss and other
amounts related to the disposal of the business, including the initial costs and
final market value settlements of the derivatives acquired by ALIC to
economically hedge substantially all of the exposure related to market
adjustments between the effective date of the Agreement and the closing of the
transaction, transactional expenses incurred and amortization of ALIC's deferred
reinsurance gain, were included as a component of gain (loss) on disposition of
operations on the Consolidated Statements of Operations and Comprehensive Income
amounted to $6 million and $(61) million, after-tax during 2007 and 2006,
respectively. Gain (loss) on disposition of operations on the Consolidated
Statement of Operations and Comprehensive Income included amortization of ALIC's
deferred gain, after-tax, of $5 million and $1 million for the years ended
December 31, 2007 and 2006, respectively. DAC and DSI were reduced by $726
million and $70 million, respectively, as of the effective date of the
transaction for balances related to the variable annuity business subject to the
Reinsurance Agreements.
The separate account balances related to the modified coinsurance
reinsurance were $13.76 billion and $15.07 billion as of December 31, 2007 and
2006, respectively. Separate account balances totaling approximately $1.17
billion and $1.10 billion at December 31, 2007 and 2006, respectively, related
primarily to the variable life business that is being retained by the Company,
and the variable annuity business in three affiliated companies that were not
included in the Agreement. In the five-months of 2006, prior to this
disposition, the Company's variable annuity business generated approximately
$127 million in contract charges, and $278 million in 2005.
4. SUPPLEMENTAL CASH FLOW INFORMATION
Non-cash investment exchanges and modifications, which primarily reflect
refinancings of fixed income securities and mergers completed with equity
securities, totaled $72 million, $39 million and $51 million for the years ended
December 31, 2007, 2006 and 2005, respectively.
Liabilities for collateral received in conjunction with the Company's
securities lending and other business activities and for funds received from the
Company's security repurchase business activities were $1.82 billion, $2.29
billion and $2.23 billion at December 31, 2007, 2006 and 2005, respectively, and
are reported in other liabilities and accrued expenses in the Consolidated
Statements of Financial Position. The accompanying cash flows are included in
cash flows from operating activities in the Consolidated Statements of Cash
Flows along with the activities resulting from management of the proceeds, which
for the years ended December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
NET CHANGE IN PROCEEDS MANAGED
Net change in fixed income securities $ 34 $ 96 $ (221)
Net change in short-term investments 443 (159) 918
----------- ----------- -----------
Operating cash flow provided (used) $ 477 $ (63) $ 697
=========== =========== ===========
NET CHANGE IN LIABILITIES
Liabilities for collateral and security repurchase,
beginning of year $ (2,294) $ (2,231) $ (2,928)
Liabilities for collateral and security repurchase, end of year (1,817) (2,294) (2,231)
----------- ----------- -----------
Operating cash flow (used) provided $ (477) $ 63 $ (697)
=========== =========== ===========
</Table>
69
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. RELATED PARTY TRANSACTIONS
BUSINESS OPERATIONS
The Company uses services performed by its affiliates, AIC and Allstate
Investments LLC, and business facilities owned or leased and operated by AIC in
conducting its business activities. In addition, the Company shares the services
of employees with AIC. The Company reimburses its affiliates for the operating
expenses incurred on behalf of the Company. The Company is charged for the cost
of these operating expenses based on the level of services provided. Operating
expenses, including compensation, retirement and other benefit programs
allocated to the Company (see Note 15), were $477 million, $494 million and $410
million in 2007, 2006 and 2005, respectively. A portion of these expenses relate
to the acquisition of business, which are deferred and amortized into income as
described in Note 2.
STRUCTURED SETTLEMENT ANNUITIES
The Company issued $74 million, $72 million and $235 million of structured
settlement annuities, a type of immediate annuity, in 2007, 2006 and 2005,
respectively, at prices determined using interest rates in effect at the time of
purchase, to fund structured settlements in matters involving AIC. Of these
amounts, $11 million, $10 million and $9 million relate to structured settlement
annuities with life contingencies and are included in premium income for 2007,
2006 and 2005, respectively.
In most cases, these annuities were issued under a "qualified assignment"
whereby prior to July 1, 2001 Allstate Settlement Corporation ("ASC"), and on
and subsequent to July 1, 2001 Allstate Assignment Corporation ("AAC"), both
wholly owned subsidiaries of ALIC, purchased annuities from ALIC and assumed
AIC's obligation to make future payments.
AIC issued surety bonds to guarantee the payment of structured settlement
benefits assumed by ASC (from both AIC and non-related parties) and funded by
certain annuity contracts issued by the Company through June 30, 2001. ASC
entered into a General Indemnity Agreement pursuant to which it indemnified AIC
for any liabilities associated with the surety bonds and gave AIC certain
collateral security rights with respect to the annuities and certain other
rights in the event of any defaults covered by the surety bonds. For contracts
written on or after July 1, 2001, AIC no longer issues surety bonds to guarantee
the payment of structured settlement benefits.
Alternatively, ALIC guarantees the payment of structured settlement
benefits on all contracts issued on or after July 1, 2001. Reserves recorded by
the Company for annuities that are guaranteed by the surety bonds of AIC were
$4.89 billion and $4.92 billion at December 31, 2007 and 2006, respectively.
BROKER-DEALER AGREEMENT
The Company receives distribution services from Allstate Financial
Services, LLC ("AFS"), an affiliated broker-dealer company, for certain variable
annuity and variable life insurance contracts sold by Allstate exclusive
agencies. For these services, the Company incurred $27 million, $44 million and
$46 million of commission and other distribution expenses for the years ending
December 31, 2007, 2006 and 2005, respectively.
REINSURANCE TRANSACTIONS
In 2005, the Company received fixed income securities with a fair value and
amortized cost of $381 million and $358 million, respectively, and $5 million of
accrued investment income for the settlement of a $386 million premium
receivable due from American Heritage Life Insurance Company ("AHL"), an
unconsolidated affiliate of the Company. The receivable related to two
coinsurance agreements entered into in 2004 whereby the Company assumed certain
interest-sensitive life insurance and fixed annuity contracts from AHL. Since
the transaction was between affiliates under common control, the securities were
recorded at amortized cost as of the date of settlement. The difference between
the amortized cost and fair value of the securities, which increased accumulated
other comprehensive income by $23 million, was recorded as a non-cash dividend
of $23 million ($15 million, after-tax). Thus, the net effect on shareholder's
equity was zero. Since the Company received assets in excess of net liabilities
from an affiliate under common control, the Company recognized a gain of $47
million ($31 million, after-tax), which was recorded as a non-cash capital
contribution. In accordance with the coinsurance agreements, for 2007, 2006 and
2005, the Company assumed premiums and contract charges of $16 million, $16
million and $17 million, respectively; contract benefits of $10 million, $11
million and $10 million, respectively; and interest credited to contractholder
funds of $13 million, $24 million and $32 million, respectively.
ALIC enters into certain intercompany reinsurance transactions with its
wholly owned subsidiaries. ALIC enters into these transactions in order to
maintain underwriting control and spread risk among various legal entities.
These reinsurance agreements have been approved by the appropriate regulatory
authorities. All significant intercompany
70
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
transactions have been eliminated in consolidation.
INCOME TAXES
The Company is a party to a federal income tax allocation agreement with
the Corporation (see Note 12).
DEBT
Effective January 1, 2008, the Company and AIC entered into a one-year
intercompany Liquidity Agreement ("Liquidity Agreement") which allows for
short-term advances of funds to be made between parties for liquidity and other
general corporate purposes. It shall be automatically renewed for subsequent
one-year terms unless terminated by the parties. The Liquidity Agreement does
not establish a commitment to advance funds on the part of either party. Both
parties may make or receive advances. The maximum amount of advances each party
may make or receive is limited to $1 billion. Netting or offsetting of advances
made and received is not permitted. Advances between the parties are required to
have specified due dates less than or equal to 364 days from the date of the
advance and be payable upon demand by written request from the lender at least
ten business days prior to the demand date. The borrower may make prepayments of
the outstanding principle balance of an advance without penalty. Advances will
bear interest equal to or greater than the rate applicable to 30-day commercial
paper issued by the Corporation on the date the advance is made with an
adjustment on the first day of each month thereafter.
On December 27, 2006, the Company issued an intercompany note in the amount
of $500 million payable to its parent, AIC, on demand and, in any event, by
March 30, 2007. This note was fully repaid in the first quarter of 2007. This
note had an interest rate of 5.25% and was reflected as note payable to parent
on the Company's Consolidated Statements of Financial Position at December 31,
2006. Interest expense on this note, which totaled $5 million in 2007, is
included as a component of operating costs and expenses on the Condensed
Consolidated Statements of Operations and Comprehensive Income.
On June 30, 2006, under an existing agreement with Kennett Capital, Inc.
("Kennett"), an unconsolidated affiliate of ALIC, ALIC sold Kennett a $100
million redeemable surplus note issued by ALIC Reinsurance Company ("ALIC Re"),
a wholly owned subsidiary of ALIC. The surplus note is due June 1, 2036 with an
initial rate of 6.18% that will reset every ten years to the then current ten
year Constant Maturity Treasury yield ("CMT"), plus 1.14%. As payment, Kennett
issued a full recourse note due June 1, 2036 to ALIC for the same amount with an
initial interest rate of 5.98% that will reset every ten years to the then
current ten year CMT, plus 0.94%. The note due from Kennett is classified as
other investments and the related surplus note is classified as long-term debt
in the Consolidated Statements of Financial Position. In 2007 and 2006, the
Company incurred $6 million and $4 million, respectively, of interest expense
related to this surplus note, which is reflected as a component of operating
costs and expenses on the Consolidated Statements of Operations and
Comprehensive Income.
On August 1, 2005, ALIC entered into an agreement with Kennett, whereby
ALIC sold to Kennett a $100 million 5.06% surplus note due July 1, 2035 issued
by ALIC Re. As payment, Kennett issued a full recourse 4.86% note due July 1,
2035 to ALIC for the same amount. As security for the performance of Kennett's
obligations under the agreement and note, Kennett granted ALIC a pledge of and
security interest in Kennett's right, title and interest in the surplus notes
and their proceeds. Under the terms of the agreement, ALIC may sell and Kennett
may choose to buy additional surplus notes, if and when additional surplus notes
are issued. The note due from Kennett is classified as other investments and the
related surplus notes are classified as long-term debt in the Consolidated
Statements of Financial Position (see Note 13). In 2007, 2006 and 2005, the
Company incurred $5 million, $5 million and $2 million, respectively, of
interest expense related to this surplus note, which is reflected as a component
of operating costs and expenses on the Consolidated Statements of Operations and
Comprehensive Income.
As of December 31, 2006, the Company's Consolidated Statements of Financial
Position included redeemable preferred stock - Series A ("redeemable preferred
stock") issued to Northbook Holdings, LLC, a wholly owned subsidiary of AIC. The
Company's Board of Directors declared and paid cash dividends on the redeemable
preferred stock from time to time, but not more frequently than quarterly. The
dividends were based on the three-month LIBOR rate. Dividends of $1 million and
$2 million were incurred and paid during 2006 and 2005, respectively, and
included as a component of operating costs and expenses on the Consolidated
Statements of Operations and Comprehensive Income. At December 31, 2006,
redeemable preferred stock totaling $6 million, was classified as mandatorily
71
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
redeemable and therefore was included as a component of long-term debt on the
Consolidated Statements of Financial Position. During 2006, $26 million of
mandatorily redeemable preferred stock was redeemed. In addition to the portion
of the redeemable preferred stock that was classified as mandatorily redeemable,
redeemable preferred stock totaling $5 million was included as a component of
shareholder's equity on the Consolidated Statements of Financial Position as of
December 31, 2006. All remaining redeemable preferred stock, including the
portion classified as mandatorily redeemable and included as a component of
long-term debt and the portion classified as shareholder's equity as of December
31, 2006, was redeemed in 2007.
The Company has an intercompany loan agreement with the Corporation. The
amount of intercompany loans available to the Company is at the discretion of
the Corporation. The maximum amount of loans the Corporation will have
outstanding to all its eligible subsidiaries at any given point in time is
limited to $1.00 billion. The Company had no amounts outstanding under the
intercompany loan agreement at December 31, 2007 and 2006. The Corporation uses
commercial paper borrowings, bank lines of credit and repurchase agreements to
fund intercompany borrowings.
CAPITAL SUPPORT AGREEMENT
The Company and AIC entered into a Capital Support Agreement effective
December 14, 2007. Under the terms of this agreement, AIC agrees to provide
capital to maintain the amount of statutory capital and surplus necessary to
maintain a company action level risk-based capital ("RBC") ratio of at least
150%. AIC's obligation to provide capital to the Company is limited to an
aggregate amount of $1 billion. In exchange for providing this capital, the
Company will pay AIC an annual commitment fee of 1% of the amount of the Capital
and Surplus Maximum that remains available on January 1 of such year. The
Company or AIC have the right to terminate this agreement when: 1) the Company
qualifies for a financial strength rating from Standard and Poor's, Moody's or
A.M. Best, without giving weight to the existence of this agreement, that is the
same or better than its rating with such support; or 2) our company action level
RBC ratio is at least 300% or 3) AIC no longer directly or indirectly owns at
least 50% of the voting stock of the Company. At December 31, 2007, no capital
had been provided by AIC under this agreement.
6. INVESTMENTS
FAIR VALUES
The amortized cost, gross unrealized gains and losses, and fair value for
fixed income securities are as follows:
<Table>
<Caption>
GROSS UNREALIZED
($ IN MILLIONS) AMORTIZED ------------------------ FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
AT DECEMBER 31, 2007
U.S. government and agencies $ 2,848 $ 880 $ - $ 3,728
Municipal 4,235 115 (39) 4,311
Corporate 31,624 757 (646) 31,735
Foreign government 1,814 374 (3) 2,185
Mortgage-backed securities 3,499 37 (46) 3,490
Commercial mortgage-backed securities 7,698 76 (386) 7,388
Asset-backed securities 6,273 20 (690) 5,603
Redeemable preferred stock 29 1 (1) 29
----------- ----------- ----------- -----------
Total fixed income securities $ 58,020 $ 2,260 $ (1,811) $ 58,469
=========== =========== =========== ===========
AT DECEMBER 31, 2006
U.S. government and agencies $ 2,763 $ 736 $ (3) $ 3,496
Municipal 4,732 101 (43) 4,790
Corporate 32,841 811 (325) 33,327
Foreign government 1,709 317 (3) 2,023
Mortgage-backed securities 4,543 31 (56) 4,518
Commercial mortgage-backed securities 7,597 64 (61) 7,600
Asset-backed securities 5,663 34 (16) 5,681
Redeemable preferred stock 21 1 - 22
----------- ----------- ----------- -----------
Total fixed income securities $ 59,869 $ 2,095 $ (507) $ 61,457
=========== =========== =========== ===========
</Table>
72
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SCHEDULED MATURITIES
The scheduled maturities for fixed income securities are as follows at
December 31, 2007:
<Table>
<Caption>
AMORTIZED FAIR
($ IN MILLIONS) COST VALUE
----------- -----------
Due in one year or less $ 1,645 $ 1,647
Due after one year through five years 11,211 11,389
Due after five years through ten years 13,164 13,603
Due after ten years 22,228 22,737
----------- -----------
48,248 49,376
Mortgage- and asset-backed securities 9,772 9,093
----------- -----------
Total $ 58,020 $ 58,469
=========== ===========
</Table>
Actual maturities may differ from those scheduled as a result of
prepayments by the issuers. Because of the potential for prepayment on mortgage-
and asset-backed securities, they are not categorized by contractual maturity.
The commercial mortgage-backed securities are categorized by contractual
maturity because they generally are not subject to prepayment risk.
NET INVESTMENT INCOME
Net investment income for the years ended December 31 is as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
Fixed income securities $ 3,589 $ 3,505 $ 3,318
Mortgage loans 552 508 469
Equity securities 4 2 --
Limited partnership interests 87 42 37
Other 243 257 78
----------- ----------- -----------
Investment income, before expense 4,475 4,314 3,902
Investment expense 270 257 195
----------- ----------- -----------
Net investment income $ 4,205 $ 4,057 $ 3,707
=========== =========== ===========
</Table>
REALIZED CAPITAL GAINS AND LOSSES, AFTER-TAX
Realized capital gains and losses by security type for the years ended
December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
Fixed income securities $ (172) $ (157) $ 29
Equity securities 6 2 7
Limited partnership interests 34 2 --
Derivatives (57) 31 (45)
Other investments (8) 43 28
----------- ----------- -----------
Realized capital gains and losses, pre-tax (197) (79) 19
Income tax benefit (expense) 69 28 (7)
----------- ----------- -----------
Realized capital gains and losses, after-tax $ (128) $ (51) $ 12
=========== =========== ===========
</Table>
73
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Realized capital gains and losses by transaction type for the years ended
December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
Write-downs $ (118) $ (21) $ (24)
Dispositions (1) (22) (89) 88
Valuation of derivative instruments (63) (17) (105)
Settlement of derivative instruments 6 48 60
----------- ----------- -----------
Realized capital gains and losses, pre-tax (197) (79) 19
Income tax benefit (expense) 69 28 (7)
----------- ----------- -----------
Realized capital gains and losses, after-tax $ (128) $ (51) $ 12
=========== =========== ===========
</Table>
- ----------
(1) Dispositions include sales, losses recognized in anticipation of
dispositions and other transactions such as calls and prepayments. The
Company recognized losses of $92 million, $60 million and $67 million
in 2007, 2006 and 2005, respectively, due to changes in intent to hold
impaired securities.
Gross gains of $131 million, $102 million and $197 million and gross losses
of $186 million, $231 million and $131 million were realized on sales of fixed
income securities during 2007, 2006 and 2005, respectively.
UNREALIZED NET CAPITAL GAINS AND LOSSES
Unrealized net capital gains and losses included in accumulated other
comprehensive income are as follows:
<Table>
<Caption>
GROSS UNREALIZED
($ IN MILLIONS) FAIR ----------------------- UNREALIZED NET
AT DECEMBER 31, 2007 VALUE GAINS LOSSES GAINS (LOSSES)
----------- ----------- ----------- ----------------
Fixed income securities $ 58,469 $ 2,260 $ (1,811) $ 449
Equity securities 102 5 (5) --
Derivative instruments (1) (32) -- (32) (32)
---------------
Total 417
Amount recognized for: (2)
Premium deficiency reserve (1,059)
Deferred policy acquisition and sales inducement costs 513
---------------
Total (546)
Deferred income taxes 45
---------------
Unrealized net capital gains and losses $ (84)
===============
</Table>
(1) Included in the fair value of derivatives are $(9) million classified as
assets and $23 million classified as liabilities.
(2) See Note 2, for Deferred policy acquisition and sales inducement costs and
Reserve for life-contingent contract benefits.
<Table>
<Caption>
GROSS UNREALIZED
($ IN MILLIONS) FAIR ----------------------- UNREALIZED NET
AT DECEMBER 31, 2006 VALUE GAINS LOSSES GAINS (LOSSES)
----------- ----------- ----------- -----------------
Fixed income securities $ 61,457 $ 2,095 $ (507) $ 1,588
Equity securities 72 11 -- 11
Derivative instruments (1) (16) 2 (18) (16)
----------------
Total 1,583
Amount recognized for: (2)
Premium deficiency reserve (1,129)
Deferred policy acquisition and sales inducement costs 46
----------------
Total (1,083)
Deferred income taxes (175)
----------------
Unrealized net capital gains and losses $ 325
----------------
</Table>
(1) Included in the fair value of derivatives are $(7) million classified as
assets and $9 million classified as liabilities.
(2) See Note 2, for Deferred policy acquisition and sales inducement costs and
Reserve for life-contingent contract benefits.
74
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CHANGE IN UNREALIZED NET CAPITAL GAINS AND LOSSES
The change in unrealized net capital gains and losses for the years ended
December 31 is as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
----------- ----------- -----------
Fixed income securities $ (1,139) $ (672) $ (1,067)
Equity securities (11) 6 (4)
Derivative instruments (16) (10) 17
----------- ----------- -----------
Total (1,166) (676) (1,054)
Amounts recognized for:
Premium deficiency reserve 70 214 (254)
Deferred policy acquisition and sales inducement costs 467 58 653
----------- ----------- -----------
Total 537 272 399
Deferred income taxes 220 141 230
----------- ----------- -----------
Decrease in unrealized net capital gains and losses $ (409) $ (263) $ (425)
=========== =========== ===========
</Table>
PORTFOLIO MONITORING
Inherent in the Company's evaluation of a particular security are
assumptions and estimates about the operations of the issuer and its future
earnings potential. Some of the factors considered in evaluating whether a
decline in fair value is other-than-temporary are: 1) the Company's ability and
intent to retain the investment for a period of time sufficient to allow for an
anticipated recovery in value; 2) the recoverability of principal and interest;
3) the length of time and extent to which the fair value has been less than
amortized cost for fixed income securities, or cost for equity securities; 4)
the financial condition, near-term and long-term prospects of the issue or
issuer, including relevant industry conditions and trends, and implications of
rating agency actions and offering prices; and 5) the specific reasons that a
security is in a significant unrealized loss position, including market
conditions which could affect access to liquidity.
75
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the gross unrealized losses and fair value
of fixed income and equity securities by the length of time that individual
securities have been in a continuous unrealized loss position.
<Table>
<Caption>
($ IN MILLIONS) LESS THAN 12 MONTHS 12 MONTHS OR MORE
---------------------------------- ---------------------------------- TOTAL
NUMBER FAIR UNREALIZED NUMBER FAIR UNREALIZED UNREALIZED
AT DECEMBER 31, 2007 OF ISSUES VALUE LOSSES OF ISSUES VALUE LOSSES LOSSES
---------- ---------- ---------- ---------- ---------- ---------- ----------
Fixed income securities
U.S. government and agencies -- $ -- $ -- 1 $ 3 $ -- $ --
Municipal 132 826 (30) 24 134 (9) (39)
Corporate 812 9,437 (474) 322 3,744 (172) (646)
Foreign government 19 167 (3) 1 1 -- (3)
Mortgage-backed securities 122 1,145 (31) 433 686 (15) (46)
Commercial mortgage-backed securities 306 3,074 (345) 133 1,137 (41) (386)
Asset-backed securities 438 4,307 (648) 60 510 (42) (690)
Redeemable preferred stock 1 13 (1) -- -- -- (1)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total fixed income securities 1,830 18,969 (1,532) 974 6,215 (279) (1,811)
Equity securities 9 64 (5) -- -- -- (5)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total fixed income & equity securities 1,839 $ 19,033 $ (1,537) 974 $ 6,215 $ (279) $ (1,816)
=========== =========== =========== =========== =========== =========== ===========
Investment grade fixed income securities 1,629 $ 17,675 $ (1,396) 930 $ 5,885 $ (247) $ (1,643)
Below investment grade fixed income securities 201 1,294 (136) 44 330 (32) (168)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total fixed income securities 1,830 $ 18,969 $ (1,532) 974 $ 6,215 $ (279) $ (1,811)
=========== =========== =========== =========== =========== =========== ===========
AT DECEMBER 31, 2006
Fixed income securities
U.S. government and agencies 11 $ 177 $ (1) 12 $ 87 $ (2) $ (3)
Municipal 184 1,018 (20) 143 558 (23) (43)
Corporate 477 6,114 (80) 607 7,665 (245) (325)
Foreign government 7 40 (1) 8 113 (2) (3)
Mortgage-backed securities 232 753 (6) 722 1,933 (50) (56)
Commercial mortgage-backed securities 131 1,624 (10) 224 2,272 (51) (61)
Asset-backed securities 100 881 (5) 59 523 (11) (16)
Redeemable preferred stock 1 7 -- -- -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total fixed income securities 1,143 10,614 (123) 1,775 13,151 (384) (507)
Equity securities -- -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total fixed income & equity securities 1,143 $ 10,614 $ (123) 1,775 $ 13,151 $ (384) $ (507)
=========== =========== =========== =========== =========== =========== ===========
Investment grade fixed income securities 1,081 $ 10,169 $ (113) 1,723 $ 12,804 $ (368) $ (481)
Below investment grade fixed income securities 62 445 (10) 52 347 (16) (26)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total fixed income securities 1,143 $ 10,614 $ (123) 1,775 $ 13,151 $ (384) $ (507)
=========== =========== =========== =========== =========== =========== ===========
</Table>
As of December 31, 2007, $1.24 billion of unrealized losses are related to
securities with an unrealized loss position less than 20% of cost or amortized
cost, the degree of which suggests that these securities do not pose a high risk
of being other-than-temporarily impaired. Of the $1.24 billion, $1.13 billion
are related to unrealized losses on investment grade fixed income securities.
Investment grade is defined as a security having a rating from the National
Association of Insurance Commissioners ("NAIC") of 1 or 2; a rating of Aaa, Aa,
A or Baa from Moody's or a rating of AAA, AA, A or BBB from Standard & Poor's
("S&P"), Fitch or Dominion; or aaa, aa, a or bbb from A.M. Best; or a comparable
internal rating if an externally provided rating is not available. Unrealized
losses on investment grade securities are principally related to rising interest
rates or changes in credit spreads since the securities were acquired.
As of December 31, 2007, the remaining $576 million of unrealized losses
are related to securities in unrealized loss positions greater than or equal to
20% of cost or amortized cost. Of the $576 million, $62 million are related to
below investment grade fixed income securities. Of these amounts, none of the
equity securities or below investment grade fixed income securities had been in
an unrealized loss position for a period of twelve or more consecutive months as
of December 31, 2007. The Company expects eventual recovery of these securities.
Every security was included in our portfolio monitoring process.
The securities comprising the $576 million of unrealized losses were
evaluated based on factors such as the financial condition and near-term and
long-term prospects of the issuer and were determined to have adequate resources
to fulfill contractual obligations, such as recent financings or bank loans,
cash flows from operations, collateral or the position of a subsidiary with
respect to its parent's bankruptcy.
76
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unrealized losses on mortgage-backed, asset-backed and commercial
mortgage-backed holdings were evaluated based on credit ratings, as well as the
performance of the underlying collateral relative to the securities' positions
in the securities' respective capital structure. The unrealized losses on
municipal bonds and asset-backed securities that had credit enhancements from
bond insurers were evaluated on the quality of the underlying security. These
investments were determined to have adequate resources to fulfill contractual
obligations.
As of December 31, 2007, the Company had the intent and ability to hold the
fixed income and equity securities with unrealized losses for a period of time
sufficient for them to recover.
LIMITED PARTNERSHIP IMPAIRMENT
As of December 31, 2007 and 2006, equity-method limited partnership
investments totaled $485 million and $99 million, respectively. The Company
recognizes a loss in value for equity-method investments when evidence
demonstrates that it is other-than-temporarily impaired. Evidence of a loss in
value that is other-than-temporary may include the absence of an ability to
recover the carrying amount of the investment or the inability of the investee
to sustain an earnings capacity that would justify the carrying amount of the
investment. In 2007, the Company had write-downs of $9 million related to
equity-method limited partnership interests. No write-downs were recognized in
2006.
As of December 31, 2007 and 2006, the carrying value for cost method
limited partnership investments was $509 million and $362 million, respectively,
which primarily included limited partnership interests in fund investments. The
fair value for cost method investments is not readily determinable because the
investments are private in nature and do not trade frequently. Therefore, the
Company evaluates whether an impairment indicator has occurred in the period
that may have a significant adverse effect on the carrying value of the
investment. Impairment indicators may include: actual recent cash flows received
being significantly less than expected cash flows; reduced valuations based on
financing completed at a lower value; completed sale of a material underlying
investment at a price significantly lower than expected; or any other recent
adverse events since the last financial statement received that might affect the
fair value of the investee's capital. Additionally, the Company uses a screening
process to identify those investments whose net asset value is below established
thresholds for certain periods of time, and investments that are performing
below expectations for consideration for inclusion on its watch-list. In 2007,
2006 and 2005, the Company had write-downs of $0.3 million, $0.1 and $0.1
million related to cost method investments that were other-than-temporarily
impaired.
MORTGAGE LOAN IMPAIRMENT
A mortgage loan is impaired when it is probable that the Company will be
unable to collect all amounts due according to the contractual terms of the loan
agreement.
The net carrying value of impaired loans at December 31, 2007 and 2006 was
$2 million and $5 million, respectively. No valuation allowances were held at
December 31, 2007 or 2006 because the fair value of the collateral was greater
than the recorded investment in the loans, and no valuation allowances were
charged to operations during the years 2007, 2006 or 2005.
Interest income for impaired loans is recognized on an accrual basis if
payments are expected to continue to be received; otherwise cash basis is used.
The Company recognized interest income on impaired loans of $0.2 million, $0.4
million and $0.2 million during 2007, 2006 and 2005, respectively. The average
balance of impaired loans was $3 million, $5 million and $6 million during 2007,
2006 and 2005, respectively.
INVESTMENT CONCENTRATION FOR MUNICIPAL BOND AND COMMERCIAL MORTGAGE PORTFOLIOS
The Company maintains a diversified portfolio of municipal bonds. The
following table shows the principal geographic distribution of municipal bond
issuers represented in the Company's portfolio. No other state represents more
than 5% of the portfolio at December 31, 2007 or 2006.
<Table>
<Caption>
(% OF MUNICIPAL BOND PORTFOLIO CARRYING VALUE) 2007 2006
---------- ----------
California 19.7% 20.4%
New York 9.5 10.6
Texas 9.0 5.4
Delaware 8.1 2.2
New Jersey 7.1 7.8
Oregon 5.2 4.6
Pennsylvania 4.1 5.2
</Table>
77
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's mortgage loans are collateralized by a variety of commercial
real estate property types located throughout the United States. Substantially
all of the commercial mortgage loans are non-recourse to the borrower. The
following table shows the principal geographic distribution of commercial real
estate represented in the Company's mortgage portfolio. No other state
represented more than 5% of the portfolio at December 31, 2007 or 2006.
<Table>
<Caption>
(% OF COMMERCIAL MORTGAGE PORTFOLIO CARRYING VALUE) 2007 2006
---------- ----------
California 22.7% 19.3%
Illinois 8.7 9.7
Texas 7.3 7.6
New York 5.7 5.1
Pennsylvania 5.5 5.7
New Jersey 5.5 4.4
</Table>
The types of properties collateralizing the commercial mortgage loans at
December 31 are as follows:
<Table>
<Caption>
(% OF COMMERCIAL MORTGAGE PORTFOLIO CARRYING VALUE) 2007 2006
---------- ----------
Office buildings 35.3% 34.7%
Retail 23.1 25.7
Warehouse 21.3 21.6
Apartment complex 15.8 15.5
Other 4.5 2.5
---------- ----------
Total 100.0% 100.0%
========== ==========
</Table>
The contractual maturities of the commercial mortgage loan portfolio as of
December 31, 2007 for loans that were not in foreclosure are as follows:
<Table>
<Caption>
NUMBER OF CARRYING
($ IN MILLIONS) LOANS VALUE PERCENT
----------- ---------- ----------
2008 52 423 4.3
2009 101 1,046 10.6
2010 94 1,134 11.5
2011 101 1,282 12.9
2012 91 1,082 10.9
Thereafter 488 4,934 49.8
----------- ----------- -----------
Total 927 $ 9,901 100.0%
=========== =========== ===========
</Table>
In 2007, $301 million of commercial mortgage loans were contractually due.
Of these, 85% were paid as due, 14% were refinanced at prevailing market terms
and 1% were extended for less than one year. None were foreclosed or are in the
process of foreclosure, and none were in the process of refinancing or
restructuring discussions.
CONCENTRATION OF CREDIT RISK
At December 31, 2007, the Company is not exposed to any credit
concentration risk of a single issuer and its affiliates greater than 10% of the
Company's shareholder's equity.
SECURITIES LOANED AND SECURITY REPURCHASE AND RESALE
The Company's business activities include securities lending programs with
third parties, mostly large brokerage firms. At December 31, 2007 and 2006,
fixed income and equity securities with a carrying value of $1.70 billion and
$1.74 billion, respectively, were on loan under these agreements. In return, the
Company receives cash that it invests and includes in short-term investments and
fixed income securities, with an offsetting liability recorded in other
liabilities and accrued expenses to account for the Company's obligation to
return the collateral. Interest income on collateral, net of fees, was $11
million, $5 million and $5 million, for the years ended December 31, 2007, 2006
and 2005, respectively.
As part of its business activities, the Company sells securities under
agreements to repurchase and purchases securities under agreements to resell. At
December 31, 2007, the Company had no securities that were subject to repurchase
or resale agreements. At December 31, 2006, the Company had $143 million of
securities that were subject to repurchase agreements and had no securities that
were subject to resale agreements. As part of these programs, the
78
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company receives cash or securities that it invests or holds in short-term or
fixed income securities. For repurchase agreements, an offsetting liability is
recorded in other liabilities and accrued expenses to account for the Company's
obligation to return these funds. Interest income recorded as a result of the
repurchase program was $(11) million, $1 million and $9 million in 2007, 2006
and 2005, respectively.
OTHER INVESTMENT INFORMATION
Included in fixed income securities are below investment grade assets
totaling $2.66 billion and $2.36 billion at December 31, 2007 and 2006,
respectively.
At December 31, 2007, fixed income securities with a carrying value of $60
million were on deposit with regulatory authorities as required by law.
At December 31, 2007, the carrying value of fixed income securities that
were non-income producing was $9 million. No other investments were non-income
producing at December 31, 2007.
7. FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets, incurs various financial liabilities and enters into agreements
involving derivative financial instruments and other off-balance-sheet financial
instruments. The fair value estimates of financial instruments presented below
are not necessarily indicative of the amounts the Company might pay or receive
in actual market transactions. Potential taxes and other transaction costs have
not been considered in estimating fair value. The disclosures that follow do not
reflect the fair value of the Company as a whole since a number of the Company's
significant assets (including DAC and DSI and certain reinsurance recoverables)
and liabilities (including reserve for life-contingent contract benefits,
contractholder funds pertaining to interest-sensitive life contracts and
deferred income taxes) are not included in accordance with SFAS No. 107,
"Disclosures about Fair Value of Financial Instruments". Other assets and
liabilities considered financial instruments such as accrued investment income
and cash are generally of a short-term nature, and as such their carrying values
are deemed to approximate fair value.
FINANCIAL ASSETS
<Table>
<Caption>
($ IN MILLIONS) DECEMBER 31, 2007 DECEMBER 31, 2006
------------------------ -------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
----------- ----------- ----------- -----------
Fixed income securities $ 58,469 $ 58,469 $ 61,457 $ 61,457
Mortgage loans 9,901 9,804 8,690 8,761
Equity securities 102 102 72 72
Limited partnership interests 994 994 461 461
Short-term investments 386 386 805 805
Reinsurance recoverables on
investment contracts 1,429 1,406 1,659 1,620
Policy loans 770 770 752 752
Other investments 1,792 1,792 1,923 1,923
Separate accounts 14,929 14,929 16,174 16,174
</Table>
The fair values of fixed income securities and equity securities are based
upon observable market quotations, observable market data or are derived from
such quotations and observable market data. The fair value of privately placed
fixed income securities is generally based on widely accepted pricing valuation
models, which are developed internally. Mortgage loans are valued based on
discounted contractual cash flows. Discount rates are selected using current
rates at which similar loans would be made to borrowers with similar
characteristics, using similar properties as collateral. Loans that exceed 100%
loan-to-value are valued at the estimated fair value of the underlying
collateral. Short-term investments are highly liquid investments with maturities
of one year or less whose carrying values are deemed to approximate fair value.
The fair value of reinsurance recoverables on investment contracts is based on
the fair value of the underlying fixed and immediate annuity contract account
liabilities, adjusted for credit risk. The carrying value of policy loans and
other investments is deemed to approximate fair value. Separate accounts assets
are carried in the Consolidated Statements of Financial Position at fair value
based on observable market prices.
79
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL LIABILITIES
<Table>
<Caption>
($ IN MILLIONS) DECEMBER 31, 2007 DECEMBER 31, 2006
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
----------- ---------- ---------- ----------
Contractholder funds on investment
contracts $ 51,533 $ 50,184 $ 52,143 $ 50,499
Note payable to parent -- -- 500 500
Long-term debt 200 200 206 206
Liability for collateral and
repurchase agreements 1,817 1,817 2,294 2,294
Separate accounts 14,929 14,929 16,174 16,174
</Table>
Contractholder funds include interest-sensitive life insurance contracts
and investment contracts. Interest-sensitive life insurance contracts are not
considered financial instruments subject to fair value disclosure requirements.
The fair value of investment contracts is based on the terms of the underlying
contracts. Fixed annuities are valued at the account balance less surrender
charges. Immediate annuities without life contingencies and funding agreements
are valued at the present value of future benefits using current interest rates.
The fair value of variable rate funding agreements approximates carrying value.
Market value adjusted annuities' fair value is estimated to be the market
adjusted surrender value. Equity-indexed annuity contracts' fair value
approximates carrying value since the embedded equity options are carried at
fair value in the consolidated financial statements.
The carrying value of the note payable to parent is deemed to approximate
fair value due to the short-term nature of the note. The carrying value of
long-term debt is deemed to approximate fair value. The liability for collateral
and repurchase agreements is valued at carrying value due to its short-term
nature. Separate accounts liabilities are carried at the account values, which
are equal to the carrying value of the corresponding assets.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company primarily uses derivatives for risk reduction and asset
replication. In addition, the Company has derivatives embedded in financial
instruments, which are required to be separated and accounted for as derivative
instruments. With the exception of derivatives used for asset replication and
embedded derivatives which are required to be separated, all of the Company's
derivatives are evaluated for their ongoing effectiveness as either accounting
or non-hedge derivative financial instruments on at least a quarterly basis (see
Note 2). The Company does not use derivatives for trading purposes. Non-hedge
accounting is used for "portfolio" level hedging strategies where the terms of
the individual hedged items do not meet the strict homogeneity requirements
prescribed in SFAS No. 133 to permit the application of SFAS No. 133's hedge
accounting model. The principal benefit of a "portfolio" level strategy is in
its cost savings through its ability to use fewer derivatives with larger
notional amounts.
Asset-liability management is a risk management strategy that is
principally employed to align the respective interest-rate sensitivities of its
assets and liabilities. Depending upon the attributes of the assets acquired and
liabilities issued, derivative instruments such as interest rate swaps, caps and
floors are acquired to change the interest rate characteristics of existing
assets and liabilities to ensure a properly matched relationship is maintained
and to reduce exposure to rising or falling interest rates. The Company uses
financial futures to hedge anticipated asset purchases and liability issuances
and financial futures and options for hedging the Company's equity exposure
contained in equity indexed and variable annuity product contracts that offer
equity returns to contractholders. In addition, the Company also uses interest
rate swaps to hedge interest rate risk inherent in funding agreements and
foreign currency swaps primarily to reduce the foreign currency risk associated
with issuing foreign currency denominated funding agreements.
Asset replication refers to the "synthetic" creation of an asset through
the use of a credit derivative and a high quality cash instrument to replicate
fixed income securities that are either unavailable in the cash bond market or
more economical to acquire in synthetic form. The Company replicates fixed
income securities using a combination of a credit default swap and one or more
highly rated fixed income securities to synthetically replicate the economic
characteristics of one or more cash market securities.
The Company has derivatives that are embedded in non-derivative "host"
contracts. The Company's primary embedded derivatives are conversion options in
fixed income investments, which provide the Company with the right to convert
the instrument into a predetermined number of shares of common stock; equity
options in annuity product contracts, which provide equity returns to
contractholders; and equity-indexed notes containing equity call
80
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
options, which provide a coupon payout based upon one or more indices.
In the tables that follow:
The notional amounts specified in the contracts are used to calculate the
exchange of contractual payments under the agreements and are not representative
of the potential for gain or loss on these agreements.
Fair value, which is equal to the carrying value, is the estimated amount
that the Company would receive (pay) to terminate the derivative contracts at
the reporting date. The fair value of exchange traded derivative contracts is
based on observable market quotations in active markets, whereas the fair value
of non-exchange traded derivative contracts is determined using widely accepted
valuation models and other appropriate valuation methods. For certain exchange
traded derivatives, the exchange requires margin deposits as well as daily cash
settlements of margin accounts. As of December 31, 2007, the Company pledged $19
million of securities in the form of margin deposits.
Carrying value amounts include the fair value of the derivatives, including
the embedded derivatives, and exclude the accrued periodic settlements which are
short term in nature and are reported in accrued investment income or other
invested assets. The carrying value amounts for freestanding derivatives have
been further adjusted for the effects, if any, of legally enforceable master
netting agreements.
The net impact to pre-tax income includes valuation and settlements of
derivatives which are reported in net income as described in Note 2. For those
derivatives which qualify for fair value hedge accounting, it also includes the
changes in the fair value of the hedged risk, and therefore reflects any hedging
ineffectiveness. For cash flow hedges, gains and losses amortized from
accumulated other comprehensive income are included. For embedded derivatives in
convertibles and equity-indexed notes subject to bifurcation, accretion income
related to the host instrument has also been included.
The following table categorizes the accounting hedge (fair value and cash
flow) and non-hedge strategies employed by the Company. The notional amount, the
fair value of the hedge and the impact on pre-tax income have been provided to
illustrate the relative volume, the Company's exposure and the level of
mark-to-market activity, respectively, for the derivative programs as of
December 31.
<Table>
<Caption>
($ IN MILLIONS) 2007 2006
---------------------------------------- ---------------------------------------
FAIR VALUE FAIR VALUE IMPACT TO PRE-TAX INCOME
------------------------------ ----------------------------- -------------------------------
FAIR CASH FAIR CASH
NOTIONAL VALUE FLOW NON- NOTIONAL VALUE FLOW NON-
AMOUNT HEDGE HEDGE HEDGE AMOUNT HEDGE HEDGE HEDGE 2007 2006 2005
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ---------
RISK REDUCTION
Interest Rate
Exposure $ 27,821 $ (288) $ -- $ (10) $ 25,819 $ 24 $ -- $ 43 $ (41) $ (45) $ (161)
Macro hedging 541 -- -- 2 3,425 -- -- 1 (29) 16 (9)
Hedging of
equity
exposure in
annuity
contracts 6,226 -- -- 106 4,722 -- -- 125 15 103 20
Hedging
interest rate
and foreign
currency risk
inherent in
funding
agreements 1,955 402 -- -- 1,948 366 -- -- (17) 13 77
Other 500 2 (32) (6) 470 3 (17) (4) (8) (75) (10)
ASSET REPLICATION 631 -- -- (23) 395 -- -- 2 (19) 4 2
EMBEDDED
DERIVATIVES
Conversion
options in
fixed income
securities 559 -- -- 191 488 -- -- 187 55 51 27
Equity indexed
notes 800 -- -- 422 625 -- -- 305 60 49 19
Annuity
contracts 6,846 -- -- (119) 6,122 -- -- (171) (26) (91) (9)
-------- -------- -------- -------- ------- -------- -------- -------- -------- -------- --------
TOTAL $ 45,879 $ 116 $ (32) $ 563 $ 44,014 $ 393 $ (17) $ 488 $ (10) $ 25 $ (44)
======== ======== ======== ======== ======= ======== ======== ======== ======== ======== ========
</Table>
81
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Derivative instruments are recorded at fair value and presented in the
Consolidated Statements of Financial Position as of December 31, as follows:
<Table>
<Caption>
($ IN MILLIONS) CARRYING VALUE
-----------------------------------------------------------
ASSETS (LIABILITIES)
---------------------------- ---------------------------
2007 2006 2007 2006
------------- ------------- ------------ -----------
Fixed income securities $ 612 $ 492 $ -- $ --
Other investments 444 666 -- --
Other assets 2 3 -- --
Contractholder funds -- -- (119) (171)
Other liabilities and accrued expenses -- -- (292) (126)
------------- ------------- ------------ -----------
Total $ 1,058 $ 1,161 $ (411) $ (297)
============= ============= ============ ===========
</Table>
For cash flow hedges, unrealized net pre-tax losses included in accumulated
other comprehensive income were $(32) million and $(16) million at December 31,
2007 and 2006, respectively. The net pre-tax changes in accumulated other
comprehensive income due to cash flow hedges were $(16) million, $(10) million
and $17 million in 2007, 2006 and 2005, respectively. Amortization to net income
of accumulated other comprehensive income related to cash flow hedges is
expected to be $(2) million in 2008.
The following table summarizes the notional amount, fair value and carrying
value of the Company's derivative financial instruments at December 31, 2007.
<Table>
<Caption>
($ IN MILLIONS) CARRYING VALUE
--------------------------
NOTIONAL FAIR
AMOUNT VALUE ASSETS (LIABILITIES)
----------- ----------- ----------- -------------
INTEREST RATE CONTRACTS
Interest rate swap agreements $ 14,886 $ (297) $ (117) $ (180)
Financial futures contracts 710 2 2 --
Interest rate cap and floor agreements 13,760 5 5 --
----------- ----------- ----------- -----------
Total interest rate contracts 29,356 (290) (110) (180)
EQUITY AND INDEX CONTRACTS
Options, financial futures, and warrants 6,057 106 176 (70)
FOREIGN CURRENCY CONTRACTS
Foreign currency swap agreements 1,493 361 388 (27)
CREDIT DEFAULT SWAPS USED FOR ASSET REPLICATION 631 (23) (10) (13)
EMBEDDED DERIVATIVE FINANCIAL INSTRUMENTS
Guaranteed accumulation benefit 1,592 -- -- --
Guaranteed withdrawal benefit 1,216 -- -- --
Conversion options in fixed income securities 559 190 190 --
Equity-indexed call options in fixed income securities 800 422 422 --
Equity-indexed and forward starting options in life and
annuity product contracts 3,934 (123) -- (123)
Other embedded derivative financial instruments 154 2 -- 2
----------- ----------- ----------- -----------
Total embedded derivative financial instruments 8,255 491 612 (121)
OTHER DERIVATIVE FINANCIAL INSTRUMENTS 87 2 2 --
----------- ----------- ----------- -----------
TOTAL DERIVATIVE FINANCIAL INSTRUMENTS $ 45,879 $ 647 $ 1,058 $ (411)
=========== =========== =========== ===========
</Table>
82
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the notional amount, fair value and carrying
value of the Company's derivative financial instruments at December 31, 2006:
<Table>
<Caption>
($ IN MILLIONS) CARRYING VALUE
-------------------------
NOTIONAL FAIR
AMOUNT VALUE ASSETS (LIABILITIES)
----------- ----------- ----------- ------------
INTEREST RATE CONTRACTS
Interest rate swap agreements $ 14,529 $ 24 $ 30 $ (6)
Financial futures contracts 3,626 1 1 --
Interest rate cap and floor agreements 12,065 27 26 1
----------- ----------- ----------- -----------
Total interest rate contracts 30,220 52 57 (5)
EQUITY AND INDEX CONTRACTS
Options, financial futures, and warrants 4,521 125 233 (108)
FOREIGN CURRENCY CONTRACTS
Foreign currency swap agreements 1,551 362 375 (13)
CREDIT DEFAULT SWAPS USED FOR ASSET REPLICATION 395 2 1 1
EMBEDDED DERIVATIVE FINANCIAL INSTRUMENTS
Guaranteed accumulation benefit 1,608 7 -- 7
Guaranteed withdrawal benefit 1,067 1 -- 1
Conversion options in fixed income securities 488 187 187 --
Equity-indexed call options in fixed income securities 625 305 305 --
Equity-indexed and forward starting options in life and
annuity product contracts 3,343 (189) -- (189)
Other embedded derivative financial instruments 104 10 -- 10
----------- ----------- ----------- -----------
Total embedded derivative financial instruments 7,235 321 492 (171)
OTHER DERIVATIVE FINANCIAL INSTRUMENTS 92 2 3 (1)
----------- ----------- ----------- -----------
TOTAL DERIVATIVE FINANCIAL INSTRUMENTS $ 44,014 $ 864 $ 1,161 $ (297)
=========== =========== =========== ===========
</Table>
The Company manages its exposure to credit risk by utilizing highly rated
counterparties, establishing risk control limits, executing legally enforceable
master netting agreements and obtaining collateral where appropriate. The
Company uses master netting agreements for over-the-counter derivative
transactions, including interest rate swap, foreign currency swap, interest rate
cap, interest rate floor, credit default swap and certain option agreements.
These agreements permit either party to net payments due for transactions
covered by the agreements. Under the provisions of the agreements, collateral is
either pledged or obtained when certain predetermined exposure limits are
exceeded. As of December 31, 2007, counterparties pledged cash of $72 million
and securities of $226 million to the Company and the Company pledged $1 million
of cash and $107 million in securities to counterparties. The Company has not
incurred any losses on derivative financial instruments due to counterparty
nonperformance. Other derivatives including futures and certain option contracts
are traded on organized exchanges, which require margin deposits and guarantee
the execution of trades, thereby mitigating any associated potential credit
risk.
Credit exposure represents the Company's potential loss if all of the
counterparties concurrently fail to perform under the contractual terms of the
contracts and all collateral, if any, becomes worthless. This exposure is
measured by the fair value of freestanding derivative contracts with a positive
fair value at the reporting date reduced by the effect, if any, of legally
enforceable master netting agreements.
83
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the counterparty credit exposure by
counterparty credit rating at December 31, as it relates to interest rate swap,
foreign currency swap, interest rate cap, interest rate floor, credit default
swap and certain option agreements.
<Table>
<Caption>
($ IN MILLIONS) 2007 2006
---------------------------------------------------- -------------------------------------------------------
NUMBER OF EXPOSURE, NUMBER OF EXPOSURE,
COUNTER- NOTIONAL CREDIT NET OF COUNTER- NOTIONAL CREDIT NET OF
RATING (1) PARTIES AMOUNT EXPOSURE (2) COLLATERAL (2) PARTIES AMOUNT EXPOSURE (2) COLLATERAL (2)
- ------------ ---------- ---------- ------------- -------------- ------------ --------- ------------ ---------------
AAA 1 $ 228 $ -- $ -- 1 $ 457 $ 10 $ 10
AA+ 1 2,016 3 3 -- -- -- --
AA 7 11,652 65 8 5 8,124 137 32
AA- 4 5,532 11 1 6 7,484 201 21
A+ 3 11,398 187 -- 3 12,494 86 20
---------- ---------- ------------- -------------- ------------ --------- ------------ --------------
Total 16 $ 30,826 $ 266 $ 12 15 $ 28,559 $ 434 $ 83
========== ========== ============= ============== ============ ========= ============ ==============
</Table>
- ----------
(1) Rating is the lower of S&P's or Moody's ratings.
(2) Only over-the-counter derivatives with a net positive fair value are
included for each counterparty.
Market risk is the risk that the Company will incur losses due to adverse
changes in market rates and prices. Market risk exists for all of the derivative
financial instruments the Company currently holds, as these instruments may
become less valuable due to adverse changes in market conditions. To limit this
risk, the Company's senior management has established risk control limits. In
addition, changes in fair value of the derivative financial instruments that the
Company uses for risk management purposes are generally offset by the change in
the fair value or cash flows of the hedged risk component of the related assets,
liabilities or forecasted transactions.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND UNCONSOLIDATED INVESTMENT VIES
The contractual amounts and fair values of off-balance-sheet financial
instruments at December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006
--------------------------- ---------------------------
CONTRACTUAL FAIR CONTRACTUAL FAIR
AMOUNT VALUE AMOUNT VALUE
------------ ------------ ------------ ------------
Commitments to invest in limited
partnership interests $ 1,210 $ -- $ 707 $ --
Private placement commitments 30 -- 112 --
Commitments to extend mortgage loans 326 3 527 5
Liens on investment 16 -- 13 --
</Table>
In the above table, the contractual amounts represent the amount at risk if
the contract is fully drawn upon, the counterparty defaults and the value of any
underlying security becomes worthless. Unless noted otherwise, the Company does
not require collateral or other security to support off-balance-sheet financial
instruments with credit risk.
Commitments to invest generally represent commitments to acquire financial
interests or instruments. The Company enters into these agreements to allow for
additional participation in certain limited partnership investments. Because the
equity investments in the limited partnerships are not actively traded, it is
not practical to estimate the fair value of these commitments.
Private placement commitments represent conditional commitments to purchase
private placement debt and equity securities at a specified future date. The
Company regularly enters into these agreements in the normal course of business.
The fair value of these commitments generally cannot be estimated on the date
the commitment is made as the terms and conditions of the underlying private
placement securities are not yet final.
Commitments to extend mortgage loans are agreements to lend to a borrower
provided there is no violation of any condition established in the contract. The
Company enters into these agreements to commit to future loan fundings at a
predetermined interest rate. Commitments generally have fixed expiration dates
or other termination clauses. Commitments to extend mortgage loans, which are
secured by the underlying properties, are valued based on estimates of fees
charged by other institutions to make similar commitments to similar borrowers.
In 2006, the Company participated in the establishment of an investment
management VIE that holds assets under the management of Allstate Investment
Management Company, an unconsolidated affiliate of the Company, on behalf of
unrelated third party investors. The VIE had assets consisting primarily of
investment securities and cash totaling $401 million and liabilities, primarily
long-term debt, of $378 million at December 31, 2007. The Company does not
consolidate the VIE because it is not the primary beneficiary. The Company's
maximum loss exposure related to its investment in the VIE is the current
carrying value of its investment, which was $13 million at December 31, 2007.
84
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. RESERVES FOR LIFE-CONTINGENT CONTRACT BENEFITS AND CONTRACTHOLDER FUNDS
At December 31, the reserve for life-contingent contract benefits consists
of the following:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006
---------- ----------
Immediate fixed annuities:
Structured settlement annuities $ 7,094 $ 6,950
Other immediate fixed annuities 2,253 2,317
Traditional life insurance 2,397 2,234
Other 854 703
---------- ----------
Total reserve for life-contingent contract benefits $ 12,598 $ 12,204
========== ==========
</Table>
The following table highlights the key assumptions generally used in
calculating the reserve for life-contingent contract benefits:
<Table>
<Caption>
INTEREST ESTIMATION
PRODUCT MORTALITY RATE METHOD
Structured settlement U.S. population with projected Interest rate assumptions Present value of
annuities calendar year improvements; range from 4.1% to 11.7% contractually specified
mortality rates adjusted for future benefits
each impaired life based on
reduction in life expectancy
and nature of impairment
Other immediate fixed 1983 group annuity mortality Interest rate assumptions Present value of expected
annuities table range from 1.9% to 11.5% future benefits based on
historical experience
1983 individual annuity
mortality table
1983-a annuity mortality table
Annuity 2000 mortality table
Traditional life insurance Actual company experience plus Interest rate assumptions Net level premium reserve
loading range from 4.0% to 11.3% method using the
Company's withdrawal
experience rates
Other:
Variable annuity guaranteed 90% of 1994 group annuity Interest rate assumptions Projected benefit ratio
minimum death benefits (1) mortality table with internal range from 6.5% to 7.0% applied to cumulative
modifications assessments
Accident & health Actual company experience plus Unearned premium;
loading additional contract
reserves for traditional
life insurance
</Table>
(1) In 2006, the Company disposed of substantially all of its variable annuity
business through reinsurance agreements with Prudential (see Note 3).
To the extent that unrealized gains on fixed income securities would result
in a premium deficiency had those gains actually been realized, a premium
deficiency reserve has been recorded for certain immediate annuities with life
contingencies. A liability of $1.06 billion and $1.13 billion is included in the
reserve for life-contingent contract benefits with respect to this deficiency as
of December 31, 2007 and 2006, respectively. The offset to this liability is
recorded as a reduction of the unrealized net capital gains included in
accumulated other comprehensive income.
85
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, contractholder funds consist of the following:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006
------------- -------------
Interest-sensitive life insurance $ 8,896 $ 8,397
Investment contracts:
Fixed annuities 38,100 39,277
Funding agreements backing medium-term notes 13,375 12,787
Other investment contracts 93 104
------------- -------------
Total contractholder funds $ 60,464 $ 60,565
============= =============
</Table>
The following table highlights the key contract provisions relating to
contractholder funds:
<Table>
<Caption>
PRODUCT INTEREST RATE WITHDRAWAL/SURRENDER CHARGES
Interest-sensitive life Interest rates credited range Either a percentage of account
insurance from 2.0% to 6.0% balance or dollar amount
grading off generally over 20
years
Fixed annuities Interest rates credited range Either a declining or a level
from 1.3% to 11.5% for percentage charge generally
immediate annuities and 0% to over nine years or less.
16.0% for other fixed Additionally, approximately
annuities (which include 27.1% of fixed annuities are
equity-indexed annuities whose subject to market value
returns are indexed to the S&P adjustment for discretionary
500) withdrawals.
Funding agreements backing Interest rates credited range Not applicable
medium-term notes from 2.2% to 7.6% (excluding
currency-swapped medium-term
notes)
Other investment contracts:
Variable guaranteed minimum Interest rates used in Withdrawal and surrender
income benefit (1) and establishing reserves range charges are based on the terms
secondary guarantees on from 1.8% to 10.3% of the related
interest-sensitive life interest-sensitive life or
and fixed annuities fixed annuity contract.
Guaranteed investment Interest rates credited range Generally not subject to
contracts from 3.7% to 7.7% discretionary withdrawal
</Table>
(1) In 2006, the Company disposed of substantially all of its variable annuity
business through reinsurance agreements with Prudential (see Note 3).
Contractholder funds include funding agreements held by VIEs issuing
medium-term notes. The VIEs are Allstate Life Funding, LLC, Allstate Financial
Global Funding, LLC, Allstate Life Global Funding and Allstate Life Global
Funding II, and their primary assets are funding agreements used exclusively to
back medium-term note programs.
Contractholder funds activity for the years ended December 31 is as
follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006
---------- ----------
Balance, beginning of year $ 60,565 $ 58,190
Deposits 7,960 9,541
Interest credited 2,635 2,600
Benefits (1,656) (1,500)
Surrenders and partial withdrawals (4,928) (4,627)
Maturities of institutional products (3,165) (2,726)
Contract charges (751) (697)
Net transfers to separate accounts 13 (145)
Fair value hedge adjustments for institutional products 34 38
Other adjustments (243) (109)
---------- ----------
Balance, end of year $ 60,464 $ 60,565
========== ==========
</Table>
86
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company offers various guarantees to variable annuity contractholders.
Liabilities for variable contract guarantees related to death benefits are
included in reserve for life-contingent contract benefits and the liabilities
related to the income, withdrawal and accumulation benefits are included in
contractholder funds in the Consolidated Statements of Financial Position. All
liabilities for variable contract guarantees are reported on a gross basis on
the balance sheet with a corresponding reinsurance recoverable asset for those
contracts subject to reinsurance, including the Prudential Reinsurance
Agreements as disclosed in Note 3.
Absent any contract provision wherein the Company guarantees either a
minimum return or account value upon death, a specified contract anniversary
date, partial withdrawal or annuitization, variable annuity and variable life
insurance contractholders bear the investment risk that the separate accounts'
funds may not meet their stated investment objectives. The account balances of
variable annuities contracts' separate accounts with guarantees included $13.32
billion and $14.64 billion of equity, fixed income and balanced mutual funds and
$661 million and $674 million of money market mutual funds at December 31, 2007
and 2006, respectively.
The table below presents information regarding the Company's variable
annuity contracts with guarantees. The Company's variable annuity contracts may
offer more than one type of guarantee in each contract; therefore, the sum of
amounts listed exceeds the total account balances of variable annuity contracts'
separate accounts with guarantees.
<Table>
<Caption>
($ IN MILLIONS) DECEMBER 31,
--------------------------------
2007 2006
---------------- ---------------
IN THE EVENT OF DEATH
Separate account value $ 13,939 $ 15,269
Net amount at risk (1) $ 956 $ 1,068
Average attained age of contractholders 66 years 65 years
AT ANNUITIZATION (INCLUDES INCOME BENEFIT GUARANTEES)
Separate account value $ 3,394 $ 3,830
Net amount at risk (2) $ 144 $ 64
Weighted average waiting period until annuitization options available 3 years 4 years
FOR CUMULATIVE PERIODIC WITHDRAWALS
Separate account value $ 1,218 $ 1,041
Net amount at risk (3) $ 4 $ --
ACCUMULATION AT SPECIFIED DATES
Separate account value $ 1,587 $ 1,595
Net amount at risk (4) $ -- $ --
Weighted average waiting period until guarantee date 10 years 11 years
</Table>
- ----------
(1) Defined as the estimated current guaranteed minimum death benefit in
excess of the current account balance at the balance sheet date.
(2) Defined as the estimated present value of the guaranteed minimum
annuity payments in excess of the current account balance.
(3) Defined as the estimated current guaranteed minimum withdrawal balance
(initial deposit) in excess of the current account balance at the
balance sheet date.
(4) Defined as the estimated present value of the guaranteed minimum
accumulation balance in excess of the current account balance.
The liability for death and income benefit guarantees is equal to a benefit
ratio multiplied by the cumulative contract charges earned, plus accrued
interest less contract benefit payments. The benefit ratio is calculated as the
estimated present value of all expected contract benefits divided by the present
value of all expected contract charges. The establishment of reserves for these
guarantees requires the projection of future separate account fund performance,
mortality, persistency and customer benefit utilization rates. These assumptions
are periodically reviewed and updated. For guarantees related to death benefits,
benefits represent the current guaranteed minimum death benefit payments in
excess of the current account balance. For guarantees related to income
benefits, benefits represent the present value of the minimum guaranteed
annuitization benefits in excess of the current account balance.
Projected benefits and contract charges used in determining the liability
for certain guarantees are developed using models and stochastic scenarios that
are also used in the development of estimated expected gross profits. Underlying
assumptions for the liability related to income benefits include assumed future
annuitization elections based on factors such as the extent of benefit to the
potential annuitant, eligibility conditions and the annuitant's attained age.
The
87
<Page>
liability for guarantees is re-evaluated periodically, and adjustments are
made to the liability balance through a charge or credit to life and annuity
contract benefits.
Guarantees related to withdrawal and accumulation benefits are considered
to be derivative financial instruments; therefore, the liability for these
benefits is established based on its fair value.
The following table summarizes the liabilities for guarantees:
<Table>
<Caption>
LIABILITY FOR
GUARANTEES LIABILITY FOR LIABILITY FOR
RELATED TO DEATH GUARANTEES GUARANTEES
BENEFITS AND RELATED TO RELATED TO
INTEREST-SENSITIVE INCOME ACCUMULATION
($ IN MILLIONS) LIFE PRODUCTS BENEFITS BENEFITS TOTAL
------------------ ------------------ ------------------ ------------------
Balance at December 31, 2005 (1) $ 97 $ 51 $ (2) $ 146
Less reinsurance recoverables 10 -- -- 10
------------------ ------------------ ------------------ ------------------
Net balance at December 31, 2005 87 51 (2) 136
Variable annuity business
disposition related
reinsurance recoverables (75) (23) 12 (86)
Incurred guaranteed benefits 23 (2) (10) 11
Paid guarantee benefits (17) (2) -- (19)
------------------ ------------------ ------------------ ------------------
Net change (69) (27) 2 (94)
Net balance at December 31, 2006 18 24 -- 42
Plus reinsurance recoverables 96 23 (8) 111
------------------ ------------------ ------------------ ------------------
Balance at December 31, 2006 (2) $ 114 $ 47 $ (8) $ 153
================== ================== ================== ==================
Less reinsurance recoverables 96 23 (8) 111
------------------ ------------------ ------------------ ------------------
Net balance at December 31, 2006 18 24 -- 42
Incurred guaranteed benefits 7 (5) -- 2
Paid guarantee benefits (1) -- -- (1)
------------------ ------------------ ------------------ ------------------
Net change 6 (5) -- 1
Net balance at December 31, 2007 24 19 -- 43
Plus reinsurance recoverables 121 26 -- 147
------------------ ------------------ ------------------ ------------------
Balance at December 31, 2007 (3) $ 145 $ 45 $ -- $ 190
================== ================== ================== ==================
</Table>
- ----------
(1) Included in the total liability balance at December 31, 2005 are
reserves for variable annuity death benefits of $77 million, variable
annuity income benefits of $20 million, variable annuity accumulation
benefits of $(2) million and other guarantees of $51 million.
(2) Included in the total liability balance at December 31, 2006 are
reserves for variable annuity death benefits of $89 million, variable
annuity income benefits of $20 million, variable annuity accumulation
benefits of $(8) million and other guarantees of $51 million.
(3) Included in the total liability balance at December 31, 2007 are
reserves for variable annuity death benefits of $111 million, variable
annuity income benefits of $23 million, variable annuity accumulation
benefits of $0.4 million and other guarantees of $56 million.
9. REINSURANCE
The Company reinsures certain of its risks to other insurers primarily
under yearly renewable term, coinsurance, and modified coinsurance agreements.
These agreements result in a passing of the agreed-upon percentage of risk to
the reinsurer in exchange for negotiated reinsurance premium payments. The
Company cedes 100% of the morbidity risk on substantially all of its long-term
care contracts. The Company cedes specified percentages of the mortality risk on
certain life policies, depending upon the issue date and product, to a pool of
fourteen unaffiliated reinsurers. Beginning in July 2007, for new life insurance
contracts, the Company reinsured the mortality risk associated with coverage in
excess of $3 million per life for contracts issued to individuals age 70 and
over, and reinsured the mortality risk associated with coverage in excess of $5
million per life for most other contracts. Also beginning in July 2007, for
certain large contracts that meet specific criteria, the Company's retention
limit was increased to $10 million per life. In the period prior to July 2007,
but subsequent to August 1998, the Company reinsured the mortality risk
associated with coverage in excess of $2 million per life, except in 2006 in
certain instances when specific criteria were met, it reinsured the mortality
risk associated with coverage in excess of $5 million per life. For business
sold prior to October 1998, the Company reinsured mortality risk in excess of
specific amounts up to $1 million per life for individual life.
88
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition, the Company has used reinsurance to effect the acquisition or
disposition of certain blocks of business. As of December 31, 2007 and 2006, the
Company had reinsurance recoverables of $166 million and $153 million,
respectively due from subsidiaries of Citigroup and Scottish Re (U.S.) Inc. in
connection with the disposition of substantially all of the direct response
distribution business. In 2006, the Company ceded virtually all of its variable
annuity exposure to Prudential (Note 3). Reinsurance recoverables associated
with this disposition as of December 31, 2007 and 2006 amounted to $1,261
million and $1,490 million, respectively.
As of December 31, 2007, the gross life insurance in force was $502 billion
of which $245 billion was ceded to the unaffiliated reinsurers.
The effects of reinsurance on life and annuity premiums and contract
charges for the years ended December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
-------- -------- --------
PREMIUMS AND CONTRACT CHARGES
Direct $ 2,342 $ 2,326 $ 2,115
Assumed
Affiliate 16 16 17
Non-affiliate 26 30 27
Ceded--non-affiliate (940) (787) (606)
-------- -------- --------
Premiums and contract charges, net of reinsurance $ 1,444 $ 1,585 $ 1,553
======== ======== ========
</Table>
The effects of reinsurance on contract benefits for the years ended
December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
-------- -------- --------
CONTRACT BENEFITS
Direct $ 1,973 $ 1,886 $ 1,824
Assumed
Affiliate 10 11 10
Non-affiliate 27 23 21
Ceded--non-affiliate (646) (548) (515)
-------- -------- --------
Contract benefits, net of reinsurance $ 1,364 $ 1,372 $ 1,340
======== ======== ========
</Table>
The effects of reinsurance on interest credited to contractholder funds for
the years ended December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
-------- -------- --------
INTEREST CREDITED TO CONTRACTHOLDER FUNDS
Direct $ 2,644 $ 2,534 $ 2,277
Assumed
Affiliate 13 24 32
Non-affiliate 18 26 35
Ceded--non-affiliate (47) (41) (4)
-------- -------- --------
Interest credited to contractholder funds, net
of reinsurance $ 2,628 $ 2,534 $ 2,340
======== ======== ========
</Table>
Reinsurance recoverables at December 31 are summarized in the following table.
<Table>
<Caption>
($ IN MILLIONS) REINSURANCE RECOVERABLE ON PAID
AND UNPAID CLAIMS
---------------------------------
2007 2006
-------------- --------------
Annuities $ 1,423 $ 1,654
Life insurance 1,365 1,217
Long-term care 526 427
Other 96 94
-------------- --------------
Total $ 3,410 3,392
============== ==============
</Table>
89
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At both December 31, 2007 and 2006, approximately 88% of the Company's
reinsurance recoverables are due from companies rated A- or better by S&P.
10. DEFERRED POLICY ACQUISITION AND SALES INDUCEMENT COSTS
Deferred policy acquisition costs for the years ended December 31 are as
follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
-------- -------- --------
BALANCE, BEGINNING OF YEAR $ 3,485 $ 3,948 $ 3,176
Impact of adoption of SOP 05-1 (1) (11) -- --
Disposition of operation (2) -- (726) --
Acquisition costs deferred 547 742 766
Amortization charged to income (518) (538) (568)
Effect of unrealized gains and losses 402 59 574
-------- -------- --------
BALANCE, END OF YEAR $ 3,905 $ 3,485 $ 3,948
======== ======== ========
</Table>
- ----------
(1) The adoption of SOP 05-1 resulted in a $11 million adjustment to unamortized
DAC related to the impact on future estimated gross profits from the changes
in accounting for certain costs associated with contract continuations that
no longer qualify for deferral. (see Note 2)
(2) In 2006, DAC was reduced related to the disposition through reinsurance
agreements of substantially all of the Company's variable annuity business
(see Note 3).
Net amortization charged to income, due to the realization of capital
losses and (gains), includes $17 million, $50 million and $(126) million in
2007, 2006 and 2005, respectively.
As disclosed in Note 3, DAC and DSI balances were reduced during 2006
related to the disposal through reinsurance agreements of substantially all of
the variable annuity business. During 2005, DAC and DSI amortization on this
business was estimated using stochastic modeling and was significantly impacted
by the anticipated return on the underlying funds. The Company's long-term
expectation of separate accounts fund performance, net of fees, was
approximately 7% in 2005. Whenever actual separate accounts fund performance
based on the two most recent years varied from the expectation, the Company
projected performance levels over the next five years such that the mean return
over a seven-year period equaled the long-term expectation. This approach is
commonly referred to as "reversion to the mean" and is commonly used by the life
insurance industry as an appropriate method for amortizing variable annuity and
life DAC and DSI. In applying the reversion to the mean process, the Company did
not allow the future mean rates of return including fees projected over the
five-year period to exceed 12.75% or fall below 0%. The Company periodically
evaluated the results of utilization of this process to confirm that it was
reasonably possible that variable annuity and life fund performance would revert
to the expected long-term mean within this time horizon.
DSI activity for the twelve months ended December 31 was as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
-------- -------- --------
BALANCE, BEGINNING OF YEAR $ 225 $ 237 $ 134
Impact of adoption of SOP 05-1 (1) (2) -- --
Disposition of operation (2) -- (70) --
Sales inducements deferred 64 105 99
Amortization charged to income (57) (48) (74)
Effects of unrealized gains and losses 65 1 78
-------- -------- --------
BALANCE, END OF YEAR $ 295 $ 225 $ 237
======== ======== ========
</Table>
- ----------
(1) The adoption of SOP 05-1 resulted in a $2 million adjustment to
unamortized DSI related to the impact on future estimated gross
profits from the changes in accounting for certain costs associated
with contract continuations that no longer qualify for deferral.
(2) In 2006, DSI was reduced related to the disposition through
reinsurance agreements of substantially all of Allstate Financial's
variable annuity business (see Note 3).
11. COMMITMENTS, GUARANTEES AND CONTINGENT LIABILITIES
LEASES
The Company was not involved in material operating lease obligations in
2007, 2006 and 2005, respectively.
90
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GUARANTY FUNDS
Under state insurance guaranty fund laws, insurers doing business in a
state can be assessed, up to prescribed limits, for certain obligations of
insolvent insurance companies to policyholders and claimants. Amounts assessed
to each company are typically related to its proportion of business written in
each state.
The New York Liquidation Bureau ("the Bureau") has publicly reported that
Executive Life Insurance Company of New York ("Executive Life"), currently under
its jurisdiction as part of a 1992 court-ordered rehabilitation plan, may only
be able to meet future obligations of its annuity contacts for the next fifteen
years due to an estimated $600 million shortfall in assets to fund those
obligations. If Executive Life were to be declared insolvent in the future, the
Company would likely have exposure to guaranty fund assessments or other costs.
Based on currently available information, the outcome of this situation is
uncertain at this time. The Bureau may eventually take actions to address this
situation that may lead to guaranty fund assessments or other costs to the
Company. Under current law, the Company may be allowed to recoup a portion of
the amount of any additional guaranty fund assessment in periods subsequent to
the recognition of the assessment by offsetting future premium taxes. The
Company's market share in New York was approximately 5.5% in 2006 based on
industry annuity premium.
GUARANTEES
The Company owns certain fixed income securities that obligate the Company
to exchange credit risk or to forfeit principal due, depending on the nature or
occurrence of specified credit events for the referenced entities. In the event
all such specified credit events were to occur, the Company's maximum amount at
risk on these fixed income securities, as measured by the amount of the
aggregate initial investment, was $197 million at December 31, 2007. The
obligations associated with these fixed income securities expire at various
dates during the next seven years.
In the normal course of business, the Company provides standard
indemnifications to contractual counterparties in connection with numerous
transactions, including acquisitions and divestitures. The types of
indemnifications typically provided include indemnifications for breaches of
representations and warranties, taxes and certain other liabilities, such as
third party lawsuits. The indemnification clauses are often standard contractual
terms and are entered into in the normal course of business based on an
assessment that the risk of loss would be remote. The terms of the
indemnifications vary in duration and nature. In many cases, the maximum
obligation is not explicitly stated and the contingencies triggering the
obligation to indemnify have not occurred and are not expected to occur.
Consequently, the maximum amount of the obligation under such indemnifications
is not determinable. Historically, the Company has not made any material
payments pursuant to these obligations.
The aggregate liability balance related to all guarantees was not material
as of December 31, 2007.
REGULATION
The Company is subject to changing social, economic and regulatory
conditions. From time to time, regulatory authorities or legislative bodies seek
to impose additional regulations regarding agent and broker compensation and
otherwise expand overall regulation of insurance products and the insurance
industry. The ultimate changes and eventual effects of these initiatives on the
Company's business, if any, are uncertain.
LEGAL AND REGULATORY PROCEEDINGS AND INQUIRIES
BACKGROUND
The Company and certain affiliates are involved in a number of lawsuits,
regulatory inquiries, and other legal proceedings arising out of various aspects
of its business. As background to the "Proceedings" sub-section below, please
note the following:
- These matters raise difficult and complicated factual and legal issues
and are subject to many uncertainties and complexities, including the
underlying facts of each matter; novel legal issues; variations
between jurisdictions in which matters are being litigated, heard or
investigated; differences in applicable laws and judicial
interpretations; the length of time before many of these matters might
be resolved by settlement, through litigation or otherwise; the fact
that some of the lawsuits are putative class actions in which a class
has not been certified and in which the purported class may not be
clearly defined; the fact that some of the lawsuits involve
multi-state class actions in which the applicable law(s) for the
claims at issue is in dispute and therefore unclear; and the current
challenging legal environment faced by large corporations and
insurance companies.
91
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- The outcome on these matters may also be affected by decisions,
verdicts, and settlements, and the timing of such decisions, verdicts
and settlements, in other individual and class action lawsuits that
involve the Company, other insurers, or other entities and by other
legal, governmental, and regulatory actions that involve the Company,
other insurers or other entities.
- In the lawsuits, plaintiffs seek a variety of remedies including
equitable relief in the form of injunctive and other remedies and
monetary relief in the form of contractual and extra-contractual
damages. In some cases, the monetary damages sought include punitive
damages. Often specific information about the relief sought, such as
the amount of damages, is not available because plaintiffs have not
requested specific relief in their pleadings. In our experience, when
specific monetary demands are made in pleadings, they bear little
relation to the ultimate loss, if any, to the Company.
- In connection with regulatory examinations and proceedings, government
authorities may seek various forms of relief, including penalties,
restitution and changes in business practices. The Company may not be
advised of the nature and extent of relief sought until the final
stages of the examination or proceeding.
- For the reasons specified above, it is often not possible to make
meaningful estimates of the amount or range of loss that could result
from the matters described below in the "Proceedings" subsection. The
Company reviews these matters on an ongoing basis and follows the
provisions of SFAS No. 5, "Accounting for Contingencies" when making
accrual and disclosure decisions. When assessing reasonably possible
and probable outcomes, the Company bases its decisions on its
assessment of the ultimate outcome following all appeals.
- Due to the complexity and scope of the matters disclosed in the
"Proceedings" subsection below and the many uncertainties that exist,
the ultimate outcome of these matters cannot be reasonably predicted.
In the event of an unfavorable outcome in one or more of these
matters, the ultimate liability may be in excess of amounts currently
reserved and may be material to the Company's operating results or
cash flows for a particular quarterly or annual period. However, based
on information currently known to it, management believes that the
ultimate outcome of all matters described below as they are resolved
over time is not likely to have a material adverse effect on the
financial position of the Company.
PROCEEDINGS
Legal proceedings involving Allstate agencies and AIC may impact the
Company, even when the Company is not directly involved, because the Company
sells its products through a variety of distribution channels including Allstate
agencies. Consequently, information about the more significant of these
proceedings is provided in the following paragraph.
AIC is defending certain matters relating to its agency program
reorganization announced in 1999. These matters are in various stages of
development.
- These matters include a lawsuit filed in 2001 by the U.S. Equal
Employment Opportunity Commission ("EEOC") alleging retaliation
under federal civil rights laws (the "EEOC I" suit) and a class
action filed in 2001 by former employee agents alleging
retaliation and age discrimination under the Age Discrimination
in Employment Act ("ADEA"), breach of contract and ERISA
violations (the "Romero I" suit). In 2004, in the consolidated
EEOC I and Romero I litigation, the trial court issued a
memorandum and order that, among other things, certified classes
of agents, including a mandatory class of agents who had signed a
release, for purposes of effecting the court's declaratory
judgment that the release is voidable at the option of the
release signer. The court also ordered that an agent who voids
the release must return to AIC "any and all benefits received by
the [agent] in exchange for signing the release." The court also
stated that "on the undisputed facts of record, there is no basis
for claims of age discrimination." The EEOC and plaintiffs have
asked the court to clarify and/or reconsider its memorandum and
order and in January 2007, the judge denied their request. In
June 2007, the court granted AIC's motions for summary judgment.
Following plaintiffs' filing of a notice of appeal, the Third
Circuit issued an order in December 2007 stating that the notice
of appeal was not taken from a final order within the meaning of
the federal law and thus not appealable at this time. Responses
to the order were filed in mid-December.
- The EEOC also filed another lawsuit in 2004 alleging age
discrimination with respect to a policy
92
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
limiting the rehire of agents affected by the agency program
reorganization ("the EEOC II" suit). In EEOC II, in 2006, the court
granted partial summary judgment to the EEOC. Although the court did
not determine that AIC was liable for age discrimination under the
ADEA, it determined that the rehire policy resulted in a disparate
impact, reserving for trial the determination on whether AIC had
reasonable factors other than age to support the rehire policy.
AIC's interlocutory appeal of the trial court's summary judgment
order is now pending in the United States Court of Appeals for the
Eighth Circuit.
- AIC is also defending a certified class action filed by former
employee agents who terminated their employment prior to the agency
program reorganization. These plaintiffs have asserted breach of
contract and ERISA claims. The court approved the form of class
notice which was sent to approximately 1,800 potential class members
in November 2007. Fifteen individuals have opted out. AIC has moved
for judgment on the pleadings and summary judgment.
- A putative nationwide class action has also been filed by former
employee agents alleging various violations of ERISA, including a
worker classification issue. These plaintiffs are challenging
certain amendments to the Agents Pension Plan and are seeking to
have exclusive agent independent contractors treated as employees
for benefit purposes. This matter was dismissed with prejudice by
the trial court, was the subject of further proceedings on appeal,
and was reversed and remanded to the trial court in 2005. In June
2007, the court granted AIC's motion to dismiss the case. Following
plaintiffs' filing of a notice of appeal, the Third Circuit issued
an order in December 2007 stating that the notice of appeal was not
taken from a final order within the meaning of the federal law and
thus not appealable at this time. Responses to the order were filed
in mid-December.
In all of these various matters, plaintiffs seek compensatory and punitive
damages, and equitable relief. AIC has been vigorously defending these lawsuits
and other matters related to its agency program reorganization.
OTHER MATTERS
Various other legal, governmental and regulatory actions, including state
market conduct exams, and other governmental and regulatory inquiries are
currently pending that involve the Company and specific aspects of its conduct
of business. Like other members of the insurance industry, the Company is the
target of a number of class action lawsuits and other types of proceedings, some
of which involve claims for substantial or indeterminate amounts. These actions
are based on a variety of issues and target a range of the Company's practices.
The outcome of these disputes is currently unpredictable.
One or more of these matters could have an adverse effect on the Company's
operating results or cash flows for a particular quarterly or annual period.
However, based on information currently known to it, management believes that
the ultimate outcome of all matters described in this "Other Matters" subsection
in excess of amounts currently reserved, as they are resolved over time is not
likely to have a material effect on the operating results, cash flows or
financial position of the Company.
12. INCOME TAXES
ALIC and its domestic subsidiaries (the "Allstate Life Group") join with
the Corporation (the "Allstate Group") in the filing of a consolidated federal
income tax return and are party to a federal income tax allocation agreement
(the "Allstate Tax Sharing Agreement"). Under the Allstate Tax Sharing
Agreement, the Allstate Life Group pays to or receives from the Corporation the
amount, if any, by which the Allstate Group's federal income tax liability is
affected by virtue of inclusion of the Allstate Life Group in the consolidated
federal income tax return. Effectively, this results in the Allstate Life
Group's annual income tax provision being computed, with adjustments, as if the
Allstate Life Group filed a separate return.
The Internal Revenue Service ("IRS") is currently examining the Company's
2005 and 2006 federal income tax returns. The IRS has completed its examination
of the Company's federal income tax returns through 2004 and the statute of
limitations has expired on years prior to 2003. Any adjustments that may result
from IRS examinations of tax returns are not expected to have a material effect
on the results of operations, cash flows or financial position of the Company.
93
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company adopted the provisions of FIN 48 on January 1, 2007. The
Company had no liability for unrecognized tax benefits at January 1, 2007 or
December 31, 2007, and believes it is reasonably possible that the liability
balance will not significantly increase or decrease within the next twelve
months. No amounts have been accrued for interest or penalties.
The components of the deferred income tax assets and liabilities at
December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006
---------- ----------
DEFERRED ASSETS
Life and annuity reserves $ 588 $ 682
Unrealized net capital losses 45 --
Other assets 62 48
---------- ----------
Total deferred assets 695 730
DEFERRED LIABILITIES
Deferred policy acquisition costs (787) (784)
Unrealized net capital gains -- (175)
Other liabilities (9) (29)
---------- ----------
Total deferred liabilities (796) (988)
---------- ----------
Net deferred liability $ (101) $ (258)
========== ==========
</Table>
Although realization is not assured, management believes it is more likely
than not that the deferred tax assets will be realized based on the assumption
that certain levels of income will be achieved.
The components of income tax expense for the years ended December 31 are as
follows:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006 2005
-------- -------- --------
Current $ 111 $ 136 $ 225
Deferred 69 60 (51)
-------- -------- --------
Total income tax expense $ 180 $ 196 $ 174
======== ======== ========
</Table>
The Company paid income taxes of $68 million, $317 million and $156 million
in 2007, 2006 and 2005, respectively. The Company had a current income tax
receivable of $6 million and $49 million at December 31, 2007 and 2006,
respectively.
A reconciliation of the statutory federal income tax rate to the effective
income tax rate on income from operations for the years ended December 31 is as
follows:
<Table>
<Caption>
2007 2006 2005
-------- -------- --------
Statutory federal income tax rate 35.0% 35.0% 35.0%
Adjustment for prior year tax liabilities (0.9) (1.6) (3.9)
Dividends received deduction (2.7) (2.7) (2.5)
Tax credits (2.3) (0.5) (0.3)
Other 1.3 1.1 1.1
-------- -------- --------
Effective income tax rate 30.4% 31.3% 29.4%
======== ======== ========
</Table>
94
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. CAPITAL STRUCTURE
DEBT OUTSTANDING
Total debt outstanding at December 31 consisted of the following:
<Table>
<Caption>
($ IN MILLIONS) 2007 2006
------------ ------------
6.18% Surplus Notes (1), due 2036 $ 100 $ 100
5.06% Surplus Notes (1), due 2035 100 100
Mandatorily redeemable preferred stock - Series A -- 6
------------ ------------
Total long-term debt 200 206
Note payable to parent -- 500
------------ ------------
Total debt $ 200 $ 706
============ ============
</Table>
- ----------
(1) No payment of principle or interest is permitted on the surplus notes
without the written approval of the Director of Insurance of the State of
South Carolina (the "Director"), the domiciliary state insurance regulatory
authority for the issuer of the notes, Allstate Re (see Note 5). The
Director could prohibit the payment of interest and principle on the
surplus notes if certain statutory capital requirements are not met.
Permission to pay interest on the surplus notes was granted in both 2007
and 2006.
All of the Company's outstanding debt as of December 31, 2007 and 2006
relates to intercompany obligations. These obligations are discussed in Note 5
to the consolidated financial statements. The Company paid $21 million, $13
million and $6 million of interest on debt in 2007, 2006 and 2005, respectively.
14. STATUTORY FINANCIAL INFORMATION
ALIC and its subsidiaries prepare their statutory-basis financial
statements in conformity with accounting practices prescribed or permitted by
the insurance department of the applicable state of domicile. Prescribed
statutory accounting practices include a variety of publications of the NAIC, as
well as state laws, regulations and general administrative rules. Permitted
statutory accounting practices encompass all accounting practices not so
prescribed.
All states require domiciled insurance companies to prepare statutory-basis
financial statements in conformity with the NAIC Accounting Practices and
Procedures Manual, subject to any deviations prescribed or permitted by the
applicable insurance commissioner and/or director.
Statutory accounting practices primarily differ from GAAP since they
require charging policy acquisition and certain sales inducement costs to
expense as incurred, establishing life insurance reserves based on different
actuarial assumptions, and valuing investments and establishing deferred taxes
on a different basis.
Statutory net income of ALIC and its insurance subsidiaries for 2007, 2006
and 2005 was $172 million, $252 million and $266 million, respectively.
Statutory capital and surplus was $2.62 billion and $3.36 billion as of December
31, 2007 and 2006, respectively.
DIVIDENDS
The ability of ALIC to pay dividends is dependent on business conditions,
income, cash requirements of ALIC, receipt of dividends from its subsidiaries
and other relevant factors. The payment of shareholder dividends by ALIC to AIC
without the prior approval of the state insurance regulator is limited to
formula amounts based on net income and capital and surplus, determined in
conformity with statutory accounting practices, as well as the timing and amount
of dividends paid in the preceding twelve months. Notification and approval of
intercompany lending activities is also required by the Illinois Department of
Insurance ("IL DOI") for transactions that exceed a level that is based on a
formula using statutory admitted assets and statutory surplus.
ALIC paid dividends of $725 million and $675 million in 2007 and 2006,
respectively. These amounts were in excess of the $336 million and $366 million
that were allowed under Illinois insurance law based on the 2006 and 2005
formula amounts, respectively. The Company received approval from the IL DOI for
the portion of the 2007 and 2006 dividends in excess of this amount. Based on
2007 ALIC statutory capital and surplus, ALIC will not be able to pay dividends
in 2008 without prior IL DOI approval.
95
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. BENEFIT PLANS
PENSION AND OTHER POSTRETIREMENT PLANS
Defined benefit pension plans, sponsored by AIC, cover most full-time
employees, certain part-time employees and employee-agents. Benefits under the
pension plans are based upon the employee's length of service and eligible
annual compensation. A cash balance formula was added to the Allstate Retirement
Plan effective January 1, 2003. All eligible employees hired before August 1,
2002 were provided with a one-time opportunity to choose between the cash
balance formula and the final average pay formula. The cash balance formula
applies to all eligible employees hired after August 1, 2002. AIC's funding
policy for the pension plans is to make annual contributions at a minimum level
that is at least in accordance with regulations under the Internal Revenue Code
and in accordance with generally accepted actuarial principles. The allocated
cost to the Company included in net income for the pension plans in 2007, 2006
and 2005 was $24 million, $37 million and $27 million, respectively.
AIC also provides certain health care and life insurance subsidies for
employees hired before January 1, 2003 when they retire ("postretirement
benefits"). Qualified employees may become eligible for these benefits if they
retire in accordance with AIC's established retirement policy and are
continuously insured under AIC's group plans or other approved plans in
accordance with the plan's participation requirements. AIC shares the cost of
the retiree medical benefits with retirees based on years of service, with AIC's
share being subject to a 5% limit on annual medical cost inflation after
retirement. AIC has the right to modify or terminate these pension and
postretirement benefit plans. The allocated cost to the Company included in net
income was $6 million, $7 million and $7 million for postretirement benefits
other than pension plans in 2007, 2006 and 2005, respectively.
PROFIT SHARING PLANS
Employees of AIC are eligible to become members of The Savings and Profit
Sharing Fund of Allstate Employees ("Allstate Plan"). The Corporation's
contributions are based on the Corporation's matching obligation and
performance. The Company's allocation of profit sharing expense from the
Corporation was $12 million, $13 million and $7 million in 2007, 2006 and 2005,
respectively.
16. OTHER COMPREHENSIVE INCOME
The components of other comprehensive (loss) income on a pre-tax and
after-tax basis for the years ended December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS)
2007 2006 2005
------------------------------ ----------------------------- -----------------------------
PRE- AFTER- PRE- AFTER- PRE- AFTER-
TAX TAX TAX TAX TAX TAX TAX TAX TAX
------- ------- ------- ------- ------- ------- ------- ------- -------
Unrealized holding (losses) gains
arising during the period, net of
related offsets $ (492) $ 172 $ (320) $ (493) $ 172 $ (321) $ (724) $ 254 $ (470)
Less: reclassification adjustment of
realized capital gains and losses 137 (48) 89 (89) 31 (58) (69) 24 (45)
------- ------- ------- ------- ------- ------- ------- ------- -------
UNREALIZED NET CAPITAL (LOSSES) GAINS (629) 220 (409) (404) 141 (263) (655) 230 (425)
------- ------- ------- ------- ------- ------- ------- ------- -------
Other comprehensive (loss) income $ (629) $ 220 $ (409) $ (404) $ 141 $ (263) $ (655) $ 230 $ (425)
======= ======= ======= ======= ======= ======= ======= ======= =======
</Table>
17. QUARTERLY RESULTS (UNAUDITED)
<Table>
<Caption>
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
---------------------- ---------------------- ---------------------- ----------------------
($ IN MILLIONS) 2007 2006 2007 2006 2007 2006 2007 2006
--------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Revenues $ 1,435 $ 1,349 $ 1,509 $ 1,360 $ 1,274 $ 1,352 $ 1,234 $ 1,502
Net income 149 96 187 56 56 122 20 154
</Table>
96
<Page>
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS AND SHAREHOLDER OF
ALLSTATE LIFE INSURANCE COMPANY
We have audited the accompanying Consolidated Statements of Financial Position
of Allstate Life Insurance Company and subsidiaries (the "Company", an affiliate
of The Allstate Corporation) as of December 31, 2007 and 2006, and the related
Consolidated Statements of Operations and Comprehensive Income, Shareholder's
Equity, and Cash Flows for each of the three years in the period ended December
31, 2007. Our audits also included the consolidated financial statement
schedules listed in the Index at Item 15. These financial statements and
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Allstate Life Insurance Company and
subsidiaries as of December 31, 2007 and 2006, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2007, in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, such consolidated
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for uncertainty in income taxes and accounting
for deferred acquisition costs associated with internal replacements in 2007.
/s/ Deloitte & Touche LLP
Chicago, Illinois
March 13, 2008
97
<Page>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. We maintain disclosure
controls and procedures as defined in Rule 13a-15(e) and 15(d)-15(e) under the
Securities Exchange Act of 1934. Under the supervision and with the
participation of our management, including our principal executive officer and
principal financial officer, we conducted an evaluation of the effectiveness of
our disclosure controls and procedures as of the end of the period covered by
this report. Based upon this evaluation, the principal executive officer and the
principal financial officer concluded that our disclosure controls and
procedures are effective in providing reasonable assurance that material
information required to be disclosed in our reports filed with or submitted to
the Securities and Exchange Commission under the Securities Exchange Act is
recorded, processed, summarized and reported within the time periods specified
by the Securities Exchange Act and made known to management, including the
principal executive officer and the principal financial officer, as appropriate
to allow timely decisions regarding required disclosure.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.
Management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) under the
Securities Exchange Act of 1934.
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of our internal control over
financial reporting as of December 31, 2007 based on the criteria related to
internal control over financial reporting described in "Internal Control -
Integrated Framework" issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on our evaluation, management concluded that our
internal control over financial reporting was effective as of December 31, 2007.
This annual report does not include an attestation report of the Company's
registered public accounting firm regarding internal control over financial
reporting. Management's report was not subject to attestation by the Company's
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit the Company to provide only management's
report in this annual report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. During the fiscal
quarter ended December 31, 2007, there have been no changes in our internal
control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
ITEM 9B. OTHER INFORMATION
None
98
<Page>
PART III
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
(1), (2), (3) AND (4) DISCLOSURE OF FEES -
The following fees have been, or are anticipated to be billed by Deloitte &
Touche LLP, the member firms of Deloitte & Touche Tohmatsu, and their respective
affiliates, for professional services rendered to us for the fiscal years ending
December 31, 2007 and 2006.
<Table>
<Caption>
2007 2006
--------------- --------------
Audit fees (a) $ 3,381,094 $ 3,207,000
Audit related fees (b) 15,219 19,250
--------------- --------------
TOTAL FEES $ 3,396,313 $ 3,226,250
=============== ==============
</Table>
(a) Fees for audits of annual financial statements including financial
statements for the separate accounts, reviews of quarterly financial
statements, statutory audits, attest services, comfort letters, consents
and review of documents filed with the Securities and Exchange
Commission.
(b) Audit related fees relate to professional services such as accounting
consultations relating to new accounting standards.
(5)(i) AND (ii) AUDIT COMMITTEE'S PRE-APPROVAL POLICIES AND PROCEDURES -
The Audit Committee of The Allstate Corporation has established
pre-approval policies and procedures for itself and its consolidated
subsidiaries, including Allstate Life. Those policies and procedures are
incorporated into this Item 14 (5) by reference to Exhibit 99 - The Allstate
Corporation Policy Regarding Pre-Approval of Independent Auditors' Services (the
"Pre-Approval Policy"). In addition, in 2005 the Audit Committee of Allstate
Life adopted the Pre-Approval Policy, as it may be amended from time to time by
the Audit Committee or the Board of Directors of the Corporation, as its own
policy, provided that the Designated Member referred to in such policy need not
be independent because the New York Stock Exchange corporate governance
standards do not apply to Allstate Life. All of the services provided by
Deloitte & Touche LLP to Allstate Life in 2006 and 2007 were pre-approved by The
Allstate Corporation and Allstate Life Audit Committees.
99
<Page>
PART IV
ITEM 15. (a) (1) EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statements, notes thereto and related
information of Allstate Life Insurance Company are included in Item 8.
Consolidated Statements of Operations and Comprehensive Income
Consolidated Statements of Financial Position
Consolidated Statements of Shareholder's Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
ITEM 15. (a) (2)
The following additional financial statement schedules and independent
auditors' report are furnished herewith pursuant to the requirements of
Form 10-K.
<Table>
<Caption>
Allstate Life Insurance Company Page
------------------------------- ----
Schedules required to be filed under the provisions
of Regulation S-X Article 7:
Schedule I - Summary of Investments - Other than
Investments in Related Parties S-1
Schedule IV - Reinsurance S-2
</Table>
All other schedules are omitted because they are not applicable,
or not required, or because the required information is included
in the Consolidated Financial Statements or notes thereto.
ITEM 15. (a) (3)
The following is a list of the exhibits filed as part of this Form 10-K.
The SEC File Number for the exhibits incorporated by reference is
000-31248 except as otherwise noted.
<Table>
<Caption>
EXHIBIT NO. DOCUMENT DESCRIPTION
- ----------- --------------------
3(i) Articles of Amendment to the Articles of Incorporation of
Allstate Life Insurance Company dated December 29, 1999.
Incorporated herein by reference to Exhibit 3.1 to Allstate Life
Insurance Company's Form 10 filed on April 24, 2002.
3(ii) Amended and Restated By-Laws of Allstate Life Insurance Company
effective May 15, 2007. Incorporated herein by reference to
Exhibit 3(ii) to Allstate Life Insurance Company's Current Report
on Form 8-K dated March 15, 2007.
4 See Exhibits 3 (i) and 3 (ii).
10.1 Form of Amended and Restated Service and Expense Agreement
between Allstate Insurance Company, The Allstate Corporation and
certain affiliates effective January 1, 2004.
10.2 New York Insurer Supplement to Amended and Restated Service and
Expense Agreement between Allstate Insurance Company, The
Allstate Corporation, Allstate Life Insurance Company of New York
and Intramerica Life Insurance Company,
</Table>
100
<Page>
<Table>
effective March 5, 2005. Incorporated herein by reference to
Exhibit 10.2 to Allstate Life Insurance Company's Quarterly
Report on Form 10-Q for quarter ended June 30, 2005.
10.3 Selling Agreement between Allstate Life Insurance Company, ALFS,
Inc. (f/k/a Allstate Life Financial Services, Inc.) and Allstate
Financial Services, LLC (f/k/a LSA Securities, Inc.) effective
July 26, 1999. Incorporated herein by reference to Exhibit 10.6
to Allstate Life Insurance Company's Annual Report on Form 10-K
for 2003.
10.4 Amendment effective August 1, 1999 to Selling Agreement between
Allstate Life Insurance Company, ALFS, Inc. and Allstate
Financial Services, LLC effective July 26, 1999. Incorporated
herein by reference to Exhibit 10.1 to Allstate Life Insurance
Company's Quarterly Report on Form 10-Q for quarter ended
September 30, 2004.
10.5 Amendment effective September 28, 2001 to Selling Agreement
between Allstate Life Insurance Company, ALFS, Inc. and Allstate
Financial Services, LLC effective July 26, 1999. Incorporated
herein by reference to Exhibit 10.2 to Allstate Life Insurance
Company's Quarterly Report on Form 10-Q for quarter ended
September 30, 2004.
10.6 Amendment effective February 15, 2002 to Selling Agreement
between Allstate Life Insurance Company, ALFS, Inc. and Allstate
Financial Services, LLC effective July 26, 1999. Incorporated
herein by reference to Exhibit 10.3 to Allstate Life Insurance
Company's Quarterly Report on Form 10-Q for quarter ended
September 30, 2004.
10.7 Amendment effective April 21, 2003 to Selling Agreement between
Allstate Life Insurance Company, ALFS, Inc. and Allstate
Financial Services, LLC effective July 26, 1999. Incorporated
herein by reference to Exhibit 10.4 to Allstate Life Insurance
Company's Quarterly Report on Form 10-Q for quarter ended
September 30, 2004.
10.8 Selling Agreement between Allstate Life Insurance Company of New
York, ALFS, Inc. and Allstate Financial Services, LLC effective
May 1 2005. Incorporated herein by reference to Exhibit 10.7 to
Allstate Life Insurance Company's Annual Report on Form 10-K for
2003.
10.9 Selling Agreement between Lincoln Benefit Life Company, ALFS,
Inc. (f/k/a Allstate Life Financial Services, Inc.) and Allstate
Financial Services, LLC (f/k/a LSA Securities, Inc.) effective
August 2, 1999. Incorporated herein by reference to Exhibit 10.8
to Allstate Life Insurance Company's Annual Report on Form 10-K
for 2003.
10.10 First Amendment to Marketing Coordination and Administrative
Services Agreement among Allstate Life Insurance Company,
Allstate Financial Services, LLC and Allstate Insurance Company
dated January 1, 2006. Incorporated herein by reference to
Exhibit 10.1 to Allstate Life Insurance Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2006.
10.11 Marketing Coordination and Administrative Services Agreement
among Allstate Insurance Company, Allstate Life Insurance Company
and Allstate Financial Services, LLC effective January 1, 2003.
Incorporated herein by reference to Exhibit 10.9 to Allstate Life
Insurance Company's Annual Report on Form 10-K for 2003.
10.12 Form of Investment Management Agreement among Allstate
Investments, LLC, Allstate Insurance Company, The Allstate
Corporation and certain affiliates effective January 1, 2007.
</Table>
101
<Page>
<Table>
10.13 Investment Advisory Agreement by and between Allstate Insurance
Company and Intramerica Life Insurance Company effective July 1,
1999. Incorporated herein by reference to Exhibit 10.29 to
Allstate Life Insurance Company's Form 10 filed on April 24,
2002.
10.14 Investment Management Agreement between Allstate Investments, LLC
and ALIC Reinsurance Company, effective July 1, 2005.
Incorporated herein by reference to Exhibit 10.1 to Allstate Life
Insurance Company's Quarterly Report on Form 10-Q for quarter
ended September 30, 2005.
10.15 Assignment and Assumption Agreement dated as of January 1, 2002
among Allstate Insurance Company, Allstate Investments, LLC and
Intramerica Life Insurance Company. Incorporated herein by
reference to Exhibit 10.30 to Allstate Life Insurance Company's
Form 10 filed on April 24, 2002.
10.16 Investment Advisory Agreement and Amendment to Service Agreement
as of January 1, 2002 between Allstate Insurance Company,
Allstate Investments, LLC and Allstate Life Insurance Company of
New York. Incorporated herein by reference to Exhibit 10.31 to
Allstate Life Insurance Company's Form 10 filed on April 24,
2002.
10.17 Cash Management Services Master Agreement between Allstate
Insurance Company and Allstate Bank (f/k/a Allstate Federal
Savings Bank) dated March 16, 1999. Incorporated herein by
reference to Exhibit 10.32 to Allstate Life Insurance Company's
Form 10 filed on April 24, 2002.
10.18 Amendment No. 1 effective January 5, 2001 to Cash Management
Services Master Agreement between Allstate Insurance Company and
Allstate Bank dated March 16, 1999. Incorporated herein by
reference to Exhibit 10.33 to Allstate Life Insurance Company's
Form 10 filed on April 24, 2002.
10.19 Amendment No. 2 entered into November 8, 2002 to the Cash
Management Services Master Agreement between Allstate Insurance
Company, Allstate Bank and Allstate Motor Club, Inc. dated March
16, 1999.
10.20 Premium Depository Service Supplement dated as of September 30,
2005 to Cash Management Services Master Agreement between
Allstate Insurance Company, Allstate Bank, Allstate Motor Club,
Inc. and certain other parties.
10.21 Variable Annuity Service Supplement dated November 10, 2005 to
Cash Management Services Agreement between Allstate Bank,
Allstate Life Insurance Company of New York and certain other
parties.
10.22 Sweep Agreement Service Supplement dated as of October 11, 2006
to Cash Management Services Master Agreement between Allstate
Life Insurance Company, Allstate Bank, Allstate Motor Club, Inc.
and certain other companies.
10.23 Agent Access Agreement among Allstate Insurance Company, Allstate
New Jersey Insurance Company, Allstate Life Insurance Company and
Allstate Bank effective January 1, 2002. Incorporated herein by
reference to Exhibit 10.17 to Allstate Life Insurance Company's
Annual Report on Form 10-K for 2003.
10.24 Form of Tax Sharing Agreement among The Allstate Corporation and
certain affiliates dated as of November 12, 1996.
</Table>
102
<Page>
<Table>
10.25 Surplus Note Purchase Agreement between Allstate Life Insurance
Company and Kennett Capital, Inc. effective, August 1, 2005.
Incorporated herein by reference to Exhibit 10.2 to Allstate Life
Insurance Company's Quarterly Report on Form 10-Q for quarter
ended September 30, 2005.
10.26 Intercompany Loan Agreement among The Allstate Corporation,
Allstate Life Insurance Company, Lincoln Benefit Life Company and
other certain subsidiaries of The Allstate Corporation dated
February 1, 1996. Incorporated herein by reference to Exhibit
10.2 to Allstate Life Insurance Company's Annual Report on Form
10-K for 2006.
10.27 Pledge and Security Agreement between Allstate Life Insurance
Company and Kennett Capital, Inc. effective August 1, 2005.
Incorporated herein by reference to Exhibit 10.3 to Allstate Life
Insurance Company's Quarterly Report on Form 10-Q for quarter
ended September 30, 2005.
10.28 Catastrophe Reinsurance Agreement between Allstate Life Insurance
Company and American Heritage Life Insurance Company effective
July 1, 2003. Incorporated herein by reference to Exhibit 10.29
to Allstate Life Insurance Company's Annual Report on Form 10-K
for 2003.
10.29 Retrocessional Reinsurance Agreement between Allstate Life
Insurance Company and American Heritage Life Insurance Company
effective December 31, 2004. Incorporated herein by reference to
Exhibit 10.23 to Allstate Life Insurance Company's Annual Report
on Form 10-K for 2004.
10.30 Reinsurance Agreement between Allstate Life Insurance Company and
American Heritage Life Insurance Company effective December 31,
2004. Incorporated herein by reference to Exhibit 10.2 to
Allstate Life Insurance Company's Current Report on Form 8-K
filed January 9, 2008.
10.31 Amendment No. 1 to Reinsurance Agreement between Allstate Life
Insurance Company and American Heritage Life Insurance Company
dated January 1, 2008. Incorporated herein by reference to
Exhibit 10.1 to Allstate Life Insurance Company's Current Report
on Form 8-K filed January 9, 2008.
10.32 Credit Agreement dated May 8, 2007, among The Allstate
Corporation, Allstate Insurance Company and Allstate Life
Insurance Company, as borrowers; the Lenders party thereto
Wachovia Bank, National Association, as Syndication Agent; Bank
of America, N.A. and Citibank, N.A., as Documentation Agents;
Lehman Brothers Bank, FSB, Merrill Lynch Bank USA, Morgan Stanley
Bank and William Street Commitment Corporation, as Co-Agents; and
JPMorgan Chase Bank, N.A., as Administrative Agent; incorporated
herein by reference to Exhibit 10.1 to The Allstate Corporation's
current report on Form 8-K filed May 9, 2007. (SEC File
No. 001-11840)
10.33 Reinsurance and Administrative Services Agreement between
American Heritage Life Insurance Company and Columbia Universal
Life Insurance Company effective February 1, 1998. Incorporated
herein by reference to Exhibit 10.3 to Allstate Life Insurance
Company's Current Report on Form 8-K filed January 30, 2008.
10.34 Novation and Assignment Agreement among Allstate Life Insurance
Company, American Heritage Life Insurance Company and Columbia
Universal Life Insurance Company effective June 30, 2004.
Incorporated herein by reference to Exhibit 10.2 to Allstate Life
Insurance Company's Current Report on Form 8-K filed January 30,
2008.
10.35 Amendment to Reinsurance Agreement effective December 1, 2007,
between American Heritage Life Insurance Company and Allstate
Life Insurance Company. Incorporated
</Table>
103
<Page>
<Table>
herein by reference to Exhibit 10.1 to Allstate Life Insurance
Company's Current Report on Form 8-K filed January 30, 2008.
10.36 Capital Support Agreement between Allstate Life Insurance Company
and Allstate Insurance Company effective December 14, 2007.
Incorporated herein by reference to Exhibit 10.1 to Allstate Life
Insurance Company's Current Report on Form 8-K filed February 7,
2008.
10.37 Intercompany Liquidity Agreement between Allstate Life Insurance
Company and Allstate Insurance Company effective January 1, 2008.
Incorporated herein by reference to Exhibit 10.2 to Allstate Life
Insurance Company's Current Report on Form 8-K filed February 7,
2008.
10.38 Agreement for the Settlement of State and Local Tax Credits among
Allstate Insurance Company and certain of its affiliates,
including Allstate Life Insurance Company effective January 1,
2007. Incorporated herein by reference to Exhibit 10.1 to
Allstate Life Insurance Company's Current Report on Form 8-K
filed February 21, 2008.
10.39 Selling Agreement and Addenda to Agreement between Allstate
Life Insurance Company as successor in interest to Glenbrook
Life and Annuity Company, ALFS, Inc. and Allstate Financial
Services, LLC effective May 17, 2001, December 31, 2001 and
November 18, 2002, respectively.
10.40 Limited Servicing Agreement between Allstate Life Insurance
Company, Allstate Distributors, L.L.C. and Allstate Financial
Services, LLC effective October 1, 2002.
10.41 Marketing Agreement between Allstate Life Insurance Company as
successor in interest to Glenbrook Life and Annuity Company,
ALFS, Inc. and Allstate Financial Services, LLC effective
June 10, 2003.
23 Consent of Independent Registered Public Accounting Firm
31.1 Rule 13a-14(a) Certification of Principal Executive Officer
31.2 Rule 13a-14(a) Certification of Principal Financial Officer
32 Section 1350 Certifications
99 The Allstate Corporation Policy Regarding Pre-Approval of
Independent Auditors' Services effective November 10, 2003.
Incorporated herein by reference to Exhibit 99 (ii) to Allstate
Life Insurance Company's Annual Report on Form 10-K for 2004.
</Table>
ITEM 15. (b)
The exhibits are listed in Item 15. (a) (3) above.
ITEM 15. (c)
The financial statement schedules are listed in Item 15. (a) (2) above.
104
<Page>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
ALLSTATE LIFE INSURANCE COMPANY
(Registrant)
March 14, 2008 /s/ SAMUEL H. PILCH
-------------------------------
By: Samuel H. Pilch
(Controller)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacity and on the dates indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JAMES E. HOHMANN President, Chief Executive Officer March 14, 2008
- ------------------------------------- and a Director (Principal Executive Officer)
James E. Hohmann
/s/ JOHN C. PINTOZZI Senior Vice President, Chief Financial March 14, 2008
- ------------------------------------- Officer and a Director (Principal Financial Officer)
John C. Pintozzi
Chairman of the Board and a Director March 14, 2008
- -------------------------------------
Thomas J. Wilson, II
/s/ DAVID A. BIRD Director March 14, 2008
- -------------------------------------
David A. Bird
/s/ MICHAEL B. BOYLE Director March 14, 2008
- -------------------------------------
Michael B. Boyle
Director March 14, 2008
- -------------------------------------
Danny L. Hale
/s/ JOHN C. LOUNDS Director March 14, 2008
- -------------------------------------
John C. Lounds
/s/ GEORGE E. RUEBENSON Director March 14, 2008
- -------------------------------------
George E. Ruebenson
/s/ ERIC A. SIMONSON Director March 14, 2008
- -------------------------------------
Eric A. Simonson
/s/ KEVIN R. SLAWIN Director March 14, 2008
- -------------------------------------
Kevin R. Slawin
/s/ MICHAEL J. VELOTTA Director March 14, 2008
- -------------------------------------
Michael J. Velotta
/s/ DOUGLAS B. WELCH Director March 14, 2008
- -------------------------------------
Douglas B. Welch
</Table>
105
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE I--SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED
PARTIES DECEMBER 31, 2007
<Table>
<Caption>
AMOUNT AT
COST/ WHICH SHOWN
AMORTIZED ON BALANCE
(IN MILLIONS) COST FAIR VALUE SHEET
--------------- -------------- --------------
TYPE OF INVESTMENT
Fixed Maturities:
Bonds:
United States government, government agencies and authorities $ 2,848 $ 3,728 $ 3,728
States, municipalities and political subdivisions 4,235 4,311 4,311
Foreign governments 1,814 2,185 2,185
Public utilities 5,205 5,377 5,377
Convertibles and bonds with warrants attached 1,497 1,505 1,505
All other corporate bonds 24,937 24,867 24,867
Asset-backed securities 6,273 5,603 5,603
Mortgage-backed securities 3,499 3,490 3,490
Commercial mortgage-backed securities 7,698 7,388 7,388
Redeemable preferred stocks 14 15 15
---------------- -------------- --------------
Total fixed maturities 58,020 $ 58,469 58,469
================ ============== ==============
Equity Securities:
Common Stocks:
Public utilities -- $ -- --
Banks, trusts and insurance companies 36 34 34
Industrial, miscellaneous and all other 14 19 19
Non-redeemable preferred stocks 52 49 49
---------------- -------------- --------------
Total equity securities 102 $ 102 102
================ ============== ==============
Limited partnership interests 994 994
Mortgage loans on real estate 9,901 9,901
Real estate -- --
Real estate acquired in satisfaction of debt 1 1
Short-term investments 386 386
Derivative instruments 464 455
Policy loans 770 770
Other long-term investments 1,336 1,336
---------------- --------------
Total investments $ 71,974 $ 72,414
================ ==============
</Table>
S-1
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE IV--REINSURANCE
<Table>
<Caption>
PERCENTAGE
CEDED ASSUMED OF AMOUNT
GROSS TO OTHER FROM OTHER NET ASSUMED
(IN MILLIONS) AMOUNT COMPANIES (1) COMPANIES AMOUNT TO NET
------------ ------------- ------------ ------------ ------------
YEAR ENDED DECEMBER 31, 2007
Life insurance in force $ 490,484 $ 244,827 $ 11,490 $ 257,147 4.5%
Premiums and contract charges:
Life and annuities $ 2,168 $ 804 $ 42 $ 1,406 3.0%
Accident and health 174 136 -- 38 --%
------------ ------------ ------------ ------------ ------------
Total premiums and contract charges $ 2,342 $ 940 $ 42 $ 1,444 2.9%
============ ============ ============ ============ ============
YEAR ENDED DECEMBER 31, 2006
Life insurance in force $ 465,634 $ 236,278 $ 11,942 $ 241,298 5.0%
Premiums and contract charges:
Life and annuities $ 2,138 $ 639 $ 45 $ 1,544 2.9%
Accident and health 188 148 1 41 2.4%
------------ ------------ ------------ ------------ ------------
Total premiums and contract charges $ 2,326 $ 787 $ 46 $ 1,585 2.9%
============ ============ ============ ============ ============
YEAR ENDED DECEMBER 31, 2005
Life insurance in force $ 434,965 $ 223,194 $ 9,400 $ 221,171 4.3%
Premiums and contract charges:
Life and annuities $ 1,928 $ 445 $ 43 $ 1,526 2.8%
Accident and health 187 161 1 27 3.7%
------------ ------------ ------------ ------------ ------------
Total premiums and contract charges $ 2,115 $ 606 $ 44 $ 1,553 2.8%
============ ============ ============ ============ ============
</Table>
(1) No reinsurance or coinsurance income was netted against premium ceded in
2007, 2006 or 2005.
S-2