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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, 2008
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, Northbrook, Illinois 60062
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (847) 402-5000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: 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 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.
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Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company
/ / / / /X/ / /
(Do not check if a smaller reporting company)
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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 18, 2009, 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, 2008
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PAGE
PART I
Item 1. Business 1
Item 1A. Risk Factors 5
Item 1B. Unresolved Staff Comments 10
Item 2. Properties 11
Item 3. Legal Proceedings 11
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 79
Item 8. Financial Statements and Supplementary Data 80
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure 134
Item 9A. Controls and Procedures 134
Item 9B. Other Information 134
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 135
PART IV
Item 15. Exhibits and Financial Statement Schedules 136
Signatures 142
Financial Statement Schedules S-1
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* 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 Allstate Insurance Holdings, LLC, which is wholly 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 is
reinventing protection and retirement to help individuals in approximately 17
million households protect what they have today and better prepare for tomorrow.
Customers can access Allstate products and services such as auto insurance and
homeowners insurance through more than 14,000 exclusive Allstate agencies and
financial representatives in the United States and Canada. Allstate is the 2nd
largest personal property and casualty insurer in the United States on the basis
of 2007 statutory direct premiums earned. In addition, according to A.M. Best,
it is the nation's 16th largest issuer of life insurance business on the basis
of 2007 ordinary life insurance in force and 17th largest on the basis of 2007
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.
To achieve its goals in 2009, Allstate is focused on three priorities:
protect Allstate's financial strength, build customer loyalty, and continue
reinventing protection and retirement for the consumer.
In this annual report on Form 10-K, we occasionally refer to statutory
financial information. All domestic United States insurance companies are
required to prepare statutory-basis financial statements. 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 of America ("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 over 60% of the 25 largest banks, a number of regional brokerage firms and
many independent broker-dealers. We sell products through independent agents
affiliated with approximately 160 master brokerage agencies. We sell funding
agreements to unaffiliated trusts used to back medium-term notes.
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DISTRIBUTION CHANNELS, PRODUCTS AND TARGET CUSTOMERS
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DISTRIBUTION CHANNEL PRIMARY PRODUCTS TARGET CUSTOMERS
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ALLSTATE EXCLUSIVE AGENCIES Term life insurance Middle market consumers(1) with
Interest-sensitive life insurance retirement and family financial
(Allstate exclusive agents Variable life insurance protection needs
and Allstate exclusive Deferred fixed annuities (including
financial specialists) indexed and market value adjusted "MVA")
Immediate fixed annuities
INDEPENDENT AGENTS Term life insurance Mass market(2) and mass affluent
(through master brokerage Interest-sensitive life insurance consumers(3) with retirement
agencies) Variable life insurance and financial protection needs
Deferred fixed annuities (including indexed
and MVA)
Immediate fixed annuities
BANKS Deferred fixed annuities (including indexed Middle market consumers with
and MVA) retirement needs
Single premium fixed life insurance
Variable annuities - fully reinsured with an
unaffiliated entity
BROKER-DEALERS Deferred fixed annuities (including indexed Mass market and mass affluent
and MVA) consumers with retirement needs
Single premium variable life insurance
STRUCTURED SETTLEMENT Structured settlement annuities Typically used to fund or annuitize
ANNUITY BROKERS large claims or litigation settlements
BROKER-DEALERS Funding agreements backing medium-term notes Institutional and individual investors
(Funding agreements)
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(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.
In connection with an initiative to lower operating expenses beginning in
2009, we plan to improve efficiency and narrow the focus of product offerings to
better serve the needs of everyday Americans.
COMPETITION
We compete on a wide variety of factors, including the scope of our
distribution systems, the type 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, 2008, there were
approximately 500 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, 2007, the Allstate Life Group is the nation's 16th largest issuer
of life insurance and related business on the basis of 2007 ordinary life
insurance in force and 17th largest on the basis of 2007 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.
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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 also sell funding agreements in the United States.
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, 2008, based on information contained
in statements filed with state insurance departments.
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Delaware 37.7%
California 6.6%
Florida 6.0%
New York 5.8%
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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
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.
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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 through continued use.
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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,
investment results, 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.
CHANGES IN UNDERWRITING AND ACTUAL EXPERIENCE COULD MATERIALLY AFFECT
PROFITABILITY AND FINANCIAL CONDITION
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 taking into account rating agencies and 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 and financial condition.
CHANGES IN RESERVE ESTIMATES MAY ADVERSELY AFFECT OUR OPERATING RESULTS
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 amortization of
deferred policy acquisition costs ("DAC") may be required which could have a
material adverse effect on our operating results.
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 partially offset decreases in investment yield on some products.
However, these changes could be limited by market conditions, regulatory minimum
rates 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.
Non-parallel shifts in interest rates, such as 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
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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. This could lead to the sale of fixed income
securities at a loss. 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 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 ADVERSELY AFFECT OUR PROFITABILITY
AND FINANCIAL CONDITION 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 and estimated future gross profits ("EGP") over the estimated lives of
the contracts. 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 contractholders, and the
effects of persistency, mortality, expenses, and hedges if applicable. Updates
to these assumptions (commonly referred to as "DAC unlocking") could adversely
affect our profitability and financial condition. In 2008, DAC unlocking
resulted in increased amortization of DAC of $329 million.
NARROWING THE FOCUS OF OUR PRODUCT OFFERINGS AND REDUCING OUR CONCENTRATION IN
FIXED ANNUITIES AND FUNDING AGREEMENTS MAY ADVERSELY AFFECT REPORTED RESULTS
Due to the current capital market conditions, we have been pursuing
strategies to narrow our product offerings and reduce our concentration in fixed
annuities and funding agreements. Lower new sales of these products, as well as
our ongoing risk mitigation and return optimization programs, could negatively
impact investment portfolio levels, complicate settlement of expiring contracts
including forced sales of assets with unrealized capital losses, impact DAC
amortization, and affect goodwill impairment testing and insurance reserves
deficiency testing.
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 AND
FINANCIAL CONDITION
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 profitability and financial condition 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 WHICH MAY ADVERSELY
IMPACT INVESTMENT INCOME AND CAUSE ADDITIONAL REALIZED LOSSES
Although we continually reevaluate our proactive risk mitigation and return
optimization programs, we remain subject to the risk that we will incur losses
due to adverse changes in equity prices, interest rates or foreign currency
exchange rates. Our primary market risk exposures are to changes in interest
rates and, to a lesser degree, equity prices and changes in 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 general
weakening in the economy. Although to some extent we use derivative financial
instruments to manage these risks, the effectiveness of such instruments is
subject to the same risks.
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
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decline could also lead us to purchase longer-term or 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.
DETERIORATING FINANCIAL PERFORMANCE ON SECURITIES COLLATERALIZED BY MORTGAGE
LOANS AND COMMERCIAL MORTGAGE LOANS MAY LEAD TO WRITE-DOWNS
Changes in mortgage delinquency or recovery rates, declining real estate
prices, changes in credit or bond insurer strength ratings 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.
THE IMPACT OF OUR INVESTMENT STRATEGIES MAY BE ADVERSELY AFFECTED BY
DEVELOPMENTS IN THE INVESTMENT MARKETS
The impact of our investment portfolio risk mitigation and return
optimization programs and enterprise asset allocation actions may be adversely
affected by unexpected developments in the investment markets. For example,
derivative contracts, when entered into, may result in coverage that is not as
effective as intended.
CONCENTRATION OF OUR INVESTMENT PORTFOLIOS IN ANY PARTICULAR SEGMENT OF THE
ECONOMY MAY HAVE ADVERSE EFFECTS ON OUR OPERATING RESULTS AND FINANCIAL
CONDITION
The concentration of our investment portfolios in any particular industry,
collateral types, 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 condition. 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.
THE DETERMINATION OF THE AMOUNT OF REALIZED CAPITAL LOSSES RECORDED FOR
IMPAIRMENTS OF OUR INVESTMENTS IS HIGHLY SUBJECTIVE AND COULD MATERIALLY IMPACT
OUR OPERATING RESULTS AND FINANCIAL CONDITION
The determination of the amount of realized capital losses recorded for
impairments vary by investment type and is based upon our periodic evaluation
and assessment of known and inherent risks associated with the respective asset
class. Such evaluations and assessments are revised as conditions change and new
information becomes available. Management updates its evaluations regularly and
reflects changes in realized capital gains and losses from impairments in
operating results as such evaluations are revised. There can be no assurance
that our management has accurately assessed the level of or amounts recorded for
impairments taken in our financial statements. Furthermore, additional
impairments may need to be recorded in the future. Historical trends may not be
indicative of future impairments. For example, the amortized cost or cost of our
fixed income and equity securities is adjusted for impairments in value deemed
to be other than temporary in the period in which the determination is made. The
assessment of whether impairments have occurred is based on management's
case-by-case evaluation of the underlying reasons for the decline in fair value.
THE DETERMINATION OF THE FAIR VALUE OF OUR FIXED INCOME AND EQUITY SECURITIES
RESULTS IN UNREALIZED NET CAPITAL GAINS AND LOSSES AND IS HIGHLY SUBJECTIVE AND
COULD MATERIALLY IMPACT OUR OPERATING RESULTS AND FINANCIAL CONDITION
In determining fair value we generally utilize market transaction data for
the same or similar instruments. The degree of management judgment involved in
determining fair values is inversely related to the availability of market
observable information. The fair value of financial assets and financial
liabilities may differ from the amount actually received to sell an asset or the
amount paid to transfer a liability in an orderly transaction between market
participants at the measurement date. Moreover, the use of different valuation
assumptions may have a material effect on the financial assets' and financial
liabilities' fair values. The difference between amortized cost or cost and fair
value, net of deferred income taxes, certain DAC, certain deferred sales
inducement costs ("DSI"), and certain reserves for life-contingent contract
benefits, is reflected as a component of accumulated other comprehensive income
in shareholder's equity. As of December 31, 2008, total unrealized net capital
losses was $6.70 billion. In the last 10 years, our quarterly net unrealized
capital gains and losses have ranged from a $4.35 billion net unrealized capital
gain at June 30, 2003 to a $6.70 billion net unrealized capital loss at December
31, 2008. Changing market conditions could materially effect the determination
of the fair value of our securities and unrealized net capital gains and losses
could vary significantly. Determining fair value is highly subjective and could
materially impact our operating results and financial condition.
7
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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.
DIFFICULT CONDITIONS IN THE ECONOMY GENERALLY COULD ADVERSELY AFFECT OUR
BUSINESS AND OPERATING RESULTS
Economists now believe the United States economy has entered into a
recessionary period and are projecting significant negative macroeconomic
trends, including widespread job losses, higher unemployment, lower consumer
spending, continued declines in home prices and substantial increases in
delinquencies on consumer debt, including defaults on home mortgages. Moreover,
recent disruptions in the financial markets, particularly the reduced
availability of credit and tightened lending requirements, have impacted the
ability of borrowers to refinance loans at more affordable rates. We cannot
predict the length and severity of a recession, but as with most businesses, we
believe a longer or more severe recession could have an adverse effect on our
business and results of operations.
A general economic slowdown could adversely affect us in the form of
consumer behavior and pressure on our investment portfolio. Consumer behavior
could include decreased demand for our products. Holders of some of our life
insurance and annuity products may engage in an elevated level of discretionary
withdrawals of contractholder funds. Our investment portfolio could be adversely
affected as a result of deteriorating financial and business conditions
affecting the issuers of the securities in our investment portfolio.
THERE CAN BE NO ASSURANCE THAT ACTIONS OF THE U.S. FEDERAL GOVERNMENT, FEDERAL
RESERVE AND OTHER GOVERNMENTAL AND REGULATORY BODIES FOR THE PURPOSE OF
STABILIZING THE FINANCIAL MARKETS AND STIMULATING THE ECONOMY WILL ACHIEVE THE
INTENDED EFFECT
In response to the financial crises affecting the banking system, the
financial markets and the broader economy, the U.S. federal government, the
Federal Reserve and other governmental and regulatory bodies have taken or are
considering taking action to address such conditions including, among other
things, purchasing mortgage-backed and other securities from financial
institutions, investing directly in banks, thrifts and bank and savings and loan
holding companies and increasing federal spending to stimulate the economy.
There can be no assurance as to what impact such actions will have on the
financial markets or on economic conditions. Such continued volatility and
economic deterioration could materially and adversely affect our business,
financial condition and results of operations.
LOSSES FROM LITIGATION MAY BE MATERIAL TO OUR OPERATING RESULTS OR CASH FLOWS
AND FINANCIAL CONDITION
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 and to our
financial condition.
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, particularly when compliance is judged in
hindsight. In addition, there is risk that any particular regulator's or
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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
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, WHICH COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING RESULTS AND FINANCIAL CONDITION
The collectability of reinsurance recoverables is subject to uncertainty
arising from a number of factors, including changes in market conditions,
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.
A DOWNGRADE IN OUR FINANCIAL STRENGTH RATINGS MAY HAVE AN ADVERSE EFFECT ON OUR
COMPETITIVE POSITION, THE MARKETABILITY OF OUR PRODUCT OFFERINGS, AND OUR
LIQUIDITY, OPERATING RESULTS AND FINANCIAL CONDITION
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 current insurance financial strength ratings
of the Company are A+, AA- and A1 from A.M. Best, Standard & Poor's and Moody's,
respectively. The current insurance financial strength ratings of AIC are A+,
AA- and Aa3 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 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.
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ADVERSE CAPITAL AND CREDIT MARKET CONDITIONS MAY SIGNIFICANTLY AFFECT OUR
ABILITY TO MEET LIQUIDITY NEEDS OR OUR ABILITY TO OBTAIN CREDIT ON ACCEPTABLE
TERMS
The capital and credit markets have been experiencing extreme volatility
and disruption. In some cases, the markets have exerted downward pressure on the
availability of liquidity and credit capacity. In the event that we need access
to additional capital to pay our operating expenses, make payments on our
indebtedness, pay for capital expenditures or fund acquisitions, our ability to
obtain such capital may be limited and the cost of any such capital may be
significant. Our access to additional financing will depend on a variety of
factors such as market conditions, the general availability of credit, the
overall availability of credit to our industry, our credit ratings and credit
capacity, as well as lenders' perception of our long- or short-term financial
prospects. Similarly, our access to funds may be impaired if regulatory
authorities or rating agencies take negative actions against us. If a
combination of these factors were to occur, our internal sources of liquidity
may prove to be insufficient, and in such case, we may not be able to
successfully obtain additional financing on favorable terms.
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, interpreted
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 REALIZATION OF DEFERRED TAX ASSETS IS SUBJECT TO UNCERTAINTY
The realization of our deferred tax assets, net of valuation allowances, is
based on our assumption that we will be able to fully utilize the deductions
that are ultimately recognized for tax purposes. However, actual results may
differ from our assumptions if adequate levels of taxable income are not
attained.
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,
PROFITABILITY OR CASH FLOWS
Allstate recognizes the scientific view that the world is getting warmer.
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.
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ITEM 2. PROPERTIES
Our home office is part of the Parent Group's home office complex in
Northbrook, Illinois. As of December 31, 2008, 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.
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.
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 Allstate Insurance Holdings, LLC, which is wholly owned by The Allstate
Corporation.
The Company did not pay dividends on its common stock in 2008. In 2007,
Allstate Life paid the following amounts to AIC in the aggregate on the dates
specified as dividends on its common stock:
<Table>
<Caption>
($ IN MILLIONS)
PAYMENT DATE AGGREGATE AMOUNT
September 24, 2007 $ 85
December 17, 2007 251
December 21, 2007 389
</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.
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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) 2008 2007 2006 2005 2004
------------- ------------- ------------- ------------ -------------
CONSOLIDATED OPERATING RESULTS
Premiums $ 585 $ 502 $ 576 $ 474 $ 637
Contract charges 911 942 1,009 1,079 961
Net investment income 3,720 4,205 4,057 3,707 3,260
Realized capital gains and losses (3,052) (197) (79) 19 (11)
Total revenues 2,164 5,452 5,563 5,279 4,847
(Loss) income before cumulative effect of
change in accounting principle, after-tax (1,690) 412 428 417 356
Cumulative effect of change in accounting
principle, after-tax -- -- -- -- (175)
Net (loss) income (1,690) 412 428 417 181
CONSOLIDATED FINANCIAL POSITION
Total investments $ 59,772 $ 72,414 $ 74,160 $ 72,756 $ 69,689
Total assets 81,946 96,117 98,758 95,022 90,401
Reserve for life-contingent contract benefits
and contractholder funds 69,036 73,062 72,769 70,071 65,142
Long-term debt/surplus notes due to related parties 650 200 206 181 104
Shareholder's equity 2,209 4,763 5,498 6,008 6,309
</Table>
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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
2008 HIGHLIGHTS ......................................... 20
OPERATIONS .............................................. 21
INVESTMENTS ............................................. 31
MARKET RISK ............................................. 68
DEFERRED TAXES .......................................... 71
CAPITAL RESOURCES AND LIQUIDITY ......................... 72
REGULATION AND LEGAL PROCEEDINGS ........................ 79
PENDING ACCOUNTING STANDARDS ............................ 79
</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", the
"Company" or "ALIC"). 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 business performance and to determine the allocation of resources.
We are focused on three priorities in 2009: protecting our financial
strength, building customer loyalty, and continue reinventing protection and
retirement for the consumer.
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, and new business returns;
- For investments: credit quality/experience, realized capital gains and
losses, investment income, unrealized capital gains and losses,
stability of long-term returns, total returns, cash flows, and asset
and liability duration; and
- For financial condition: liquidity, our financial strength ratings,
operating leverage, debt leverage, and return on equity.
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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:
- Fair Value of Financial Assets and Financial Liabilities
- Impairment of Fixed Income and Equity Securities
- Deferred Policy Acquisition Costs ("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 our
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.
FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES Statement of Financial
Accounting Standards No. 157, FAIR VALUE MEASUREMENTS ("SFAS No. 157"), is
effective for fiscal years beginning after November 15, 2007. We adopted the
provisions of SFAS No. 157 as of January 1, 2008 for financial assets and
financial liabilities that are measured at fair value. SFAS No. 157:
- Defines 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, and establishes a
framework for measuring fair value;
- Establishes a three-level hierarchy for fair value measurements based
upon the transparency of inputs to the valuation as of the measurement
date;
- Expands disclosures about financial instruments measured at fair
value.
We categorize our financial assets and financial liabilities measured at
fair value based on the observability of inputs to the valuation techniques,
into a three-level fair value hierarchy as follows:
LEVEL 1: Financial assets and financial liabilities whose values are based on
unadjusted quoted prices for identical assets or liabilities in an
active market that we can access.
LEVEL 2: Financial assets and financial liabilities whose values are based on
the following:
(a) Quoted prices for similar assets or liabilities in active
markets;
(b) Quoted prices for identical or similar assets or liabilities in
non-active markets; or
(c) Valuation models whose inputs are observable, directly or
indirectly, for substantially the full term of the asset or
liability.
LEVEL 3: Financial assets and financial liabilities whose values are based on
prices or valuation techniques that require inputs that are both
unobservable and significant to the overall fair value measurement.
These inputs may reflect our estimates of the assumptions that market
participants would use in valuing the financial assets and financial
liabilities.
Observable inputs are those used by market participants in valuing
financial instruments that are developed based on market data obtained from
independent sources. In the absence of sufficient observable inputs,
unobservable inputs reflect our estimates of the assumptions market participants
would use in valuing financial assets and financial liabilities and are
developed based on the best information available in the circumstances. The
degree of management judgment involved in determining fair values is inversely
related to the availability of market observable information.
To distinguish among the categories, we consider the frequency of completed
transactions such as daily trading for equity securities. If inputs used to
measure a financial instrument fall within different levels of the fair value
hierarchy, the categorization is based on the lowest level input that is
significant to the fair value measurement of the
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entire instrument. Certain financial assets are not carried at fair value on a
recurring basis, including investments such as mortgage loans, limited
partnership interests, bank loans and policy loans. Accordingly, such
investments are only included in the fair value hierarchy disclosure when the
investment is subject to remeasurement at fair value after initial recognition
and the resulting measurement is reflected in the consolidated financial
statements. In addition, equity options embedded in fixed income securities are
not disclosed in the hierarchy with free-standing derivatives, as the embedded
derivatives are presented as combined instruments in fixed income securities.
We are responsible for the determination of fair value of financial assets
and financial liabilities and the supporting assumptions and methodologies. We
gain assurance on the overall reasonableness and consistent application of
valuation input assumptions, valuation methodologies and compliance with
accounting standards for fair value determination through the execution of
various processes and controls designed to ensure that our financial assets and
financial liabilities are appropriately valued. We monitor fair values received
from third parties and those derived internally on an ongoing basis.
In certain situations, we employ independent third-party valuation service
providers to gather, analyze, and interpret market information and derive fair
values based upon relevant assumptions and methodologies for individual
instruments. In situations where our valuation service providers are unable to
obtain sufficient market observable information upon which to estimate the fair
value for a particular security, fair value is determined either by requesting
brokers who are knowledgeable about these securities to provide a single quote
or by employing internal valuation models that are widely accepted in the
financial services industry. Changing market conditions are incorporated into
valuation assumptions and reflected in the fair values, which are validated by
calibration and other analytical techniques to available market observable data.
Valuation service providers typically obtain data about market transactions
and other key valuation model inputs from multiple sources and, through the use
of proprietary algorithms, produce valuation information in the form of a single
fair value for individual securities for which a fair value has been requested
under the terms of our agreements. For certain equity securities, valuation
service providers provide market quotations for completed transactions on the
measurement date. For other security types, fair values are derived from the
valuation service providers' proprietary valuation models. The inputs used by
the valuation service providers include, but are not limited to, market prices
from recently completed transactions and transactions of comparable securities,
interest rate yield curves, credit spreads, liquidity spread, currency rates,
and other market-observable information, as applicable. Credit and liquidity
spreads are typically implied from completed transactions and transactions of
comparable securities. Valuation service providers also use proprietary
discounted cash flow models that are widely accepted in the financial services
industry and similar to those used by other market participants to value the
same financial instruments. The valuation models take into account, among other
things, market observable information as of the measurement date, as described
above, as well as the specific attributes of the security being valued including
its term, interest rate, credit rating, industry sector, and where applicable,
collateral quality and other issue or issuer specific information. Executing
valuation models effectively requires seasoned professional judgment and
experience. In cases where market transactions or other market observable data
is limited, the extent to which judgment is applied varies inversely with the
availability of market observable information.
For certain of our financial assets carried at fair value, where our
valuation service providers cannot provide fair value determinations, we obtain
non-binding price quotes from brokers familiar with the security who, similar to
our valuation service providers, may consider transactions or activity in
similar securities, as applicable, among other information. The brokers
providing price quotes are generally from the brokerage divisions of leading
financial institutions with market making, underwriting and distribution
expertise.
The fair value of financial assets and financial liabilities, including
privately-placed securities, certain free-standing derivatives and certain
derivatives embedded in certain contractholder liabilities, where our valuation
service providers or brokers do not provide fair value determinations, is
determined using valuation methods and models widely accepted in the financial
services industry. Internally developed valuation models, which include inputs
that may not be market observable and as such involve some degree of judgment,
are considered appropriate for each class of security to which they are applied.
Our internal pricing methods are primarily based on models using discounted
cash flow methodologies that determine a single best estimate of fair value for
individual financial instruments. In addition, our models use internally
assigned credit ratings as inputs (which are generally consistent with any
external ratings and those we use to report our holdings by credit rating) and
stochastically determined cash flows for certain derivatives embedded in certain
contractholder liabilities, both of which are difficult to independently observe
and verify. Instrument specific inputs used in our internal fair value
determinations include: coupon rate, coupon type, weighted average life, sector
of the issuer, call provisions, and the contractual elements of derivatives
embedded in certain contractholder liabilities. Market related inputs used in
these fair values, which we believe are representative of inputs other market
participants would use to determine the fair value of the same instruments
include: interest rate yield curves, quoted market prices of comparable
securities, credit spreads, estimated liquidity premiums, and other applicable
15
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market data including lapse and anticipated market return estimates for
derivatives embedded in certain contractholder liabilities. Credit spreads are
determined using those published by a commonly used industry specialist for
comparable public securities. A liquidity premium is also added to certain
securities to reflect spreads commonly required for the types of securities
being valued and are calibrated based on actual trades or other market data. As
a result of the significance of non-market observable inputs, including
internally assigned credit ratings and stochastic cash flow estimates as
described above, judgment is required in developing these fair values. The fair
value of these financial assets and financial liabilities may differ from the
amount actually received to sell an asset or the amount paid to transfer a
liability in an orderly transaction between market participants at the
measurement date. Moreover, the use of different valuation assumptions may have
a material effect on the financial assets' and financial liabilities' fair
values.
Fair value of our investments comprise an aggregation of numerous, single
best estimates for each security in the Consolidated Statements of Financial
Position. Because of this detailed approach, there is no single set of
assumptions that determine our fair value estimates at a consolidated level.
Moreover, management does not compile a range of estimates for items reported at
fair value at the consolidated level because we do not believe that a range
would provide meaningful information. In the last 10 years, our quarterly net
unrealized capital gains and losses have ranged from a $4.35 billion net
unrealized capital gain at June 30, 2003 to a $6.70 billion net unrealized
capital loss at December 31, 2008. The change in net unrealized capital gains
and losses by quarter over the 10 year period has averaged $741 million and has
ranged from a $3.66 billion decrease to a $1.45 billion increase.
Level 1 and Level 2 measurements represent valuations where all significant
inputs are market observable. Level 3 measurements have one or more significant
inputs that are not market observable and as a result these fair value
determinations have greater potential variability as it relates to their
significant inputs. The Level 3 principal components are privately placed
securities valued using internal models and broker quoted securities.
Additionally, due to the reduced availability of actual market prices or
relevant observable inputs as a result of the decrease in liquidity that has
been experienced in the market, all asset-backed residential mortgage-backed
securities ("ABS RMBS"), auction rate securities ("ARS") backed by student
loans, Alt-A residential mortgage-backed securities ("Alt-A"), other
collateralized debt obligations ("CDO"), certain asset-backed securities ("ABS")
and certain commercial mortgage-backed securities ("CMBS") are categorized as
Level 3. In general, the greater the reliance on significant inputs that are not
market observable, the greater potential variability of the fair value
determinations. For broker quoted securities' fair value determinations, which
were all categorized as Level 3, we believe the brokers providing the quotes may
consider market observable transactions or activity in similar securities, as
applicable, and other information as calibration points. Privately placed
securities' fair value determinations, which are based on internal ratings that
are not market observable and categorized as Level 3, are calibrated to market
observable information in the form of external National Association of Insurance
Commissioners ("NAIC") ratings and credit spreads.
We believe our most significant exposure to changes in fair value is due to
market risk. Our exposure to changes in market conditions is discussed fully in
the Market Risk section of the MD&A.
We employ specific control processes to determine the reasonableness of the
fair value of our financial assets and financial liabilities. Our processes are
designed to ensure that the values received or internally estimated are
accurately recorded and that the data inputs and the valuation techniques
utilized are appropriate, consistently applied, and that the assumptions are
reasonable and consistent with the objective of determining fair value. For
example, on a continuing basis, we assess the reasonableness of individual
security values received from valuation service providers that exceed certain
thresholds as compared to previous values received from those valuation service
providers. In addition, we may validate the reasonableness of fair values by
comparing information obtained from our valuation service providers to other
third party valuation sources for selected financial assets. When fair value
determinations are expected to be more variable, we validate them through
reviews by members of management who have relevant expertise and who are
independent of those charged with executing investment transactions. We do not
alter fair values provided by our valuation providers or brokers.
16
<Page>
The following table identifies investments as of December 31, 2008 by
source of value determination:
<Table>
<Caption>
INVESTMENTS
---------------------------
($ IN MILLIONS) FAIR PERCENT
VALUE TO TOTAL
------------- -----------
Fair value based on internal sources $ 8,551 14.3%
Fair value based on external sources (1) 37,835 63.3
------------- -----------
Total fixed income, equity and short-term securities 46,386 77.6
Fair value of derivatives 138 0.2
Mortgage loans, policy loans, bank loans and limited
partnership and other investments, valued at cost,
amortized cost and the equity method 13,248 22.2
------------- -----------
Total $ 59,772 100.0%
============= ===========
</Table>
- ----------
(1) Includes $2.58 billion that are valued using broker quotes.
For more detailed information on our accounting policy for the fair value
of financial assets and financial liabilities and information on the financial
assets and financial liabilities included in the levels promulgated by SFAS No.
157, see Note 2 of the consolidated financial statements.
IMPAIRMENT OF FIXED INCOME AND EQUITY SECURITIES 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 the decline in fair value is
deemed other than temporary. The assessment of whether the impairment of a
security's fair value is other than temporary is performed using a portfolio
review as well as a case-by-case review considering a wide range of factors.
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 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 obtained
that causes a change in our ability or intent to hold a security to maturity or
until it recovers in value. Examples of situations which may change our ability
or intent to hold a security to maturity or recovery include where significant
unanticipated new facts and circumstances emerge or existing facts and
circumstances increase in significance and are anticipated to adversely impact a
security's future valuations more than previously expected, including negative
developments that would change the view of long term investors and their intent
to continue to hold the investment, subsequent credit deterioration of an issuer
or holding, subsequent further deterioration in capital markets (i.e. debt and
equity) and of economic conditions, subsequent further deterioration in the
financial services and real estate industries, liquidity needs, federal income
tax situations involving capital gains and capital loss carrybacks and
carryforwards with specific expiration dates, investment risk mitigation
actions, and other new facts and circumstances that would cause a change in our
previous intent to hold a security to recovery or maturity. 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 our entire 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 described 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
17
<Page>
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.
Fixed income securities subject to other-than-temporary impairment
write-downs continue to earn investment income when future expected payments are
both reasonably estimable and probable, and any discount or premium is
recognized using the effective yield method over the expected life of the
security; otherwise income recognition is discontinued. 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
Risk Factors sections of this document.
DEFERRED POLICY ACQUISITION COSTS AMORTIZATION We incur significant costs in
connection with acquiring insurance policies and investment contracts. In
accordance with GAAP, costs that vary with and are primarily related to
acquiring insurance policies and investment contracts are deferred and recorded
as an asset on the Consolidated Statements of Financial Position. The
amortization methodology for DAC includes significant assumptions and estimates.
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 are consistent with the assumptions used to calculate the reserve
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 policies 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
policies on an aggregate basis using actual experience. We aggregate all
products accounted for pursuant to Statement of Financial Accounting Standards
No. 60, "Accounting and Reporting by Insurance Enterprises" ("SFAS No. 60"), in
the analysis. 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.
In 2008, for traditional life insurance and immediate annuities with life
contingencies, an aggregate premium deficiency of $336 million pre-tax ($219
million after-tax) resulted primarily from a study indicating that the
annuitants on certain life-contingent contracts are projected to live longer
than we anticipated when the contracts were issued and, to a lesser degree, a
reduction in the related investment portfolio yield. The deficiency was recorded
through a reduction in DAC. In 2007 and 2006, our reviews concluded that no
premium deficiency adjustments were necessary, primarily due to projected income
from traditional life insurance more than offsetting the projected deficiency in
immediate annuities with life contingencies.
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: contract charges for the
cost of insurance less mortality costs and other benefits (benefit margin);
investment income and realized capital gains and losses less interest credited
(investment margin); and surrender and other contract charges less maintenance
expenses (expense margin). 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 contractholders,
and the effects of persistency, mortality, expenses, and hedges if applicable,
and these assumptions 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 reasonably 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
18
<Page>
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.
Annually we review all assumptions underlying the projections of EGP,
including investment returns, comprising investment income and realized capital
gains and losses, interest crediting rates, persistency, mortality, 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, primarily realized capital losses, expenses,
mortality and the number of contracts in force or persistency resulting in net
DAC amortization acceleration of $329 million in 2008, deceleration of $12
million in 2007 and acceleration of $2 million in 2006.
The following table provides the effect on DAC amortization of changes in
assumptions relating to the gross profit components of investment margin,
benefit margin and expense margin during the years ended December 31.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
----------- ----------- -----------
Investment margin $ (303) $ 11 $ 15
Benefit margin 35 34 (13)
Expense margin (61) (33) (4)
----------- ----------- -----------
Net (acceleration) deceleration $ (329) $ 12 $ (2)
=========== =========== ===========
</Table>
DAC amortization acceleration related to changes in the EGP component of
investment margin in 2008 was primarily due to the level of realized capital
losses impacting actual gross profits in 2008 and the impact of realized capital
losses on expected gross profits in 2009. The deceleration related to benefit
margin was due to more favorable projected life insurance mortality. The
acceleration related to expense margin resulted from current and expected
expense levels higher than previously projected. DAC amortization deceleration
related to changes in the EGP component of investment margin in 2007 was due to
higher yields from repositioning of the investment portfolio and reduced
interest crediting rates on annuities. The deceleration related to benefit
margin was due to more favorable projected life insurance mortality. The
acceleration related to expense margin was a result of expenses being higher
than expected.
The following table displays the sensitivity of reasonably likely changes
in assumptions included in the gross profit components of investment margin or
benefit margin to amortization of the DAC balance as of December 31, 2008.
<Table>
<Caption>
($ IN MILLIONS) DECEMBER 31, 2008
INCREASE/(REDUCTION) IN DAC
-----------------------------
Increase in future investment margins of 25 basis points $ 169
Decrease in future investment margins of 25 basis points $ (195)
Decrease in future life mortality by 1% $ 28
Increase in future life mortality by 1% $ (31)
</Table>
Any potential changes in assumptions discussed above are measured without
consideration of correlation among assumptions. Therefore, it would be
inappropriate to add them together in an attempt to estimate overall variability
in amortization.
For additional discussion see the Risk Factors section of this document and
Note 2 and 10 of the consolidated financial statements.
19
<Page>
RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS ESTIMATION Benefits for these
policies 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 immediate annuities. These assumptions, which for
traditional life insurance 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. 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 policies, 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 policies 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. In
2008, for traditional life insurance and immediate annuities with life
contingencies, an aggregate premium deficiency of $336 million pre-tax ($219
million after-tax) resulted primarily from a study indicating that the
annuitants on certain life-contingent contracts are projected to live longer
than we anticipated when the contracts were issued and, to a lesser degree, a
reduction in the related investment portfolio yield. The deficiency was recorded
through a reduction in DAC. In 2007 and 2006, our reviews concluded that no
premium deficiency adjustments were necessary, primarily due to projected income
from traditional life insurance more than offsetting the projected deficiency in
immediate annuities with life contingencies. We will continue to monitor the
experience of our traditional life insurance and immediate annuities. Further
significant changes in mortality experience or the portfolio yield could result
in additional charges in future periods. 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 Risk Factors section of this document.
2008 HIGHLIGHTS
- - Net loss was $1.69 billion in 2008 compared to net income of $412 million
in 2007.
- - Net realized capital losses totaled $3.05 billion in 2008 compared to $197
million in 2007.
- - During 2008, we recorded $399 million in accelerated DAC and deferred sales
inducement costs ("DSI") amortization related to deferred annuities and
interest-sensitive life insurance due to changes in assumptions (which
resulted in changes to total EGP). Additional amortization of DAC totaling
$336 million was recorded in connection with a premium deficiency
assessment for traditional life insurance and immediate annuities with life
contingencies primarily due to revised annuity mortality assumptions.
- - Contractholder fund deposits totaled $9.29 billion for 2008 compared to
$7.96 billion for 2007.
- - Investments as of December 31, 2008 decreased 17.5% to $59.77 billion from
$72.41 billion as of December 31, 2007 and net investment income decreased
11.5% to $3.72 billion in 2008 from $4.21 billion in 2007.
- - Continued focus on improving returns and reducing our concentration in
spread based products, primarily fixed annuities and institutional markets
products.
- - Launched an initiative that will result in lower operating expenses in
2009 and 2010, and targeting annual savings of $90 million beginning in
2011.
20
<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 strategic vision is to reinvent protection and retirement for the
consumer.
To achieve our vision and reach our financial goals, our primary objectives
are to deepen financial services relationships with Allstate customers and
restore profitability through operational excellence and portfolio optimization.
Sales in non-proprietary channels will be increasingly tactical as we assess
market opportunities. In addition to focusing on higher return markets,
products, and distribution channels, we will continue to emphasize capital
efficiency and enterprise risk and return management strategies and actions.
Our strategy provides a platform to profitably grow our business. Based
upon Allstate's strong financial position and brand, our customers seek
assistance in meeting their protection and retirement 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 distribution partners
provide a foundation to deliver value to our customers.
We plan to offer a more focused suite of products designed for middle
market consumers to help everyday Americans meet their financial protection
needs 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 a wide range of distribution
channels including Allstate exclusive agencies, which include exclusive
financial specialists, independent agents (including master brokerage agencies),
financial service firms such as banks and 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) 2008 2007 2006
----------- ----------- -----------
REVENUES
Premiums (1) $ 585 $ 502 $ 576
Contract charges (1) 911 942 1,009
Net investment income 3,720 4,205 4,057
Realized capital gains and losses (3,052) (197) (79)
----------- ----------- -----------
Total revenues 2,164 5,452 5,563
COSTS AND EXPENSES
Contract benefits (1,397) (1,364) (1,372)
Interest credited to contractholder funds (2,356) (2,628) (2,543)
Amortization of DAC (643) (518) (538)
Operating costs and expenses (399) (338) (374)
Restructuring and related charges (1) (2) (24)
----------- ----------- -----------
Total costs and expenses (4,796) (4,850) (4,851)
Loss on disposition of operations (4) (10) (88)
Income tax benefit (expense) 946 (180) (196)
----------- ----------- -----------
Net (loss) income $ (1,690) $ 412 $ 428
=========== =========== ===========
Investments at December 31 $ 59,772 $ 72,414 $ 74,160
=========== =========== ===========
</Table>
- ----------
(1) Beginning in 2008, certain ceded reinsurance premiums previously
included as a component of traditional life insurance premiums were
reclassified prospectively to be reported as a component of
interest-sensitive life insurance contract charges. In 2007 and 2006,
these ceded reinsurance premiums were $90 million and $53 million,
respectively.
21
<Page>
Effective June 1, 2006, the Company disposed of substantially all of its
variable annuity business through reinsurance with Prudential Financial Inc.
("Prudential"). The following table presents the results of operations
attributable to our reinsured variable annuity business for the period of 2006
prior to the disposition.
<Table>
<Caption>
($ IN MILLIONS) 2006
----------
Contract charges $ 136
Net investment income 17
Realized capital gains and losses (8)
----------
Total revenues 145
Contract benefits (13)
Interest credited to contractholder funds (24)
Amortization of deferred policy acquisition costs (44)
Operating costs and expenses (43)
----------
Total costs and expenses (124)
Loss on disposition of operations (89)
----------
Income from operations before income tax
expense (1) $ (68)
==========
</Table>
- ----------
(1) For 2006, income from operations before income tax
expense attributable to the variable annuity business
reinsured to Prudential included investment spread and
benefit spread of $(7) million and $13 million,
respectively.
NET LOSS in 2008 was $1.69 billion compared to net income of $412 million and
$428 million in 2007 and 2006, respectively. The change in 2008 was primarily
the result of the recognition of higher net realized capital losses in the
current year compared to the prior year and, to a lesser extent, DAC and DSI
amortization acceleration for changes in assumptions and additional amortization
of DAC that was recorded in connection with a premium deficiency assessment for
traditional life insurance and immediate annuities with life contingencies due
to revised annuity mortality assumptions. Net income in 2007 was comparable to
2006 as lower losses associated with dispositions of operations were almost
entirely offset by a decline in total revenues.
ANALYSIS OF REVENUES Total revenues decreased 60.3% or $3.29 billion in 2008
compared to 2007, due to a $2.86 billion increase in net realized capital losses
and a $485 million decrease in net investment income. Total revenues decreased
2.0% or $111 million in 2007 compared to 2006, due to higher net realized
capital losses and lower premiums and contract charges, partially offset by
higher net investment income.
PREMIUMS represent revenues generated from traditional life insurance, immediate
annuities with life contingencies, and accident, health and other insurance
products that have significant mortality or morbidity risk.
CONTRACT CHARGES are revenues generated from interest-sensitive and variable
life insurance, fixed annuities and variable annuities for which deposits are
classified as contractholder funds or separate accounts liabilities. Contract
charges are assessed against the contractholder account values for maintenance,
administration, cost of insurance and surrender prior to contractually specified
dates. As a result, changes in contractholder funds are considered in the
evaluation of growth and as indicators of future levels of revenues. Subsequent
to the close of our reinsurance transaction with Prudential effective June 1,
2006, variable annuity contract charges on the business subject to the
transaction are fully reinsured to Prudential and presented net of reinsurance
on the Consolidated Statements of Operations and Comprehensive Income (see Note
3 to the consolidated financial statements).
22
<Page>
The following table summarizes premiums and contract charges by product.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
PREMIUMS
Traditional life insurance (1) $ 368 $ 260 $ 257
Immediate annuities with life contingencies 132 204 278
Accident, health and other 85 38 41
---------- ---------- ----------
TOTAL PREMIUMS 585 502 576
CONTRACT CHARGES
Interest-sensitive life insurance (1) 855 862 797
Fixed annuities 55 79 73
Variable annuities 1 1 139
---------- ---------- ----------
TOTAL CONTRACT CHARGES (2) 911 942 1,009
---------- ---------- ----------
TOTAL PREMIUMS AND CONTRACT CHARGES $ 1,496 $ 1,444 $ 1,585
========== ========== ==========
</Table>
- ----------
(1) Beginning in 2008, certain ceded reinsurance premiums previously
included as a component of traditional life insurance premiums were
reclassified prospectively to be reported as a component of
interest-sensitive life insurance contract charges. In 2007 and 2006,
these ceded reinsurance premiums were $90 million and $53 million,
respectively.
(2) Contract charges primarily reflect non-cash charges to contractholder
account balances. Total contract charges for 2008, 2007 and 2006
include contract charges related to the cost of insurance of $572
million, $617 million and $600 million, respectively.
Total premiums increased 16.5% in 2008 compared to 2007, due to the
prospective reporting reclassification for certain ceded reinsurance premiums.
Excluding the impact of this reporting reclassification, total premiums
decreased 1.2% in 2008 compared to 2007 as higher sales of traditional life
insurance and increased accident and health insurance premiums assumed from
American Heritage Life Insurance Company, an unconsolidated affiliate, were more
than offset by lower sales of immediate annuities with life contingencies due to
highly competitive market conditions and our continued focus on returns.
Total premiums decreased 12.8% in 2007 compared to 2006 as higher sales of
traditional life insurance products were more than offset by a decline in sales
of life contingent immediate annuities due to market competitiveness.
Total premiums in the three years ended December 31, 2008, adjusted for the
reporting reclassification of certain ceded reinsurance premiums, averaged $602
million.
Total contract charges decreased 3.3% in 2008 compared to 2007 due to the
prospective reporting reclassification of certain ceded reinsurance premiums.
Excluding the impact of this reclassification, total contract charges increased
6.9% in 2008 due to higher contract charges on interest-sensitive life insurance
policies resulting from increased contract charge rates and growth in business
in force, partially offset by decreased contract charges on fixed annuities
resulting primarily from lower contract surrenders.
Contract charges decreased 6.6% in 2007 compared to 2006 due to the
disposal of substantially all of our variable annuity business through
reinsurance effective June 1, 2006. Excluding contract charges on variable
annuities, substantially all of which are reinsured to Prudential effective June
1, 2006, contract charges increased 8.2% in 2007 compared to 2006. The increase
reflects growth in interest-sensitive life insurance policies in force, higher
maintenance charge rates on interest-sensitive life products and, to a lesser
extent, higher contract charges on fixed annuities. The increase in contract
charges on fixed annuities was mostly attributable to higher contract
surrenders.
CONTRACTHOLDER FUNDS represent interest-bearing liabilities arising from the
sale of individual and institutional products, such as interest-sensitive life
insurance, fixed annuities and funding agreements. The balance of contractholder
funds is equal to the cumulative deposits received and interest credited to the
contractholder less cumulative contract maturities, benefits, surrenders,
withdrawals and contract charges for mortality or administrative expenses.
23
<Page>
The following table shows the changes in contractholder funds.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------ ------------ ------------
CONTRACTHOLDER FUNDS, BEGINNING BALANCE $ 60,464 $ 60,565 $ 58,190
DEPOSITS
Fixed annuities 3,801 3,635 6,006
Institutional products (funding agreements) 4,158 3,000 2,100
Interest-sensitive life insurance 1,325 1,324 1,336
Variable annuity and life deposits allocated to fixed accounts 2 1 99
------------ ------------ ------------
Total deposits 9,286 7,960 9,541
INTEREST CREDITED 2,350 2,635 2,600
MATURITIES, BENEFITS, WITHDRAWALS AND OTHER ADJUSTMENTS
Maturities and retirements of institutional products (8,599) (3,165) (2,726)
Benefits (1,701) (1,656) (1,500)
Surrenders and partial withdrawals (4,329) (4,928) (4,627)
Contract charges (819) (751) (697)
Net transfers from (to) separate accounts 19 13 (145)
Fair value hedge adjustments for institutional products (56) 34 38
Other adjustments (1) 165 (243) (109)
------------ ------------ ------------
Total maturities, benefits, withdrawals and other adjustments (15,320) (10,696) (9,766)
------------ ------------ ------------
CONTRACTHOLDER FUNDS, ENDING BALANCE $ 56,780 $ 60,464 $ 60,565
============ ============ ============
</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 6.1% and 0.2% in 2008 and 2007,
respectively, and increased 4.1% in 2006. Average contractholder funds decreased
3.1% in 2008 compared to 2007, and increased 1.9% in 2007 compared to 2006.
Contractholder deposits increased 16.7% in 2008 compared to 2007 due
primarily to higher deposits on institutional products, and to a lesser extent,
higher deposits on fixed annuities. Sales of our institutional products vary
from period to period based on management's assessment of market conditions,
investor demand and operational priorities. Deposits on fixed annuities
increased 4.6% in 2008 compared to 2007 due primarily to increased consumer
demand as the attractiveness of fixed annuities relative to competing products
improved, partially offset by pricing decisions aimed to increase new business
returns.
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 institutional products. 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.
Contractholder deposits on fixed annuities have varied over the past
several years based on factors such as the attractiveness of fixed annuities
to consumers relative to other investment alternatives, the competitiveness
of our crediting rates, and our target returns on newly issued fixed annuity
contracts. The level of fixed annuity deposits in 2008 and 2007 was also
influenced by our strategy to raise new business returns, which we continue
to pursue. Beginning in 2009, we intend to reduce our concentration of spread
based business, including fixed annuities.
Maturities and retirements of institutional products increased $5.43
billion in 2008 compared to 2007. During 2008, we retired $5.36 billion of
extendible institutional market obligations for which investors had elected to
non-extend their maturity date through a combination of maturities, calls, and
acquisitions in the secondary market. All of our outstanding extendible
institutional market contracts, which totaled $1.45 billion as of December 31,
2008, have non-extended. We have called $1.21 billion of these contracts and we
will retire them in March 2009; the remainder will become due by July 31, 2009.
We have accumulated, and expect to maintain, short-term and other maturing
investments to fund the retirement of these obligations. We will assess market
conditions and may take actions in the secondary market to retire additional
institutional market obligations prior to their stated maturity.
Surrenders and partial withdrawals decreased 12.2% to $4.33 billion in 2008
from $4.93 billion in 2007 due to lower surrenders and partial withdrawals on
market value adjusted annuities and traditional fixed annuities, partially
offset by higher surrenders and partial withdrawals on interest-sensitive life
insurance products. The surrender and
24
<Page>
partial withdrawal rate on deferred fixed annuities and interest-sensitive life
insurance products, based on the beginning of period contractholder funds, was
10.3% in 2008 compared to 11.6% in 2007.
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. The surrenders and partial withdrawals line in the
table above, for 2006 includes $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.
NET INVESTMENT INCOME decreased 11.5% in 2008 compared to 2007 and increased
3.6% in 2007 compared to 2006. The decline in 2008 was primarily due to lower
investment yields on floating rate securities, increased short-term investment
balances reflecting liquidity management activities, lower average investment
balances and lower income from limited partnership interests. The increase in
2007 was primarily due to higher average portfolio balances, increased portfolio
yields and higher income from limited partnership interests.
REALIZED CAPITAL GAINS AND LOSSES reflected net losses of $3.05 billion, $197
million and $79 million in 2008, 2007 and 2006, respectively. 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 decreased 1.1% or $54
million in 2008 compared to 2007 due to lower interest credited to
contractholder funds, partially offset by higher amortization of DAC, contract
benefits and operating costs and expenses. Total costs and expenses in 2007 were
consistent with 2006 as increased interest credited to contractholder funds was
offset by lower amortization of DAC, operating costs and expenses, and
restructuring and related charges.
CONTRACT BENEFITS increased 2.4% or $33 million in 2008 compared to 2007 due
primarily to higher contract benefits on life insurance products, partially
offset by lower contract benefits on annuities. The increase in contract
benefits on life insurance products was primarily due to unfavorable mortality
experience, partially offset by the recognition in the prior year period of
litigation related costs in the form of additional policy benefits. The decline
in contract benefits on annuities was due to the impact of lower sales of
immediate annuities with life contingencies, partially offset by unfavorable
mortality experience.
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.
We analyze our mortality and morbidity results using the difference between
premiums and 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"). This implied interest
totaled $552 million, $547 million and $539 million in 2008, 2007 and 2006,
respectively. The benefit spread by product group is disclosed in the following
table.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ----------- -----------
Life insurance $ 374 $ 337 $ 386
Annuities (62) (35) (43)
---------- ----------- -----------
Total benefit spread $ 312 $ 302 $ 343
========== =========== ===========
</Table>
INTEREST CREDITED TO CONTRACTHOLDER FUNDS, which represents non-cash charges for
interest accrued on interest-sensitive life and investment contracts, decreased
10.4% or $272 million in 2008 compared to 2007 and increased 3.3% or $85 million
in 2007 compared to 2006. The decrease in 2008 compared to 2007 was due
primarily to a decline in average contractholder funds, decreased weighted
average interest crediting rates on institutional products resulting from a
decline in market interest rates on floating rate obligations, and a favorable
change in amortization of DSI relating to realized capital gains and losses,
partially offset by the acceleration of amortization of DSI due to changes in
assumptions. The acceleration of amortization of DSI due to changes in
assumptions increased interest
25
<Page>
credited to contractholder funds by $70 million in 2008 compared to amortization
deceleration which decreased interest credited to contractholder funds by $5
million in 2007.
The increase in interest credited to contractholder funds in 2007 compared
to 2006 was due primarily to growth in average contractholder funds and, to a
lesser extent, higher weighted average interest crediting rates on institutional
products, which are detailed in the table of investment yields, crediting rates
and investment spreads by product below. The increase was partially offset by
the impact of the reinsured variable annuity business. Excluding the impact of
the reinsured variable annuity business, interest credited to contractholder
funds increased 4.3% in 2007 compared to 2006.
In order to analyze the impact of net investment income and interest
credited to contractholders on net income, we monitor the difference between net
investment income and the sum of interest credited to contractholder funds and
the implied interest on immediate annuities with life contingencies, which is
included as a component of contract benefits on the Consolidated Statements of
Operations and Comprehensive Income ("investment spread").
The investment spread by product group is shown in the following table.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
Annuities $ 388 $ 504 $ 480
Life insurance 50 55 49
Institutional products 71 87 88
Net investment income on investments supporting capital 303 384 358
---------- ---------- ----------
Total investment spread $ 812 $ 1,030 $ 975
========== ========== ==========
</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 and investment spreads for 2008, 2007 and
2006.
<Table>
<Caption>
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
INVESTMENT YIELD INTEREST CREDITING RATE INVESTMENT SPREADS
---------------- ------------------------ ------------------
2008 2007 2006 2008 2007 2006 2008 2007 2006
---- ---- ---- ---- ---- ---- ---- ---- ----
Interest-sensitive life insurance 6.0% 6.2% 6.2% 4.6% 4.6% 4.7% 1.4% 1.6% 1.5%
Deferred fixed annuities 5.6 5.8 5.7 3.8 3.7 3.7 1.8 2.1 2.0
Immediate fixed annuities with and
without life contingencies 6.8 7.1 7.2 6.5 6.5 6.6 0.3 0.6 0.6
Institutional products 4.2 6.1 6.0 3.5 5.2 5.0 0.7 0.9 1.0
Investments supporting capital,
traditional life and other products 5.3 6.3 6.2 N/A N/A N/A N/A N/A N/A
</Table>
The following table summarizes our product liabilities as of December 31
and indicates the account value of those contracts and policies in which an
investment spread is generated.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
Immediate fixed annuities with life contingencies $ 8,350 $ 8,288 $ 8,138
Other life contingent contracts and other 3,906 4,310 4,066
---------- ---------- ----------
Reserve for life-contingent contract benefits $ 12,256 $ 12,598 $ 12,204
========== ========== ==========
Interest-sensitive life insurance $ 9,308 $ 8,896 $ 8,397
Deferred fixed annuities 33,734 34,182 35,498
Immediate fixed annuities without life contingencies 3,891 3,918 3,779
Institutional products 8,974 12,983 12,467
Market value adjustments related to fair value hedges and other 873 485 424
---------- ---------- ----------
Contractholder funds $ 56,780 $ 60,464 $ 60,565
========== ========== ==========
</Table>
26
<Page>
AMORTIZATION OF DAC increased 24.1% in 2008 compared to 2007 and decreased
3.7% in 2007 compared to 2006. The components of amortization of DAC are
summarized in the following table.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
Amortization of DAC before amortization
relating to realized capital gains and
losses, changes in assumptions and
premium deficiency (1) $ (493) $ (547) $ (586)
Accretion relating to realized capital
gains and losses (2) 515 17 50
Amortization (acceleration) deceleration
for changes in assumptions ("DAC unlocking") (329) 12 (2)
Amortization charge relating to premium
deficiency (336) -- --
---------- ---------- ----------
Total amortization of DAC (3) (4) $ (643) $ (518) $ (538)
========== ========== ==========
</Table>
- ----------
(1) Amortization of DAC before accretion relating to realized
capital gains and losses and changes in assumptions for 2006
includes $(72) million relating to the reinsured variable
annuity business.
(2) Amortization relating to realized capital gains and losses for
2006 includes $28 million relating to the reinsured variable
annuity business.
(3) Total amortization of DAC for 2006 includes $44 million relating
to the reinsured variable annuity business.
(4) Amortization of DAC reflects a non-cash charge to the
Consolidated Statements of Operations and Comprehensive Income.
The increase of $125 million in 2008 was due primarily to amortization
acceleration relating to changes in assumptions and additional amortization
recorded in connection with a premium deficiency assessment for traditional life
insurance and immediate annuities with life contingencies, partially offset by
higher accretion of DAC relating to net realized capital losses.
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.
In 2008, DAC amortization acceleration for changes in assumptions, recorded
in connection with comprehensive reviews of the DAC balances and assumptions for
interest-sensitive life insurance, annuities and other investment contracts,
resulted in an increase to amortization of DAC of $329 million. The evaluations
covered assumptions for investment returns, including capital gains and losses,
interest crediting rates to policyholders, the effect of any hedges,
persistency, mortality and expenses in all product lines. The principle
assumption impacting the amortization acceleration in 2008 was the level of
realized capital losses impacting actual gross profits in 2008 and the impact of
realized capital losses on EGP in 2009. During the fourth quarter of 2008, our
assumptions for EGP were impacted by a view of further anticipated impairments
in our investment portfolio. In 2007, DAC amortization deceleration for changes
in assumptions (credit to income) was $12 million.
During 2008, indicators emerged that suggested a study of mortality
experience for our immediate annuities with life contingences was warranted. At
the same time, the underlying profitability of the traditional life business
deteriorated due to lower investment returns and growth. For traditional life
insurance and immediate annuities with life contingencies, an aggregate premium
deficiency of $336 million, pre-tax, resulted primarily from the experience
study indicating that the annuitants on certain life contingent contracts are
projected to live longer than we anticipated when the contracts were issued and,
to a lesser degree, a reduction in the related investment portfolio yield. The
deficiency was recorded through a reduction in DAC. There was no similar charge
to income recorded in 2007 or 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 in 2007 increased 4.9% or $24 million compared to 2006 due
primarily to increased amortization related to higher gross profits on fixed
annuities and a decline in the credit to income for amortization relating to
realized capital gains and losses, partially offset by a favorable impact
relating to DAC unlocking.
27
<Page>
The changes in the DAC asset are detailed in the following tables.
<Table>
<Caption>
ACCRETION EFFECT OF
RELATING TO AMORTIZATION UNREALIZED
BEGINNING ACQUISITION AMORTIZATION REALIZED ACCELERATION CAPITAL ENDING
BALANCE COSTS BEFORE CAPITAL CHARGED TO GAINS BALANCE
DECEMBER 31, REINSURANCE (1) DEFERRED ADJUSTMENTS GAINS AND INCOME AND DECEMBER 31,
($ IN MILLIONS) 2007 ASSUMED (2) (3) (4) LOSSES (4) (4) (5) LOSSES (6) 2008
------------ --------------- ----------- ------------ ----------- ------------ ---------- ------------
Traditional
life and other $ 644 $ 32 $ 87 $ (59) $ -- $ (336) $ -- $ 368
Interest-sensitive
life 1,765 -- 288 (167) 141 (77) 340 2,290
Fixed annuities 1,487 -- 213 (258) 374 (252) 2,471 4,035
Variable annuities 2 -- -- (2) -- -- -- --
Other 7 -- 8 (7) -- -- -- 8
------------ --------------- ----------- ------------ ----------- ------------ ---------- ------------
Total $ 3,905 $ 32 $ 596 $ (493) $ 515 $ (665) $ 2,811 $ 6,701
============ =============== =========== ============ =========== ============ ========== ============
</Table>
<Table>
<Caption>
ACCRETION AMORTIZATION EFFECT OF
RELATING TO (ACCELERATION) UNREALIZED
BEGINNING ACQUISITION AMORTIZATION REALIZED DECELERATION CAPITAL ENDING
BALANCE IMPACT OF COSTS BEFORE CAPITAL (CHARGED) GAINS BALANCE
DECEMBER 31, ADOPTION OF DEFERRED ADJUSTMENTS GAINS AND CREDITED TO AND DECEMBER 31,
($ IN MILLIONS) 2006 SOP 05-1 (7) (2) (3) (4) LOSSES (4) INCOME (4) LOSSES (6) 2007
------------ --------------- ----------- ------------ ----------- -------------- ---------- ------------
Traditional life
and other $ 622 $ -- $ 76 $ (54) $ -- $ -- $ -- $ 644
Interest-sensitive
life 1,632 -- 249 (175) 12 17 30 1,765
Fixed annuities 1,217 (11) 220 (311) 5 (5) 372 1,487
Variable annuities 4 -- -- (2) -- -- -- 2
Other 10 -- 2 (5) -- -- -- 7
------------ --------------- ----------- ------------ ----------- -------------- ---------- ------------
Total $ 3,485 $ (11) $ 547 $ (547) $ 17 $ 12 $ 402 $ 3,905
============ =============== =========== ============ =========== ============== ========== ============
</Table>
- ----------
(1) The DAC balance increased $32 million during 2008 as a result of a
reinsurance transaction. Effective January 1, 2008, the Company's
coinsurance reinsurance agreement with its unconsolidated affiliate
American Heritage Life Insurance Company ("AHL"), which went into effect in
2004, was amended to include the assumption by the Company of certain
accident and health insurance policies.
(2) Total acquisition costs deferred in 2008 and 2007 include commissions
paid totaling $464 million and $435 million, respectively.
(3) Amortization before adjustments reflects total DAC amortization before
accretion relating to realized capital gains and losses, and amortization
(acceleration) deceleration (charged) credited to income.
(4) Included as a component of amortization of DAC on the Consolidated
Statements of Operations and Comprehensive Income.
(5) The $(336) million in the traditional life and other line was recorded in
connection with a premium deficiency assessment for traditional life
insurance and immediate annuities with life contingencies and was primarily
due to revised annuity mortality assumptions.
(6) The effect of unrealized capital gains and losses represents the amount by
which the amortization of DAC would increase or decrease if the unrealized
capital gains and losses in the respective product portfolios were
realized. Recapitalization of DAC is limited to the originally deferred
policy acquisition costs plus interest.
(7) 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 an
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 $7 million reduction of retained
income at January 1, 2007 and a reduction of the DAC balance of $11
million, pre-tax.
28
<Page>
OPERATING COSTS AND EXPENSES increased 18.1% in 2008 compared to 2007 and
decreased 9.6% in 2007 compared to 2006. The following table summarizes
operating costs and expenses.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
-------- -------- --------
Non-deferrable acquisition costs $ 82 $ 97 $ 118
Other operating costs and expenses 317 241 256
-------- -------- --------
Total operating costs and expenses $ 399 $ 338 $ 374
======== ======== ========
Restructuring and related charges $ 1 $ 2 $ 24
======== ======== ========
</Table>
Non-deferrable acquisition costs decreased 15.5% or $15 million in 2008
compared to 2007 primarily due to lower non-deferrable commissions. Other
operating costs and expenses increased 31.5% or $76 million in 2008 compared to
2007 due primarily to increased spending on consumer research, product
development, marketing and technology related to the effort to reinvent
protection and retirement for consumers as well as increases in the net cost of
benefits due to unfavorable investment results. In addition, the prior years
benefitted to a greater degree from a servicing fee paid by Prudential for our
servicing of the variable annuity business that we ceded to them during a
transition period beginning in 2006 which ended in May 2008.
Non-deferrable acquisition costs and other operating costs and expenses
declined in 2007 compared to 2006 due to expenses in 2006 related to the
reinsured variable annuity business. 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.
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 2008, 2007 and 2006 totaled $4 million,
$10 million and $88 million, respectively. In both 2008 and 2007, the net loss
was primarily comprised of losses associated with the previously anticipated
disposition of our direct response long-term care business, partially offset by
amortization of the deferred reinsurance gain associated with our reinsured
variable annuity business. The net loss in 2006 was almost entirely attributable
to the reinsured variable annuity business.
INCOME TAX BENEFIT of $946 million in 2008 compared to income tax expense of
$180 million in 2007. The change reflects the shift from net pre-tax income in
2007 to a net pre-tax loss in 2008. Income tax expense decreased by 8.2% or $16
million in 2007 compared to 2006 due to lower income from operations before
income tax expense and an energy tax credit that reduced income tax expense.
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 $15 million,
$16 million and $21 million in 2008, 2007 and 2006, respectively.
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, 2008 and 2007, 47% and 49%, respectively, of our face
amount of life insurance in force was reinsured. As of December 31, 2008 and
2007, for certain term life insurance policies, we ceded up to 90% of the
mortality risk depending on the year of policy issuance. 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, our 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
29
<Page>
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 $1 million per individual life.
Amounts recoverable from reinsurers by type of policy or contract at
December 31, are summarized in the following table.
<Table>
<Caption>
REINSURANCE RECOVERABLE ON
PAID AND UNPAID BENEFITS
($ IN MILLIONS) ---------------------------
2008 2007
------------ -----------
Annuities (1) $ 1,734 $ 1,423
Life insurance 1,465 1,365
Long-term care 630 526
Other 94 96
------------ -----------
Total $ 3,923 $ 3,410
============ ===========
</Table>
- ----------
(1) Reinsurance recoverables as of December 31, 2008 and
2007 include $1.57 billion and $1.26 billion,
respectively, for general account reserves related to
reinsured variable annuities.
The estimation of reinsurance recoverables is impacted by the uncertainties
involved in the establishment of reserves.
Our reinsurance recoverables, summarized by reinsurer as of December 31,
are shown in the following table.
<Table>
<Caption>
S&P FINANCIAL REINSURANCE RECOVERABLE
STRENGTH ON PAID AND
($ IN MILLIONS) RATING (3) UNPAID BENEFITS
------------- -----------------------
2008 2007
----------- ----------
Prudential Insurance Company of America AA- $ 1,569 $ 1,261
Employers Reassurance Corporation A+ 644 541
Transamerica Life Group AA 341 288
RGA Reinsurance Company AA- 340 325
Swiss Re Life and Health America, Inc. A+ 191 172
Paul Revere Life Insurance Company A- 151 147
Scottish Re Group (1) CCC 135 110
Munich American Reassurance AA- 113 103
Security Life of Denver AA 86 86
Manulife Insurance Company AA+ 74 78
Triton Insurance Company NR 66 73
Lincoln National Life Insurance AA- 63 63
American Health & Life Insurance Co. NR 53 57
Other (2) 97 106
----------- ----------
Total $ 3,923 $ 3,410
=========== ==========
</Table>
- ----------
(1) The reinsurance recoverable on paid and unpaid benefits related
to the Scottish Re Group of $135 million as of December 31, 2008
is comprised of $73 million related to Scottish Re Life
Corporation and $62 million related to Scottish Re (U.S.), Inc.
(2) As of December 31, 2008 and 2007, the other category includes
$81 million and $69 million, respectively, of recoverables due
from reinsurers with an investment grade credit rating from
Standard & Poor's ("S&P").
(3) Rating as of March 6, 2009.
During 2008, the financial strength rating of the Scottish Re Group was
downgraded by S&P to CCC+ from BB+ as of December 31, 2007 due to the
deterioration of the Scottish Re Group's financial position and liquidity. The
Scottish Re Group's financial strength rating was further downgraded by S&P in
January 2009 to CCC. Although a significant impact has not been observed, the
unprecedented deterioration in the global financial markets in 2008 could impact
the financial condition of reinsurers in a variety of ways, including the
decline in value of assets held as capital resources or to meet technical
provisions, increases in risk-based economic or regulatory capital requirements
and shortage of available capital in the event that recapitalization is required
following a major claim. 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, 2008.
30
<Page>
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 its
other 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 will continue to focus on improving returns and reducing our
concentration in spread based products, primarily fixed annuities and
institutional markets products, resulting in lower premiums and deposits
and reductions in net contractholder obligations.
- - We plan to improve efficiency and narrow the focus of product offerings to
better serve the needs of everyday Americans. We are targeting savings at
20% of certain operating expenses, excluding acquisition costs, and expect
to yield estimated annual savings of $90 million beginning in 2011. We
anticipate a reduction of approximately 1,000 workforce positions, through
a combination of attrition and position elimination over the next two
years.
- - Maintaining high liquidity in our investment portfolio will result in lower
net investment income but will ensure our ability to meet contractholder
obligations. We will target sales of our spread based products at levels
that allow us to avoid sales of investments with significant unrealized
losses into distressed or illiquid markets.
- - We expect continued investment spread compression due to credit losses,
reduced contractholder funds and maintenance of liquidity.
INVESTMENTS
OVERVIEW AND STRATEGY An important component of our financial results is the
return on our investment portfolio. We manage the underlying portfolio based
upon the nature of the business and its corresponding liability structure.
The global economy is under significant stress and financial markets
continue to experience extreme levels of volatility. Our strategy in 2009 will
focus primarily upon mitigating the risks from a potential increase in risk-free
interest rates, reducing exposure to certain investment sectors, and maintaining
sufficient liquidity and capital. In order to achieve this, we expect to use a
combination of reinvestment of the portfolio's significant cash flows,
derivatives and other portfolio actions.
Our investment strategy focuses on the total return of assets needed to
support the underlying liabilities to achieve return on capital and profitable
growth. The portfolio management process begins with a strategic asset
allocation model which considers the nature and risk tolerances of the
liabilities, as well as the risk and return parameters of the various asset
classes in which we invest. This approach is informed by our economic and market
outlook, as well as other inputs and constraints including duration, liquidity
and capital preservation. Within the ranges set by the strategic asset
allocation model, tactical investment decisions are made in consideration of
prevailing market conditions.
As a result of decisions in managing our portfolio, we may sell securities
during a period in which fair value has declined below amortized cost for fixed
income securities or cost for equity securities. For more information, see the
Net Realized Capital Gains and Losses section of the MD&A.
During 2008, we developed risk mitigation and return optimization programs
as our outlook on the economy changed significantly as conditions deteriorated
throughout the year. The risk mitigation and return optimization programs
augment earlier actions to reduce investments in real estate and other market
sectors as well as to mitigate credit spread risk. At the end of the second
quarter of 2008, we had an outlook for continued weakness in the global
financial markets and economy including continued volatility in the financial
markets, reduced liquidity in certain asset classes and unfavorable economic
trends. During the third quarter of 2008, we significantly modified our outlook
to a more severe and prolonged downturn. We continue to expect extreme levels of
volatility in the financial markets, suppressed liquidity in certain asset
classes and further unfavorable global economic conditions. In addition, the
potential for market supply and demand imbalances has remained above normal due
to the deteriorating credit strength of financial institutions and eroding
investor confidence.
31
<Page>
Among our risk mitigation and return optimization activities, we have taken
the following actions:
- Developed and maintained a tactical positioning in liquid assets and
assets that we can sell without generating significant additional
realized capital losses.
- Continued to reduce exposure in assets other than those for which we
have asserted an intent to hold until recovery where we have credit
concerns or where there has been a significant change in facts and
circumstances.
- Decreased exposure to financial-related market sectors to $6.32
billion as of December 31, 2008 from $9.82 billion as of December 31,
2007, primarily as a result of targeted sales and declines in fair
value. Also reduced our short-term investing in financial
institutions.
- Decreased exposure to residential and commercial real estate market
sectors to $18.60 billion as of December 31, 2008 from $24.36 billion
as of December 31, 2007 as a result of targeted sales, principal
payments and declines in fair value.
- Reduced overall counterparty exposure replacing over-the-counter
("OTC") derivatives transactions with exchange-traded instruments
where available.
- In the second half of 2008, we sold $1.67 billion of government
securities and recognized realized capital gains of $241 million.
- As part of the risk mitigation and return optimization programs,
hedges were implemented to mitigate credit spread risk.
Investments for which we changed our intent to hold to recovery as of June
30, 2008 totaled $2.97 billion and included $2.64 billion as part of the risk
mitigation and return optimization programs and $329 million related to
individual securities. A risk mitigation and return optimization program,
approved as of the end of the second quarter of 2008, was designed to reduce our
exposure to residential and commercial real estate and the financial-related
market sector by approximately $3 billion of amortized cost, prior to change in
intent write-downs. A comprehensive review identified specific investments that
could be significantly impacted by continued deterioration in the economy that
may be sold. This included a portion of our residential and commercial real
estate securities including securities collateralized by residential and
commercial mortgage loans, mortgage loans and securities issued by financial
institutions.
During the third and fourth quarters of 2008, we sold $1.26 billion of
these securities. On October 1, 2008, it was determined that, due to the
financial markets experiencing additional severe deterioration and disruptions,
we would be unable to sell certain of the investments identified as part of the
programs at a value equal to or greater than our view of their intrinsic values.
Approximately $834 million of these investments were re-designated as intent to
hold to recovery. Investments for which we had changed our intent to hold to
recovery totaled $774 million as of December 31, 2008. For a more detailed
discussion on securities written down due to a change in intent, see the Net
Realized Capital Gains and Losses section of the MD&A.
We continue to monitor the progress of these actions as market and economic
conditions develop and will adapt our strategies as appropriate. Our continuing
focus is to manage our risks and to position our portfolio to take advantage of
market opportunities while attempting to mitigate further adverse effects.
INVESTMENTS OUTLOOK
- - Continuing risk mitigation efforts will focus on reducing exposures to real
estate and certain other market sectors, shortening duration of the
fixed income portfolio, and managing excess market volatility through our
macro hedging program for credit spread risk.
- - Net investment income will decline due to lower asset balances and yields,
and the costs of maintaining high liquidity and the risk mitigation
programs.
- - Our portfolio continues to generate significant cash flow from maturities,
principal and interest receipts which will be available to manage
liabilities and take advantage of market opportunities.
32
<Page>
PORTFOLIO COMPOSITION The composition of the investment portfolio at December
31, 2008 is presented in the table below. Also see Notes 2 and 6 to the
consolidated financial statements for investment accounting policies and
additional information.
<Table>
<Caption>
PERCENT TO
($ IN MILLIONS) INVESTMENTS TOTAL
------------- ------------
Fixed income securities (1) $ 42,446 71.0%
Mortgage loans 10,012 16.7
Equity securities (2) 82 0.1
Limited partnership interests (3) 1,187 2.0
Short-term (4) 3,858 6.5
Policy loans 813 1.4
Other 1,374 2.3
------------- ------------
Total $ 59,772 100.0%
============= ============
</Table>
- ----------
(1) Fixed income securities are carried at fair value. Amortized cost
basis for these securities was $49.14 billion.
(2) Equity securities are carried at fair value. Cost basis for these
securities was $106 million.
(3) We have commitments to invest in additional limited partnership
interests totaling $1.08 billion.
(4) Short-term investments are carried at fair value. Amortized cost
basis for these investments was $3.86 billion.
Total investments decreased to $59.77 billion at December 31, 2008, from
$72.41 billion at December 31, 2007, due to unrealized net capital losses, net
reductions in contractholder funds, net realized capital losses, and lower funds
associated with collateral received in conjunction with securities lending,
partially offset by capital contributions from AIC.
Total investments at amortized cost related to collateral received in
connection with securities lending business activities and collateral posted by
counterparties related to derivative transactions decreased to $340 million at
December 31, 2008, from $1.82 billion at December 31, 2007. As of December 31,
2008, these investments are included as a component of short-term investments.
At December 31, 2007, these investments were carried at fair value and $1.57
billion were classified in fixed income securities and $219 million were
classified in short-term investments.
Securities lending activities are primarily used as an investment yield
enhancement, and are conducted with third parties such as large banks. We obtain
collateral, typically in the form of cash, in an amount generally equal to 102%
of the fair value of securities and monitor the market value of the securities
loaned on a daily basis with additional collateral obtained as necessary. The
cash we receive is invested in short-term and fixed income investments, and an
offsetting liability to return the collateral is recorded in other liabilities
and accrued expenses.
We obtain fair values of our fixed income and equity securities and
exchange traded and non-exchange traded derivative contracts from several
sources and methods. For a discussion of these sources and methods, see the
Application of Critical Accounting Estimates section of the MD&A.
We may utilize derivative financial instruments to help manage the exposure
to interest rate risk, and to a lesser extent currency and credit risks, from
the fixed income securities portfolio. For a more detailed discussion of
interest rate, currency and credit risks and our use of derivative financial
instruments, see the Net realized capital gains and losses and Market Risk
sections of the MD&A and Note 7 of the consolidated financial statements.
33
<Page>
FIXED INCOME SECURITIES See Note 6 of the consolidated financial statements for
a table showing the amortized cost, unrealized gains, unrealized losses and fair
value for each type of fixed income security for the years ended December 31,
2008 and 2007.
The following table shows fixed income securities by type.
<Table>
<Caption>
FAIR VALUE AT % TO TOTAL FAIR VALUE AT % TO TOTAL
($ IN MILLIONS) DECEMBER 31, 2008 INVESTMENTS DECEMBER 31, 2007 INVESTMENTS
----------------- ----------- ----------------- -----------
U.S. government and agencies $ 3,687 6.2% $ 3,728 5.2%
Municipal 3,308 5.5 4,311 6.0
Corporate 24,269 40.6 31,735 43.8
Foreign government 2,100 3.5 2,185 3.0
Mortgage-backed securities ("MBS") 2,719 4.6 3,490 4.8
CMBS 3,730 6.2 7,388 10.2
ABS 2,623 4.4 5,603 7.7
Redeemable preferred stock 10 -- 29 --
-------- ------ -------- -----
Total fixed income securities $ 42,446 71.0% $ 58,469 80.7%
======== ====== ======== =====
</Table>
At December 31, 2008, 95.9% of the consolidated fixed income securities
portfolio was rated investment grade, which is 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, a
rating of AAA, AA, A or BBB from S&P'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. The following table summarizes the credit
quality of the fixed income securities portfolio at December 31, 2008.
<Table>
<Caption>
($ IN MILLIONS)
NAIC MOODY'S FAIR PERCENT TO
RATING EQUIVALENT VALUE TOTAL
-------- ----------------------------- -------- ----------
1 Aaa/Aa/A $ 28,198 66.4%
2 Baa 12,520 29.5
-------- ----------
Investment grade 40,718 95.9
3 Ba 1,257 3.0
4 B 316 0.7
5 Caa or lower 130 0.3
6 In or near default 25 0.1
-------- ----------
Below investment grade 1,728 4.1
-------- ----------
Total $ 42,446 100.0%
======== ==========
</Table>
The table above includes 25 securities with a fair value totaling $166
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 NAIC rating.
34
<Page>
MUNICIPAL BONDS totaled $3.31 billion at December 31, 2008, substantially
all of which are taxable securities. The following table summarizes the
municipal bond portfolio by Moody's equivalent rating as of December 31, 2008.
<Table>
<Caption>
FAIR VALUE AS A
PAR AMORTIZED FAIR UNREALIZED PERCENT OF
($ IN MILLIONS) VALUE COST VALUE GAIN/LOSS AMORTIZED COST
--------- --------- --------- ---------- ---------------
Non - zero-coupon:
Rating (1)
Aaa $ 42 $ 46 $ 52 $ 6 113.0%
Aa 829 815 756 (59) 92.8
A 553 553 530 (23) 95.8
Baa 433 435 396 (39) 91.0
Ba or lower 49 51 35 (16) 68.6
------- ------- ------- -------
Total $ 1,906 $ 1,900 $ 1,769 $ (131) 93.1
======= ======= ======= =======
Zero-coupon:
Rating (1)
Aaa $ 147 $ 42 $ 39 $ (3) 92.9
Aa 975 413 289 (124) 70.0
A 771 331 228 (103) 68.9
Baa 3,600 565 330 (235) 58.4
------- ------- ------- -------
Total $ 5,493 $ 1,351 $ 886 $ (465) 65.6
======= ======= ======= =======
Total:
Rating (1) (2)
Aaa $ 880 $ 778 $ 714 $ (64) 91.8
Aa 1,822 1,247 1,061 (186) 85.1
A 1,340 900 771 (129) 85.7
Baa 4,033 1,000 727 (273) 72.7
Ba or lower 49 51 35 (16) 68.6
------- ------- ------- -------
Total (2) $ 8,124 $ 3,976 $ 3,308 $ (668) 83.2
======= ======= ======= =======
</Table>
- ----------
(1) Moody's equivalent rating will not necessarily tie to ratings
distributions from the NAIC due to potential timing differences
between the various rating suppliers and the number of external
rating agencies used in the determination.
(2) Includes ARS securities with par value of $725 million, amortized
cost of $725 million, fair value of $653 million and unrealized
gain/loss of $(72) million.
The unrealized net capital loss of $668 million at December 31, 2008 in our
municipal bond portfolio was mainly caused by widening credit spreads that
affected two main areas in this portfolio: zero-coupon holdings contributing
$465 million of the unrealized losses and student loan ARS contributing $72
million of the unrealized losses.
Included in our municipal bond portfolio at December 31, 2008 are $653
million of ARS that have long-term stated maturities, with the interest rate
reset based on auctions that generally occur every 7, 28 or 35 days depending on
the specific security. This is compared to a balance of ARS at December 31, 2007
of $866 million, with the decline primarily representing redemptions from calls
or refunding proceeds since December 31, 2007. Our holdings primarily have a
Moody's or equivalent rating of Aaa. All of our holdings are pools of student
loans for which at least 85% of the collateral was insured by the U.S.
Department of Education at the time we purchased the security. As of December
31, 2008, $426 million of our ARS backed by student loans was 100% insured by
the U.S. Department of Education, $154 million was 90% to 99% insured and $59
million was 80% to 89% insured. All of our student loan ARS holdings are
experiencing failed auctions and we receive the failed auction rate or, for
those which contain maximum reset rate formulas, we receive the contractual
maximum rate. We anticipate that failed auctions may persist and most of our
holdings will continue to pay the failed auction rate or, for those that contain
maximum rate reset formulas, the maximum rate, as described below. Auctions
continue to be conducted as scheduled for each of the securities.
We estimate that approximately 48% of our student loan backed ARS include
maximum rate reset formulas with a look back feature whereby if the failed
auction rate exceeds an annual contractual maximum rate over a preceding
stipulated period, the coupon interest rate is temporarily reset to the maximum
rate, which can vary between zero and the failed auction rate. This maximum rate
formula causes the reset interest rate on these securities to be lower than the
failed auction rate in order to reduce the annual interest rate so that it does
not exceed the annual contractual maximum rate. Generally, the annual
contractual maximum rate is higher than the historical rates paid on these
securities. At December 31, 2008, interest on $67 million of our ARS has reset
using the maximum rate reset formula.
35
<Page>
CORPORATE BONDS totaled $24.27 billion at December 31, 2008. As of December
31, 2008, $12.36 billion or 50.9% of the portfolio consisted of privately placed
securities compared to $15.57 billion or 49.1% at December 31, 2007. Privately
placed securities primarily consist of corporate issued senior debt securities
that are in unregistered form and are directly negotiated with the borrower. All
privately placed corporate securities are rated by the NAIC based on information
provided to them and are also internally rated. Additionally, approximately
40.2% of the privately placed corporate securities in our portfolio are rated by
an independent rating agency.
The following table summarizes the corporate fixed income portfolio by
Moody's equivalent rating as of December 31, 2008.
<Table>
<Caption>
CORPORATE-PUBLIC
------------------------------------------------------------------------
($ IN MILLIONS) NON-HYBRID HYBRID TOTAL
----------------------- ---------------------- -----------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
RATING (1) VALUE GAIN/LOSS VALUE GAIN/LOSS VALUE GAIN/LOSS
---------- ----- --------- ----- --------- ----- ---------
Aaa $ 167 $ (11) $ -- $ -- $ 167 $ (11)
Aa 770 18 93 7 863 25
A 4,109 (164) 353 (185) 4,462 (349)
Baa 5,568 (627) 164 (165) 5,732 (792)
Ba or lower 676 (218) 9 (12) 685 (230)
-------- --------- ------- ------- -------- ---------
Total $ 11,290 $ (1,002) $ 619 $ (355) $ 11,909 $ (1,357)
======== ========= ======= ======= ======== =========
<Caption>
CORPORATE-PRIVATE
------------------------------------------------------------------------
NON-HYBRID HYBRID TOTAL
----------------------- ---------------------- -----------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
RATING (1) VALUE GAIN/LOSS VALUE GAIN/LOSS VALUE GAIN/LOSS
---------- ----- --------- ----- --------- ----- ---------
Aaa $ 529 $ 33 $ -- $ -- $ 529 $ 33
Aa 1,013 (35) 71 (28) 1,084 (63)
A 3,195 (185) 565 (444) 3,760 (629)
Baa 6,067 (760) 84 (97) 6,151 (857)
Ba or lower 818 (254) 18 (20) 836 (274)
-------- --------- ------- ------- -------- ---------
Total $ 11,622 $ (1,201) $ 738 $ (589) $ 12,360 $ (1,790)
======== ========= ======= ======= ======== =========
<Caption>
TOTAL CORPORATE
------------------------------------------------------------------------
NON-HYBRID HYBRID TOTAL
----------------------- ---------------------- -----------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
RATING (1) VALUE GAIN/LOSS VALUE GAIN/LOSS VALUE GAIN/LOSS
---------- ----- --------- ----- --------- ----- ---------
Aaa $ 696 $ 22 $ -- $ -- $ 696 $ 22
Aa 1,783 (17) 164 (21) 1,947 (38)
A 7,304 (349) 918 (629) 8,222 (978)
Baa 11,635 (1,387) 248 (262) 11,883 (1,649)
Ba or lower 1,494 (472) 27 (32) 1,521 (504)
-------- --------- -------- ------- -------- ---------
Total $ 22,912 $ (2,203) $ 1,357 $ (944) $ 24,269 $ (3,147)
======== ========= ======== ======= ======== =========
</Table>
- ----------
(1) Moody's equivalent rating will not necessarily tie to ratings
distributions from the NAIC due to potential timing differences
between the various rating suppliers and the number of external
rating agencies used in the determination.
The unrealized net capital loss of $3.15 billion at December 31, 2008 is
driven primarily by significantly widening credit spreads resulting from
deteriorating macro economic conditions and continued credit market
deterioration. Credit spread widening particularly affected our non-hybrid Baa
and lower rated corporate bond holdings, contributing to approximately $1.86
billion of the unrealized net capital loss. The other significant driver of
unrealized net capital losses in our corporate bond portfolio is from hybrid
securities, contributing $944 million of the unrealized loss. While these
securities are generally issued by highly rated financial institutions, they
have structural features which make them more sensitive to credit market
deterioration. Specifically, features allowing coupon deferral and the extension
of call dates have severely impacted prices as the global financial system
undergoes significant stress.
36
<Page>
The following table shows additional details of our hybrid securities
reported in corporate fixed income securities.
<Table>
<Caption>
UNITED KINGDOM EUROPE (NON-UK) ASIA/AUSTRALIA NORTH AMERICA TOTAL
--------------------- --------------------- --------------------- --------------------- ----------------------
($ IN MILLIONS) FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE GAIN/LOSS VALUE GAIN/LOSS VALUE GAIN/LOSS VALUE GAIN/LOSS VALUE GAIN/LOSS
----- --------- ----- --------- ----- --------- ----- --------- ----- ---------
Tier 1:
Public $ 82 $ (61) $ 73 $ (77) $ 17 $ (8) $ 232 $ (210) $ 404 $ (356)
Private 61 (96) 226 (244) 167 (111) 124 (116) 578 (567)
------ ------- ------ ------- ------ ------- ------ ------- ------- -------
143 (157) 299 (321) 184 (119) 356 (326) 982 (923)
Tier 2:
Public 61 (4) 111 10 32 (2) 10 (3) 214 1
Private 8 (3) 50 (6) 103 (13) -- -- 161 (22)
------ ------- ------ ------- ------ ------- ------ ------- ------- -------
69 (7) 161 4 135 (15) 10 (3) 375 (21)
Total hybrids
Public 143 (65) 184 (67) 49 (10) 242 (213) 618 (355)
Private 69 (99) 276 (250) 270 (124) 124 (116) 739 (589)
------ ------- ------ ------- ------ ------- ------ ------- ------- -------
Total $ 212 $ (164) $ 460 $ (317) $ 319 $ (134) $ 366 $ (329) $ 1,357 $ (944)
====== ======= ====== ======= ====== ======= ====== ======= ======= =======
</Table>
Our portfolio of privately placed securities are broadly diversified by
issuer, industry sector, and by country. The portfolio is made up of
approximately 551 issues with an average security value of approximately $22
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 approximately once a year.
FOREIGN GOVERNMENT securities totaled $2.10 billion, with 94.6% rated
investment grade, at December 31, 2008.
37
<Page>
CERTAIN COLLATERALIZED SECURITIES are detailed in the following table by
Moody's equivalent rating as of December 31, 2008.
<Table>
<Caption>
FAIR VALUE AT
DECEMBER 31, % TO TOTAL Ba OR
($ IN MILLIONS) 2008 INVESTMENTS Aaa Aa A Baa LOWER
------------- ----------- ------ ----- ----- ----- ------
MBS
U.S. Agency $ 1,881 3.2% 100.0% -- -- -- --
Prime 523 0.9 94.6 3.1% -- 2.3% --
Alt-A 315 0.5 78.7 8.0 -- 2.2 11.1%
------- ----
Total MBS $ 2,719 4.6%
======= ====
CMBS
CMBS $ 3,703 6.2% 90.9 8.0 0.9% 0.2 --
Commercial real estate
collateralized debt
obligations ("CRE CDO") 27 -- -- 29.6 37.1 29.6 3.7
------- ----
Total CMBS $ 3,730 6.2%
======= ====
ABS
ABS RMBS non-insured $ 1,005 1.7% 41.5 36.2 10.0 4.4 7.9
ABS RMBS insured 243 0.4 1.7 18.1 2.9 50.2 27.1
------- ----
Total ABS RMBS 1,248 2.1 33.7 32.7 8.7 13.3 11.6
Asset-backed collateralized
debt obligations ("ABS CDO") 6 -- -- -- -- -- 100.0
------- ----
Total asset-backed
securities collateralized
by sub-prime residential
mortgage loans 1,254 2.1
Other collateralized debt
obligations:
Cash flow CLO 497 0.8 51.3 21.2 19.7 5.8 2.0
Synthetic CDO 47 0.1 6.4 31.9 -- 46.8 14.9
Trust preferred CDO 73 0.1 1.4 76.7 15.1 4.1 2.7
Market value CDO 26 0.1 -- 30.8 15.4 7.7 46.1
Project finance CDO 39 0.1 -- 28.2 51.3 20.5 --
CDOs that invest in other CDOs
("CDO squared") 9 -- -- -- 55.6 44.4 --
Collateralized bond
obligations 21 -- -- -- -- 57.2 42.8
Other CLO 40 0.1 100.0 -- -- -- --
------- ----
Total other collateralized
debt obligations 752 1.3 39.8 25.9 18.4 10.6 5.3
------- ----
Other asset-backed securities 617 1.0 30.8 9.9 29.7 20.4 9.2
------- ----
Total ABS $ 2,623 4.4%
======= ====
</Table>
During 2008, certain financial markets continued to experience price
declines due to market and liquidity disruptions. We experienced this
illiquidity and disruption in certain of our MBS, CMBS and ABS fixed income
securities, particularly in our Prime residential mortgage-backed securities
("Prime"), Alt-A, CMBS, CRE CDO, ABS RMBS, ABS CDO, and other collateralized
debt obligations ("other CDO") portfolios. These portfolios totaled $6.57
billion or approximately 11% of our total investments at December 31, 2008.
Other securities markets, including certain other asset-backed and real
estate-backed securities markets, also experienced illiquidity, but to a lesser
degree.
We determine the fair values of securities comprising these illiquid
portfolios by obtaining information from an independent third-party valuation
service provider and brokers. We confirmed the reasonableness of the fair value
of these portfolios as of December 31, 2008 by analyzing available market
information including, but not limited to, collateral quality, anticipated cash
flows, credit enhancements, default rates, loss severities, securities' relative
position within their respective capital structures, and credit ratings from
statistical rating agencies.
38
<Page>
The following table summarizes our illiquid portfolios as of December 31,
2008.
<Table>
<Caption>
AMORTIZED COST FAIR VALUE AS
PAR AMORTIZED AS A PERCENT FAIR A PERCENT OF UNREALIZED
($ IN MILLIONS) VALUE (2) COST (1)(2) OF PAR VALUE VALUE PAR VALUE GAIN/LOSS
------------ --------------- ---------------- --------- --------------- ------------
MBS
Prime $ 671 $ 662 98.7% $ 523 77.9% $ (139)
Alt-A 513 432 84.2 315 61.4 (117)
CMBS
CMBS 5,787 5,687 98.3 3,703 64.0 (1,984)
CRE CDO 201 25 12.4 27 13.4 2
ABS
ABS RMBS 2,344 2,000 85.3 1,248 53.2 (752)
ABS CDO 137 10 7.3 6 4.4 (4)
Other CDO 2,244 1,858 82.8 752 33.5 (1,106)
-------- -------- ------- --------
Total $ 11,897 $ 10,674 89.7 $ 6,574 55.3 $ (4,100)
======== ======== ======= ========
</Table>
- ----------
(1) Amortized cost includes other-than-temporary impairment charges, as
applicable.
(2) The difference between par value and amortized cost of $1.22 billion is
primarily attributable to write-downs. Par value has been reduced by
principal payments.
The following table presents realized capital gains and losses and
principal transactions relating to our illiquid portfolios for the year ended
December 31, 2008.
<Table>
<Caption>
REALIZED CAPITAL GAINS AND LOSSES PRINCIPAL TRANSACTIONS
-------------------------------------------- ---------------------------------------
CHANGE IN
IMPAIRMENT INTENT PRINCIPAL
($ IN MILLIONS) SALES WRITE-DOWNS WRITE-DOWNS SOLD RECEIVED ACQUIRED
---------- --------------- --------------- ---------- ------------- ------------
MBS
Prime $ (10) $ (9) $ (11) $ 179 $ 71 $ --
Alt-A (6) (44) (44) 44 47 --
CMBS
CMBS (15) -- (226) 2,215 164 1,284
CRE CDO (44) (45) (330) 279 5 --
ABS
ABS RMBS (31) (169) (200) 91 283 --
ABS CDO -- (63) -- 3 1 --
Other CDO 3 (324) -- 25 17 11
------ ------ ------ ------- ------- -------
Total $ (103) $ (654) $ (811) $ 2,836 $ 588 $ 1,295
====== ====== ====== ======= ======= =======
</Table>
Securities included in our illiquid portfolios with a fair value less than
70% of amortized cost as of December 31, 2008 are shown in the following table.
<Table>
<Caption>
($ IN MILLIONS) FAIR UNREALIZED
VALUE GAIN/LOSS
---------- --------------
MBS
Prime $ 49 $ (55)
Alt-A 99 (81)
CMBS
CMBS 857 (1,623)
CRE CDO -- --
ABS
ABS RMBS 501 (618)
ABS CDO 5 (3)
Other CDO 449 (1,044)
------- --------
Total $ 1,960 $ (3,424)
======= ========
</Table>
39
<Page>
We continue to believe that the unrealized losses on these securities are
not predictive of the ultimate 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 be other than
temporary, the unrealized losses should reverse over the remaining lives of the
securities.
The cash flows of the underlying mortgages or collateral for MBS, CMBS
(including CRE CDO) and ABS are generally applied in a pre-determined order and
are designed so that each security issued qualifies for a specific original
rating. The security issue is typically referred to as the "class". For example,
the "senior" portion or "top" of the capital structure which would originally
qualify for a rating of Aaa is referred to as the "Aaa class" and typically has
priority in receiving the principal repayments on the underlying mortgages. In a
sequential structure, underlying collateral principal repayments are directed to
the most senior rated Aaa class in the structure until paid in full, after which
principal repayments are directed to the next most senior Aaa class in the
structure until it is paid in full. Although the various Aaa classes may receive
principal sequentially, they may share any losses from the underlying collateral
on a pro-rata basis after losses are absorbed by classes with lower original
ratings or what may be referred to as more "junior" or "subordinate" securities
in the capital structure. The underlying mortgages have fixed interest rates,
variable interest rates (such as adjustable rate mortgages ("ARM")) or are
hybrid, meaning that they contain features of both fixed and variable rate
mortgages.
MBS totaled $2.72 billion, with 98.7% rated investment grade, at December
31, 2008. The MBS portfolio is subject to interest rate risk since price
volatility and the ultimate realized yield are affected by the rate of
prepayment of the underlying mortgages. The credit risk associated with MBS is
mitigated due to the fact that 69.2% of the portfolio consists of securities
that were issued by, or have underlying collateral that is guaranteed by, U.S.
government agencies or U.S. government sponsored entities ("U.S. Agency").
PRIME are collateralized by residential mortgage loans issued to prime
borrowers. The following table shows our Prime portfolio as of December 31, 2008
by vintage year, based upon our participation in the capital structure.
<Table>
<Caption>
($ IN MILLIONS) VINTAGE YEAR
-------------------------------
CAPITAL STRUCTURE FAIR AMORTIZED UNREALIZED
CLASSIFICATION (1) 2007 2006 2005 PRE-2005 VALUE COST (2) GAIN/LOSS
- ------------------ ---- ---- ---- -------- ----- --------- ----------
Aaa - Fixed rate $ 88 $ 26 $ 76 $ 255 $ 445 $ 538 $ (93)
Aaa - Hybrid -- -- 39 29 68 108 (40)
Aa - Fixed rate -- -- -- 7 7 8 (1)
A - Hybrid -- -- 3 -- 3 8 (5)
----- ----- ----- ------ ------ -------- ------
Total $ 88 $ 26 $ 118 $ 291 $ 523 $ 662 $ (139)
===== ===== ===== ====== ====== ======== ======
</Table>
- ----------
(1) May not be consistent with current ratings due to downgrades.
(2) Amortized cost includes other-than-temporary impairment charges, as
applicable.
ALT-A can be issued by trusts backed by pools of residential mortgages with
either fixed or variable interest rates. The mortgage pools can include
residential mortgage loans issued to borrowers with stronger credit profiles
than sub-prime borrowers, but who do not qualify for prime financing terms due
to high loan-to-value ratios or limited supporting documentation. The following
table presents information about the collateral in our Alt-A holdings at
December 31, 2008.
<Table>
<Caption>
% TO TOTAL
($ IN MILLIONS) FAIR VALUE INVESTMENTS
---------- -----------
ALT-A
Fixed rate $ 277 0.5%
Variable rate 38 --
------ ----
Total Alt-A $ 315 0.5%
====== ====
</Table>
40
<Page>
The following table shows our Alt-A portfolio at December 31, 2008 by
vintage year, based upon our participation in the capital structure.
<Table>
<Caption>
($ IN MILLIONS) VINTAGE YEAR
----------------------------
CAPITAL STRUCTURE PRE- FAIR AMORTIZED UNREALIZED
CLASSIFICATION (1) 2007 2006 2005 2005 VALUE COST (2) GAIN/LOSS
------------------ ---- ---- ---- ---- ----- --------- ----------
Aaa - Fixed rate $ 25 $ 22 $ 89 $ 132 $ 268 $ 359 $ (91)
Aaa - Hybrid -- -- -- 5 5 9 (4)
Aaa - Option adjustable rate mortgage -- -- -- 1 1 2 (1)
Aa - Fixed rate -- 7 2 -- 9 8 1
Aa - Option adjustable rate mortgage -- -- 2 9 11 14 (3)
A and lower -- 14 7 -- 21 40 (19)
----- ----- ----- ----- ------ -------- -----
Total $ 25 $ 43 $ 100 $ 147 $ 315 $ 432 $(117)
===== ===== ===== ===== ====== ======== =====
</Table>
- ----------
(1) May not be consistent with current ratings due to downgrades.
(2) Amortized cost includes other-than-temporary impairment charges, as
applicable.
CMBS totaled $3.73 billion, all of which were rated investment grade, at
December 31, 2008. The CMBS portfolio is subject to credit risk, but unlike
other structured securities, is generally not subject to prepayment risk due to
protections within the underlying commercial mortgages whereby borrowers are
effectively restricted from prepaying their mortgages due to changes in interest
rates. Approximately 92.0% of the CMBS investments are structured securities
collateralized by pools of commercial mortgages, broadly diversified across
property types and geographical area.
41
<Page>
The following table shows our CMBS portfolio, excluding CRE CDO, at
December 31, 2008 by vintage year, based upon our participation in the capital
structure.
<Table>
<Caption>
($ IN MILLIONS)
CAPITAL STRUCTURE PAR AMORTIZED FAIR UNREALIZED
CLASSIFICATION (1) VALUE COST (2) VALUE GAIN/LOSS
------------------ ------ --------- ------ ----------
Aaa
2007:
Super senior (3) $ 383 $ 379 $ 263 $ (116)
Mezzanine senior (4) 130 122 58 (64)
Subordinated senior (5) 596 569 166 (403)
Other (6) 21 22 9 (13)
------ ------ ------ -------
1,130 1,092 496 (596)
2006:
Super senior (3) 102 102 64 (38)
Mezzanine senior (4) 81 77 41 (36)
Subordinated senior (5) 314 301 94 (207)
Other (6) 55 56 37 (19)
------ ------ ------ -------
552 536 236 (300)
2005:
Super senior (3) 309 311 245 (66)
Mezzanine senior (4) 22 22 13 (9)
Subordinated senior (5) 108 115 48 (67)
Other (6) 95 95 70 (25)
------ ------ ------ -------
534 543 376 (167)
Pre-2005 (7): 2,081 2,108 1,896 (212)
------ ------ ------ -------
Aaa total 4,297 4,279 3,004 (1,275)
Aa 1,108 1,176 520 (656)
A 345 222 169 (53)
Baa 35 8 8 --
Ba or lower 2 2 2 --
------ ------ ------ -------
Total CMBS $5,787 $5,687 $3,703 $(1,984)
====== ====== ====== =======
</Table>
- ----------
(1) May not be consistent with current ratings due to upgrades and downgrades.
(2) Amortized cost includes other-than-temporary impairment charges, as
applicable.
(3) Most senior of the Aaa rated tranches, typically has a high level of credit
enhancement of approximately 30%, meaning actual losses in the deal have to
reach 30% before incurring a first dollar loss.
(4) Middle Aaa rated tranche, typically having credit enhancement of
approximately 20%, are subordinate only to the Super senior bonds.
(5) Lowest Aaa rated tranche, typically with credit enhancement in the low
teens. This bond is subordinate to the Super senior and Mezzanine senior
tranches, but still senior to all tranches rated below Aaa.
(6) Includes Aaa bonds that were originated in 2005 through 2007 that do not
fall into the categories above. These are non-traditional CMBS bonds (large
loan pools, single borrower transactions) that did not have a Aaa Senior
type breakdown.
(7) Prior to 2005, the Aaa bonds in a transaction were generally not divided
into Super senior, Mezzanine senior, or Subordinated senior (with the
exception of a few deals structured very late in 2004); therefore all 2004
and prior Aaa-rated securities are grouped into this category.
The unrealized net capital loss of $1.98 billion at December 31, 2008 on
our CMBS portfolio was a result of significant widening of credit spreads due to
deteriorating macro economic conditions and continued credit market
deterioration. Credit spread widening occurred in all rating classes but was
particularly evident in our subordinated senior Aaa, Pre-2005 Aaa-rated and
lower rated securities. These holdings accounted for $1.66 billion, or
approximately 83% of the unrealized net capital loss. Our analysis suggests that
the vast majority of our CMBS portfolio is well insulated from a severe rise in
commercial mortgage default rates. Credit protections in the portfolio,
including those on subordinated senior Aaa and Aa-rated securities, are
multiples of historic high commercial mortgage loss experience and well in
excess of our current loss expectations.
42
<Page>
CRE CDO are structured securities secured primarily by CMBS and other
commercial mortgage debt obligations. These securities are generally less liquid
and have a higher risk profile than other CMBS. The following table shows our
CRE CDO portfolio at December 31, 2008 by vintage year, based upon our
participation in the capital structure.
<Table>
<Caption>
($ IN MILLIONS) VINTAGE YEAR
------------------
CAPITAL STRUCTURE FAIR AMORTIZED UNREALIZED
CLASSIFICATION (1) 2007 2006 2005 VALUE COST (2) GAIN/LOSS
------------------ ---- ---- ---- ----- --------- ----------
Aa $ -- $ 15 $ 1 $ 16 $ 14 $ 2
A 4 1 3 8 8 --
Baa 1 -- 2 3 3 --
---- ---- ---- ----- ---- ----
Total $ 5 $ 16 $ 6 $ 27 $ 25 $ 2
==== ==== ==== ===== ==== ====
</Table>
- ----------
(1) May not be consistent with current ratings due to downgrades.
(2) Amortized cost includes other-than-temporary impairment charges, as
applicable.
ABS totaled $2.62 billion, with 92.4% rated investment grade, at December
31, 2008. 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 ultimate realized yields are affected
by the rate of prepayment of the underlying assets.
ABS RMBS includes securities that are collateralized by mortgage loans
issued to borrowers that cannot qualify for Prime or Alt-A financing terms due
in part to weak or limited credit history. It also includes securities that are
collateralized by certain second lien mortgages regardless of the borrower's
credit history. $957 million or 76.7% of the ABS RMBS portfolio consisted of
securities that were issued during 2005, 2006 and 2007. At December 31, 2008,
37.5% of securities issued during 2005, 2006 and 2007 were rated Aaa, 26.7%
rated Aa, 7.0% rated A, 14.4% rated Baa and 14.4% rated Ba or lower.
The following table presents additional information about our ABS RMBS
portfolio including a summary by first and second lien collateral at December
31, 2008.
<Table>
<Caption>
% TO TOTAL
($ IN MILLIONS) FAIR VALUE INVESTMENTS
---------- -----------
ABS RMBS
First lien:
Fixed rate(1) $ 375 0.6%
Variable rate(1) 652 1.1
------- -------
Total first lien(2) 1,027 1.7
Second lien:
Insured 166 0.3
Other 55 0.1
------- -------
Total second lien(3) 221 0.4
------- -------
Total ABS RMBS $ 1,248 2.1%
======= =======
</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
38.1% Aaa, 37.8% Aa, 10.0% A, 6.0% Baa and 8.1% Ba or
lower at December 31, 2008.
(3) The credit ratings of the second lien ABS RMBS were
13.6% Aaa, 9.0% Aa, 2.2% A, 47.1% Baa and 28.1% Ba or
lower at December 31, 2008.
43
<Page>
The following table includes first lien non-insured ABS RMBS by vintage
year and the interest rate characteristics of the underlying mortgage product.
<Table>
<Caption>
VARIABLE FIXED FAIR AMORTIZED UNREALIZED
($ IN MILLIONS) RATE RATE VALUE COST (1) GAIN/LOSS
---- ---- ----- -------- ---------
Total first lien
non-insured ABS RMBS
2007 $ 74 $ 156 $ 230 $ 417 $ (187)
2006 198 88 286 384 (98)
2005 162 43 205 316 (111)
Pre-2005 194 35 229 314 (85)
------- ------- ------- -------- ------
Total $ 628 $ 322 $ 950 $ 1,431 $ (481)
======= ======= ======= ======== ======
</Table>
- ----------
(1) Amortized cost includes other-than-temporary impairment charges,
as applicable.
We also own approximately $55 million of second lien ABS RMBS non-insured
securities, representing 78.6% of amortized cost. Approximately $16 million, or
29.1%, of this portfolio are 2006 and 2007 vintage years. Together with the
first lien non-insured ABS RMBS in the table above, this comprises our $1.01
billion of non-insured ABS RMBS.
At December 31, 2008, $243 million or 19.5% of the total ABS RMBS
securities are insured by four bond insurers and 72.9% of these insured
securities were rated investment grade. The following table shows our insured
ABS RMBS portfolio at December 31, 2008 by vintage year for the first lien and
second lien collateral.
<Table>
<Caption>
($ IN MILLIONS) VINTAGE YEAR
-----------------------------------
FAIR AMORTIZED UNREALIZED
2007 2006 2005 PRE- 2005 VALUE COST (1) GAIN/LOSS
------ ------ ------ --------- ------- ---------- ----------
First lien: $ 30 $ 7 $ 32 $ 8 $ 77 $ 113 $ (36)
Second lien: 92 48 3 23 166 386 (220)
------ ------ ----- ------ ------ -------- --------
Total insured ABS RMBS $ 122 $ 55 $ 35 $ 31 $ 243 $ 499 $ (256)
====== ====== ===== ====== ====== ======== ========
</Table>
- ----------
(1) Amortized cost includes other-than-temporary impairment charges, as
applicable.
Other CDO totaled $752 million, with 94.7% rated investment grade, at
December 31, 2008. Other CDO consist primarily of obligations secured by high
yield and investment grade corporate credits including cash flow CLO, synthetic
CDO, trust preferred CDO, market value CDO, project finance CDO, CDO squared,
collateralized bond obligations and other CLO.
The following table presents realized and unrealized capital gains and
losses and principal transactions on our Other CDO portfolio for the year ended
December 31, 2008.
<Table>
<Caption>
REALIZED CAPITAL GAINS
AND LOSSES (1) PRINCIPAL TRANSACTIONS
-------------------------- ----------------------------------
IMPAIRMENT UNREALIZED PRINCIPAL
($ IN MILLIONS) SALES WRITE-DOWNS GAINS/LOSSES SOLD RECEIVED ACQUIRED
--------- --------------- --------------- -------- ------------ ----------
OTHER CDO
Cash flow CLO $ 1 $ (59) $ (685) $ 7 $ 5 $ 11
Synthetic CDO -- (186) (160) 2 -- --
Trust preferred CDO -- (28) (91) -- 11 --
Market value CDO 1 (33) (63) 1 -- --
Project finance CDO -- -- (34) -- -- --
CDO squared -- -- (68) -- -- --
Collateralized
bond obligations -- -- (5) 1 1 --
Other CLO 1 (18) -- 14 -- --
--------- --------------- --------------- -------- ------------ ----------
Total $ 3 $ (324) $ (1,106) $ 25 $ 17 $ 11
========= =============== =============== ======== ============ ==========
</Table>
- ----------
(1) For the year ended December 31, 2008, there were no change in intent
write-downs.
44
<Page>
Cash flow CLO are structures where the underlying assets are primarily
comprised of below investment grade senior secured corporate loans. The
collateral is actively managed by external managers that monitor the collateral
performance. The underlying investments are well diversified across industries
and among issuers and there have been no significant downgrades in the
portfolio. Cash flow CLO issues differ by seniority. A transaction will
typically issue notes with various capital structure class (i.e. Aaa, Aa, A,
etc.) as well as equity. The following table shows our cash flow CLO portfolio
at December 31, 2008 by vintage year, based upon our participation in the
capital structure.
<Table>
<Caption>
($ IN MILLIONS) VINTAGE YEAR
-------------------------------------------------
CAPITAL STRUCTURE FAIR AMORTIZED UNREALIZED
CLASSIFICATION (1) 2008 2007 2006 2005 PRE- 2005 VALUE COST (2) GAIN/LOSS
- ------------------ ------ ------ ------- ------- --------- ------- --------- ----------
Aaa $ -- $ -- $ 58 $ 52 $ 144 $ 254 $ 350 $ (96)
Aa 2 39 48 7 10 106 296 (190)
A 1 23 24 16 34 98 455 (357)
Baa -- -- 5 6 23 34 72 (38)
Ba or below -- 4 1 -- -- 5 9 (4)
------ ------ ------- ------- -------- ------- -------- ---------
Total $ 3 $ 66 $ 136 $ 81 $ 211 $ 497 $ 1,182 $ (685)
====== ====== ======= ======= ======== ======= ======== =========
</Table>
- ----------
(1) May not be consistent with current ratings due to downgrades.
(2) Amortized cost includes other-than-temporary impairment charges, as
applicable.
Synthetic CDO primarily consist of a portfolio of corporate credit default
swaps ("CDS") which are collateralized by Aaa rated LIBOR-based securities (i.e.
"fully funded" synthetic CDO). Our synthetic CDO collateral primarily is
actively managed by an external manager monitoring the CDS selection and
performance. The following table shows our synthetic CDO at December 31, 2008 by
vintage year, based upon our participation in the capital structure.
<Table>
<Caption>
($ IN MILLIONS) VINTAGE YEAR
-----------------
CAPITAL STRUCTURE FAIR AMORTIZED UNREALIZED
CLASSIFICATION(1) 2007 2006 VALUE COST (2) GAIN/LOSS
----------------- -------- ------- ------ --------- --------------
Aaa $25 $-- $25 $ 85 $ (60)
Aa 6 16 22 122 (100)
--- --- --- ---- ------
Total $31 $16 $47 $207 $(160)
=== === === ==== ======
</Table>
- ----------
(1) May not be consistent with current ratings due to downgrades.
(2) Amortized cost includes other-than-temporary impairment charges,
as applicable.
Trust preferred CDO underlying assets are primarily comprised of portfolios
of preferred securities issued by a diversified portfolio of domestic banks and
other financial institutions. The underlying collateral for our trust preferred
CDO portfolio is not actively managed and is diversified by issuer,
predominately regional banks, with a small percentage of insurance companies.
Market value CDO are structurally similar to cash flow CLO. The primary
difference is that the market value of the underlying assets is managed in order
to enhance returns and the structure is governed by market value based tests.
The managers are also offered more flexibility to purchase other asset types
including secured leveraged loans, public and private high yield bonds,
structured products, mezzanine investments, and equities.
Project finance CDO underlying assets are primarily below investment grade
senior secured project finance loans and energy finance investments.
CDO squared transactions are CDOs where the underlying assets are primarily
other cash flow CLO tranches, typically with an average rating of Baa.
Other asset-backed securities totaled $617 million at December 31, 2008 and
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, 2008, the net unrealized losses on these securities were $164
million. Additionally, 22.2% of the other asset-backed securities that are rated
Aaa, Aa, A and Baa were insured by four bond insurers. During 2008, we sold $102
million of these securities recognizing a gain of $1 million. In addition, we
acquired $28 million of securities during 2008. We also collected $73 million of
principal repayments consistent with the expected cash flows during 2008.
45
<Page>
INSURED INVESTMENTS As of December 31, 2008, we hold $2.14 billion of fixed
income securities that are insured by bond insurers, including $1.68 billion or
50.8% of our municipal bond portfolio, $243 million of our ABS RMBS and $172
million of our other asset-backed securities. Additionally, we hold $4 million
of corporate bonds and $(5) million in credit default swaps that were directly
issued by these bond insurers. 50.8% of our municipal bond portfolio is insured
by six bond insurers and 36.4% of these securities have a Moody's equivalent
rating of Aaa or Aa. Our practices for acquiring and monitoring municipal bonds
primarily are based on the quality of the primary obligor. As of December 31,
2008, we believe the valuations already reflected a decline in the value of the
insurance, and further related declines if any, are not expected to be material.
While the valuation of these holdings may be temporarily impacted by negative
and rapidly changing market developments, we continue to have the intent and
ability to hold the bonds and expect to receive all of the contractual cash
flows. As of December 31, 2008, 57.0% of our insured municipal bond portfolio
was insured by MBIA, Inc., 13.9% by Ambac Financial Group, Inc., 18.4% by
Financial Security Assurance Inc. and 6.5% by Financial Guarantee Insurance
Company.
Credit ratings without the insurance guarantee are not available in certain
cases where the issuer does not solicit the rating agency to provide the rating
without the insurance guarantee and, as a result, the rating agency does not
disclose it. The ratings of our holdings with insurance guarantee generally
follow the rating of the bond insurer. In cases where the rating of the bond
insurer is lower than that of the underlying security, the rating without
insurance guarantee could be higher than that with the guarantee.
The following table shows our insured investments by Moody's equivalent
rating with and without the impact to the rating from the insurance guarantee,
where it is available, as of December 31, 2008.
<Table>
<Caption>
($ IN MILLIONS)
RATING WITH INSURANCE GUARANTEE RATING WITHOUT INSURANCE GUARANTEE
--------------------------------------------------------- --------------------------------------------
FAIR PERCENT TO FAIR PERCENT TO
RATING VALUE TOTAL RATING VALUE TOTAL
------------------------------ ---------- ------------- ---------------- ---------- -------------
MUNICIPAL BONDS
Aaa $ 77 4.6 % Aaa $ 77 4.6 %
Aa 534 31.8 Aa 308 18.3
A 488 29.0 A 837 49.8
Baa 581 34.6 Baa 458 27.3
--------- ----------- ---------- -----------
Total municipal bonds $ 1,680 100.0 % $ 1,680 100.0 %
========= =========== ========== ===========
ABS RMBS
Aaa $ 4 1.6 % Aaa $ 6 2.5 %
Aa 44 18.1 Aa 19 7.8
A 7 2.9 A 31 12.8
Baa 122 50.2 Baa 13 5.3
Ba 39 16.1 Ba 20 8.2
B 10 4.1 B 13 5.3
Caa or lower 17 7.0 Caa or lower 11 4.6
Rating without Insurance
Guarantee not provided
("NA") -- -- NA 130 53.5
--------- ----------- ---------- -----------
Total ABS RMBS $ 243 100.0 % $ 243 100.0 %
========= =========== ========== ===========
OTHER ASSET-BACKED SECURITIES
Aaa $ 62 36.0 % Aaa $ -- -- %
Aa 46 26.7 Aa -- --
A -- -- A 8 4.7
Baa 29 16.9 Baa 69 40.1
Ba 17 9.9 Ba -- --
NA 18 10.5 NA 95 55.2
--------- ----------- ---------- -----------
Total other asset-backed
securities $ 172 100.0 % $ 172 100.0 %
========= =========== ========== ===========
</Table>
MORTGAGE LOANS Our mortgage loan portfolio was $10.01 billion and $9.90 billion
at December 31, 2008 and 2007, respectively, and comprised primarily loans
secured by first mortgages on developed commercial real estate. Geographical and
property type diversification are key considerations used to manage our
exposure. The portfolio is diversified across several property types. Our
largest exposure to any metropolitan area is also highly diversified, with the
largest exposure not exceeding 10% of the portfolio. The average debt service
coverage ratio represents the amount of cash flows available from the property
to meet the borrower's principal and interest payment obligations.
46
<Page>
The average debt service coverage ratio of the portfolio as of December 31, 2008
was approximately 2.0, and only approximately 3.0% of the mortgage loan
portfolio had a debt service coverage ratio under 1.0.
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 at least quarterly for purposes of establishing valuation
allowances and placing loans on non-accrual status as 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 $3 million of realized capital losses related to valuation
allowances on mortgage loans for the year ended December 31, 2008 and had no
realized capital losses related to valuation allowances on mortgage loans for
the year ended December 31, 2007. Additionally, realized capital losses due to
changes in intent to hold mortgage loans to maturity totaled $73 million and $28
million for the years ended December 31, 2008 and 2007, respectively. For
further detail, see Note 6 to the consolidated financial statements.
EQUITY SECURITIES Equity securities include common stocks, real estate
investment trust equity investments and non-redeemable preferred stocks. The
equity securities portfolio was $82 million at December 31, 2008 compared to
$102 million at December 31, 2007. The decrease is primarily attributable to
higher unrealized losses and sales of equity securities with realized gains of
$4 million and realized losses of $12 million. Gross unrealized gains totaled $1
million at December 31, 2008 compared to $5 million at December 31, 2007. Gross
unrealized losses totaled $25 million at December 31, 2008 compared to $5
million at December 31, 2007.
LIMITED PARTNERSHIP INTERESTS consist of investments in private equity/debt
funds, real estate funds and hedge funds. The overall limited partnership
interests portfolio is well diversified across a number of metrics including
fund sponsors, vintage years, strategies, geography (including international),
and company/property types.
The following table presents information about our limited partnership
interests as of December 31, 2008.
<Table>
<Caption>
PRIVATE EQUITY/ REAL ESTATE HEDGE
($ IN MILLIONS) DEBT FUNDS FUNDS FUNDS TOTAL
---------- ----- ----- -----
COST METHOD OF ACCOUNTING ("COST") $ 384 $ 175 $ 1 $ 560
EQUITY METHOD OF ACCOUNTING ("EMA") 345 218 64 627
-------- ------ ----- -------
TOTAL $ 729 $ 393 $ 65 $ 1,187
======== ====== ===== =======
NUMBER OF SPONSORS 68 32 2
NUMBER OF INDIVIDUAL FUNDS 118 54 3
LARGEST EXPOSURE TO SINGLE FUND $ 22 $ 31 $ 36
</Table>
Our aggregate limited partnership exposure represented 2.0% and 1.4% of
total invested assets as of December 31, 2008 and December 31, 2007,
respectively.
The following table shows the income from our limited partnership interests
by fund type and accounting classification for the years ended December 31.
<Table>
<Caption>
2008 2007
--------------------------------- ----------------------------
($ IN MILLIONS) COST EMA(1) TOTAL COST EMA TOTAL
------- ------ ---------- ------- --- ------
Private equity/debt funds $ 12 $ 43 $ 55 $ 27 $ 19 $ 46
Real estate funds 3 (26) (23) 10 24 34
Hedge funds -- (17) (17) -- 7 7
----- ------ ------- ----- ---- -----
Total $ 15 $ -- $ 15 $ 37 $ 50 $ 87
===== ====== ======= ===== ==== =====
</Table>
- ----------
(1) Beginning in the fourth quarter of 2008, income from limited
partnerships accounted for on the equity method of accounting ("EMA
LP") is reported in realized capital gains and losses. EMA LP income
for periods prior to the fourth quarter of 2008 is reported in net
investment income.
Income from limited partnership interests was $15 million for 2008 and $87
million for 2007. The decrease in 2008 is primarily related to losses from EMA
LP resulting from reduced valuations on the net asset value of the partnerships.
Further, income on EMA LP is recognized on a delay due to the availability of
the related financial statements. The recognition of income on hedge funds is
primarily on a one-month delay and the income recognition on private equity/debt
funds and real estate funds are generally on a three-month delay as of December
31, 2008. As such, the income recognized through December 31, 2008 for EMA LP
may not include the full impact for calendar year investment market changes as
they will ultimately impact the valuation of the underlying assets or
47
<Page>
liabilities within the partnerships. Limited partnership interests accounted for
under the cost method of accounting recognize income only upon cash
distributions by the partnership.
SHORT-TERM INVESTMENTS Our short-term investment portfolio was $3.86 billion and
$386 million at December 31, 2008 and 2007, respectively. The increase in
short-term investments was primarily due to liquidity management actions. 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 $813 million and $770 million at
December 31, 2008 and 2007, respectively. Policy loans are carried at the unpaid
principal balances.
OTHER INVESTMENTS Our other investments as of December 31, 2008 are comprised of
$981 million of bank loans, $138 million of certain derivatives, including
credit default swaps, and $255 of other investments. Bank loans are comprised
primarily of senior secured corporate loans and are carried at amortized cost.
Other investments are comprised primarily of intercompany notes issued by an
unconsolidated affiliate.
CREDIT DEFAULT SWAPS ("CDS") are utilized for both buying and selling
credit protection against a specified credit event. In selling protection, CDS
are used to replicate fixed income securities and to complement the cash market
when credit exposure to certain issuers is not available or when the derivative
alternative is less expensive than the cash market alternative. We are not
selling protection to acquire revenues as a business activity. When buying
protection, the objective is to mitigate credit risk on fixed income holdings in
our portfolio. Credit risk includes both default risk and market value exposure
due to spread widening. CDS typically have a five-year term. The following table
shows the CDS notional amounts and fair value of protection bought or sold as of
December 31, 2008.
<Table>
<Caption>
FAIR VALUE
($ IN MILLIONS) NOTIONAL FAIR TO NOTIONAL
AMOUNTS VALUE (1) AMOUNT
------------- -------------- -------------
Buying protection (recoverable)
Single name $ 422 $ 8 1.9%
Index 723 23 3.2
------------- --------------
Total buying protection $ 1,145 $ 31 2.7
============= ==============
Selling protection (payable)
Single name $ 272 $ (25) (9.2)
First-to-default 245 (48) (19.6)
------------- --------------
Total selling protection $ 517 $ (73) (14.1)
============= ==============
</Table>
- ----------
(1) Included as a component of other investments and other
liabilities and accrued expenses on the Consolidated
Statements of Financial Position.
In buying and selling protection CDS, we buy or sell credit protection on
an identified single name, a basket of names in a first-to-default ("FTD")
structure or credit derivative index ("CDX") that is generally investment grade,
and in return pay or receive periodic premiums through expiration or termination
of the agreement. With single name CDS, the premium or credit spread generally
corresponds to the difference between the yield on the referenced name's public
fixed maturity cash instruments and swap rates, at the time the agreement is
executed. With FTD baskets, because of the additional credit risk inherent in a
basket of named credits, the premium generally corresponds to a high proportion
of the sum of the credit spreads of the names in the basket and correlation
between the names. CDX index is utilized to take a position on multiple
(generally 125) credit entities. Credit events are typically defined as
bankruptcy, failure to pay, or restructuring, depending on the nature of the
reference credit. If a credit event occurs, we settle with the counterparty,
either through physical settlement or cash settlement. In a physical settlement,
a reference asset is delivered by the buyer of protection to the seller of
protection, in exchange for cash payment at par, while in a cash settlement, the
seller pays the difference between par and the prescribed value of the reference
asset. When such an event occurs in a single name or FTD basket (for FTD, the
first such event occurring for any one name in the basket), the contract
terminates at time of settlement. For CDX index, the reference entity's name
incurring the credit event is removed from the index while the contract
continues until expiration. The maximum payout on a CDS is the contract notional
amount. For all CDS, once a credit event and settlement has occurred, there may
be subsequent recoveries. Recovery amounts, if any, vary and they may reduce the
ultimate amount of net gain or loss.
48
<Page>
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 losses totaled $6.70
billion as of December 31, 2008, compared to unrealized net capital gains of
$417 million at December 31, 2007 as a result of significantly widening credit
spreads and, to a much lesser extent, declining equity markets.
The following table presents unrealized net capital gains and losses,
pre-tax and after-tax at December 31.
<Table>
<Caption>
($ IN MILLIONS)
2008 2007
---------- ----------
U.S. GOVERNMENT AND AGENCIES $ 895 $ 880
MUNICIPAL (668) 76
CORPORATE (3,147) 111
FOREIGN GOVERNMENT 448 371
MBS (204) (9)
CMBS (1,982) (310)
ABS (2,026) (670)
REDEEMABLE PREFERRED STOCK (6) --
---------- ----------
FIXED INCOME SECURITIES (6,690) 449
EQUITY SECURITIES (24) --
SHORT-TERM INVESTMENTS 3 --
DERIVATIVES 14 (32)
---------- ----------
UNREALIZED NET CAPITAL GAINS AND LOSSES, PRE-TAX (6,697) 417
---------- ----------
AMOUNTS RECOGNIZED FOR:
INSURANCE RESERVES (1) (378) (1,059)
DAC AND DSI (2) 3,493 513
---------- ----------
AMOUNTS RECOGNIZED 3,115 (546)
DEFERRED INCOME TAXES 1,245 45
---------- ----------
UNREALIZED NET CAPITAL GAINS AND LOSSES, AFTER-TAX $ (2,337) $ (84)
========== ==========
</Table>
- ----------
(1) The insurance reserves adjustment represents the amount by which
the reserve balance would increase if the net unrealized gains
in the applicable product portfolios were realized and
reinvested at current lower interest rates, resulting in a
premium deficiency. Although we evaluate premium deficiencies on
the combined performance of our life insurance and immediate
annuities with life contingencies, the adjustment primarily
relates to structured settlement annuities with life
contingencies, in addition to annuity buy-outs and certain
payout annuities with life contingencies.
(2) The DAC and DSI adjustment represents the amount by which the
amortization of DAC and DSI would increase or decrease if the
unrealized gains or losses in the respective product portfolios
were realized. Recapitalization of the DAC and DSI balances is
limited to the originally deferred costs plus interest.
The net unrealized loss for the fixed income portfolio totaled $6.69
billion, comprised of $1.92 billion of gross unrealized gains and $8.61 billion
gross unrealized losses at December 31, 2008. This is compared to a net
unrealized gain for the fixed income portfolio totaling $449 million at December
31, 2007, comprised of $2.26 billion of gross unrealized gains and $1.81 billion
of gross unrealized losses.
49
<Page>
Gross unrealized gains and losses as of December 31, 2008 on fixed income
securities by type and sector are provided in the table below.
<Table>
<Caption>
AMORTIZED
GROSS UNREALIZED COST AS A FAIR VALUE
($ IN MILLIONS) PAR AMORTIZED ---------------- FAIR PERCENT OF AS A PERCENT
VALUE (1) COST GAINS LOSSES VALUE PAR VALUE OF PAR VALUE
---------- --------- ------ ------- ----- ---------- ------------
Corporate:
Banking $ 4,298 $ 4,009 $ 89 $ (923) $ 3,175 93.3% 73.9%
Financial services 3,196 2,934 17 (509) 2,442 91.8 76.4
Consumer goods (cyclical and non-cyclical) 4,332 4,330 40 (427) 3,943 99.9 91.0
Utilities 5,079 5,071 127 (413) 4,785 99.8 94.2
Capital goods 2,751 2,732 36 (269) 2,499 99.3 90.8
Basic industry 1,500 1,510 5 (167) 1,348 100.7 89.9
Transportation 1,529 1,546 25 (156) 1,415 101.1 92.5
Communications 1,622 1,596 13 (155) 1,454 98.4 89.6
Energy 1,369 1,377 10 (121) 1,266 100.6 92.5
Technology 776 777 13 (77) 713 100.1 91.9
Other 1,820 1,534 33 (338) 1,229 84.3 67.5
-------- -------- ------- -------- --------
Total corporate fixed income portfolio 28,272 27,416 408 (3,555) 24,269 97.0 85.8
ABS 5,636 4,649 8 (2,034) 2,623 82.5 46.5
CMBS 5,988 5,712 10 (1,992) 3,730 95.4 62.3
Municipal 8,124 3,976 28 (696) 3,308 48.9 40.7
MBS 3,041 2,923 59 (263) 2,719 96.1 89.4
Foreign government 2,609 1,652 513 (65) 2,100 63.3 80.5
Redeemable preferred stock 15 16 -- (6) 10 106.7 66.7
U.S. government and agencies 4,819 2,792 895 -- 3,687 57.9 76.5
-------- -------- ------- -------- --------
Total fixed income securities $ 58,504 $ 49,136 $ 1,921 $ (8,611) $ 42,446 84.0 72.6
======== ======== ======= ======== ========
</Table>
- ----------
(1) Included in par value are zero-coupon securities that are generally
purchased at a deep discount to the par value that is received at
maturity.
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, 2008. The gross unrealized losses in
these sectors were primarily the result of significantly widening credit
spreads. As of December 31, 2008, $3.01 billion or 84.7% of the gross unrealized
losses in the corporate fixed income portfolio and $4.81 billion or 95.2% of the
gross unrealized losses in the remaining fixed income securities related to
securities rated investment grade. Credit spreads are the additional yield on
fixed income securities above the risk-free rate (typically defined as the yield
on U.S. Treasury securities) that market participants require to compensate them
for assuming credit, liquidity and/or prepayment risks for fixed income
securities with consistent terms. Credit spreads vary with the market's
perception of risk and liquidity in a specific issuer or specific sectors.
Credit spreads can widen (increase) or tighten (decrease) and may offset or add
to the effects of risk-free interest rate changes in the valuation of fixed
income securities from period to period.
All securities in an unrealized loss position at December 31, 2008 were
included in our portfolio monitoring process for determining whether declines in
value are other than temporary.
50
<Page>
The following table shows gross unrealized losses at December 31, 2008 by
credit quality of the fixed income securities using Moody's equivalent rating.
<Table>
<Caption>
RATING (1)
--------------------------------------------------------------------------------
IN OR TOTAL
Caa or NEAR UNREALIZED FAIR
($ IN MILLIONS) Aaa Aa A Baa Ba B lower DEFAULT LOSS VALUE
--- -- - --- -- - ------ ------- ---------- -----
AT DECEMBER 31, 2008
Corporate:
Banking $ -- $ (45) $ (663) $ (190) $ (22) $ (3) $ -- $ -- $ (923) $ 2,272
Financial services (20) (30) (202) (218) (38) -- -- (1) (509) 2,092
Consumer goods (cyclical
and non-cyclical) -- (4) (53) (218) (122) (20) (10) -- (427) 2,688
Utilities -- (8) (58) (298) (42) (1) (6) -- (413) 3,151
Capital goods -- -- (39) (156) (46) (28) -- -- (269) 1,698
Basic industry -- (4) (13) (95) (23) (32) -- -- (167) 1,096
Transportation -- -- (39) (76) (40) (1) -- -- (156) 822
Communications -- -- (6) (99) (41) (9) -- -- (155) 1,072
Energy -- (3) (6) (101) (8) (3) -- -- (121) 901
Technology (2) (2) (15) (49) (5) (4) -- -- (77) 513
Other -- -- (71) (259) (8) -- -- -- (338) 820
--------- --------- --------- --------- ------- ------- ------- ------- --------- ---------
Total corporate fixed
income portfolio (22) (96) (1,165) (1,759) (395) (101) (16) (1) (3,555) 17,125
--------- --------- --------- --------- ------- ------- ------- ------- --------- ---------
ABS (243) (560) (566) (467) (86) (59) (39) (14) (2,034) 2,443
CMBS (1,311) (642) (24) (15) -- -- -- -- (1,992) 3,547
Municipal (72) (197) (137) (274) -- (16) -- -- (696) 2,658
MBS (200) (17) -- (26) (10) (10) -- -- (263) 957
Foreign government -- -- (4) (21) (17) (23) -- -- (65) 318
Redeemable preferred
stock -- -- -- (6) -- -- -- -- (6) 9
U.S. government and
agencies -- -- -- -- -- -- -- -- -- 81
--------- --------- --------- --------- ------- ------- ------- ------- --------- ---------
Total fixed income
securities $ (1,848) $ (1,512) $ (1,896) $ (2,568) $ (508) $ (209) $ (55) $ (15) $ (8,611) $ 27,138
========= ========= ========= ========= ======= ======= ======= ======= ========= =========
Rating % to total
unrealized loss 21.5% 17.6% 22.0% 29.8% 5.9% 2.4% 0.6% 0.2% 100.0%
========= ========= ========= ========= ======= ======= ======= ======= =========
</Table>
- ----------
(1) Moody's equivalent rating will not necessarily tie to ratings
distributions from the NAIC due to potential timing differences
between the various rating suppliers and the number of external rating
agencies used in the determination.
The scheduled maturity dates for fixed income securities at December 31,
2008 are shown below. Actual maturities may differ from those scheduled as a
result of prepayments by the issuers.
<Table>
<Caption>
FIXED INCOME SECURITIES IN GROSS FIXED INCOME SECURITIES IN GROSS
UNREALIZED GAIN POSITION UNREALIZED LOSS POSITION
-------------------------------------------- ------------------------------------------
UNREALIZED PERCENT FAIR PERCENT UNREALIZED PERCENT FAIR PERCENT
($ IN MILLIONS) GAIN TO TOTAL VALUE TO TOTAL LOSS TO TOTAL VALUE TO TOTAL
--------- -------- ----- -------- --------- -------- ----- --------
Due in one year or less $ 12 0.6% $ 1,441 9.4% $ (14) 0.2% $ 713 2.6%
Due after one year through two years 20 1.1 704 4.6 (121) 1.4 1,313 4.9
Due after two years through three years 24 1.2 627 4.1 (166) 1.9 1,880 6.9
Due after three years through four years 46 2.4 976 6.4 (207) 2.4 1,731 6.4
Due after four years through five years 48 2.5 772 5.0 (291) 3.4 1,880 6.9
Due after five years through ten years 858 44.7 4,530 29.6 (1,265) 14.7 5,918 21.8
Due after ten years 846 44.0 4,315 28.2 (4,250) 49.3 10,304 38.0
MBS and ABS(1) 67 3.5 1,943 12.7 (2,297) 26.7 3,399 12.5
--------- ------ -------- ------ -------- ------ -------- ------
Total $ 1,921 100.0% $ 15,308 100.0% $ (8,611) 100.0% $ 27,138 100.0%
========= ====== ======== ====== ======== ====== ======== ======
</Table>
- ----------
(1) Because of the potential for prepayment, these securities are not
categorized based on their contractual maturities.
51
<Page>
For fixed income securities, 67.2% of the gross unrealized losses at
December 31, 2008 were from $4.62 billion of securities with a fair value below
70% of amortized cost, or 10.9% of our fixed income portfolio, at December 31,
2008. The following table reconciles fixed income securities with unrealized
losses based on the percentage of fair value to amortized cost.
<Table>
<Caption>
% TO TOTAL
FIXED
($ IN MILLIONS) PAR UNREALIZED FAIR INCOME
VALUE(1) GAIN/LOSS VALUE SECURITIES
------------ -------------- ------------- ------------
GREATER THAN 80% of amortized cost $ 21,134 $ (1,709) $ 19,055 44.9%
70% to 80% of amortized cost 4,954 (1,118) 3,459 8.1
LESS THAN 70% of amortized cost (2) 14,250 (5,784) 4,624 10.9
------------ -------------- ------------- ------------
Gross unrealized losses on fixed income securities 40,338 (8,611) 27,138 63.9
Gross unrealized gains on fixed income securities 18,166 1,921 15,308 36.1
------------ -------------- ------------- ------------
Net unrealized gains and losses on fixed income securities $ 58,504 $ (6,690) (3) $ 42,446 (3) 100.0%
============ ============== ============= ============
</Table>
- ----------
(1) Included in par value are $5.49 billion of zero-coupon securities
that are generally purchased at a deep discount to the par value
that is received at maturity.
(2) Illiquid portfolios represent $3.42 billion of net unrealized
losses and $1.96 billion of fair value.
(3) Illiquid portfolios represent $4.10 billion of net unrealized
losses and $6.57 billion of fair value.
The following table presents gross unrealized losses by type of fixed
income security with a fair value below 70% of amortized cost.
<Table>
<Caption>
($ IN MILLIONS) GROSS UNREALIZED
FAIR VALUE LOSSES
-------------- -----------------
Municipal $ 281 $ (383)
Corporate 2,218 (1,850)
Foreign government 29 (28)
MBS 148 (135)
CMBS 857 (1,623)
ABS 1,083 (1,759)
Redeemable preferred stock 8 (6)
-------------- -----------------
Total fixed income securities $ 4,624 $ (5,784)
============== =================
</Table>
We continue to believe that the unrealized losses on these securities are
not predictive of the ultimate performance. The unrealized losses should reverse
over the remaining lives of the securities. As of December 31, 2008, we have the
intent and ability to hold these securities to recovery. Our ability to do so is
substantially enhanced by our liquidity position, which cushions us from the
need to liquidate securities with significant unrealized losses to meet cash
obligations. During 2008, our fixed income securities portfolio provided
approximately $5.49 billion in principal and interest cash flows, of which
substantially all have been received in accordance with the contractual terms.
The equity portfolio is comprised of securities in the following sectors.
<Table>
<Caption>
($ IN MILLIONS) GROSS UNREALIZED
-----------------------
AT DECEMBER 31, 2008 COST GAINS LOSSES FAIR VALUE
-------------------- ---------- ---------- ---------- ------------
Banking $ 43 $ -- $ (15) $ 28
Financial services 30 -- (4) 26
Consumer goods 11 1 (4) 8
Real estate 14 -- -- 14
Technology 1 -- -- 1
Utilities 1 -- -- 1
Other 6 -- (2) 4
---------- ---------- ---------- ------------
Total equity securities $ 106 $ 1 $ (25) $ 82
========== ========== ========== ============
</Table>
The net unrealized loss for the equity portfolio totaled $24 million,
comprised of $1 million of unrealized gains and $25 million of unrealized losses
at December 31, 2008. This is compared to $5 million of both unrealized gains
and losses for the equity portfolio at December 31, 2007. Within the equity
portfolio, the losses were primarily concentrated in the banking, financial
services and consumer goods sectors. The unrealized losses in these sectors
52
<Page>
were company and sector specific. All securities in an unrealized loss position
at December 31, 2008 were included in our portfolio monitoring process for
determining whether declines in value are other than temporary.
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, 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. All investments in an unrealized loss position at December 31, 2008
were included in our portfolio monitoring process for determining whether
declines in value were other than temporary.
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 negative developments that would change the
view of long term investors and their intent to continue to hold the investment,
subsequent credit deterioration of an issuer or holding, subsequent further
deterioration of capital markets (i.e. debt and equity) and of economic
conditions, subsequent further deterioration in the financial services and real
estate industries, changes in duration, revisions to strategic asset
allocations, liquidity needs, unanticipated federal income tax situations
involving capital gains and capital loss carrybacks and carryforwards with
specific expiration dates, investment risk mitigation actions, and other new
facts and circumstances that would cause a change in our previous intent to hold
a security to recovery or maturity.
53
<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, 2008 DECEMBER 31, 2007
-------------------------------------------- ------------------------------------------
FIXED INCOME FIXED INCOME
----------------------- -----------------------
BELOW BELOW
($ IN MILLIONS, EXCEPT NUMBER OF INVESTMENT INVESTMENT INVESTMENT INVESTMENT
ISSUES) GRADE GRADE EQUITY TOTAL GRADE GRADE EQUITY TOTAL
---------- ---------- -------- ----- ---------- ---------- ------ -----
Category (I): Unrealized loss
less than 20% of cost(1)
Number of issues 1,933 113 4 2,050 2,403 227 9 2,639
Fair value $ 18,433 $ 622 $ 31 $ 19,086 $ 22,615 $ 1,517 $ 64 $ 24,196
Unrealized $ (1,627) $ (82) $ (3) $ (1,712) $ (1,129) $ (106) $ (5) $ (1,240)
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 853 183 35 1,071 156 18 -- 174
Fair value $ 6,346 $ 802 $ 24 $ 7,172 $ 945 $ 107 $ -- $ 1,052
Unrealized $ (4,442) $ (553) $ (22) $ (5,017) $ (514) $ (62) $ -- $ (576)
Category (III): Unrealized loss
greater than or equal to 20%
of cost for a period of 6 or
more consecutive months, but
less than 12 consecutive
months (1)
Number of issues 193 19 -- 212 -- -- -- --
Fair value $ 783 $ 79 $ -- $ 862 $ -- $ -- $ -- $ --
Unrealized $ (1,579) $ (139) $ -- $ (1,718) $ -- $ -- $ -- $ --
Category (IV): Unrealized loss
greater than or equal to 20%
of cost for a period of 12 or
more consecutive months (1)
Number of issues 33 4 -- 37 -- -- -- --
Fair value $ 66 $ 7 $ -- $ 73 $ -- $ -- $ -- $ --
Unrealized $ (176) $ (13) $ -- $ (189) $ -- $ -- $ -- $ --
-------- ------- ------ -------- -------- ------- ----- --------
Total number of issues 3,012 319 39 3,370 2,559 245 9 2,813
======== ======= ====== ======== ======== ======= ===== ========
Total fair value (2) $ 25,628 $ 1,510 $ 55 $ 27,193 $ 23,560 $ 1,624 $ 64 $ 25,248
======== ======= ====== ======== ======== ======= ===== ========
Total unrealized losses $ (7,824) $ (787) $ (25) $ (8,636) $ (1,643) $ (168) $ (5) $ (1,816)
======== ======= ====== ======== ======== ======= ===== ========
</Table>
- ----------
(1) For fixed income securities, cost represents amortized cost.
(2) At December 31, 2008, 95.9% of the fixed income securities portfolio was
rated investment grade compared to 95.5% at December 31, 2007.
The largest individual unrealized loss was $9 million for category (I), $61
million for category (II), $38 million for category (III) and $27 million for
category (IV) as of December 31, 2008.
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 historically adversely
affected by industry and issue specific, or issuer specific conditions.
At December 31, 2008, Category (III) for fixed income was comprised
primarily of fair values of $246 million of ABS RMBS, $130 million for cash flow
CLO, $130 million of corporate private and $94 million of CMBS, for a total of
$600 million with unrealized losses of $317 million, $416 million, $139 million
and $407 million, respectively, for a total of $1.28 billion of unrealized
losses. No other security type individually represents more than $56 million of
fair value within this category.
Of the unrealized losses on below investment grade securities, 19.3% were
in significant unrealized loss positions (greater than or equal to 20% of
amortized cost) for six or more consecutive months prior to December 31,
54
<Page>
2008. 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 activities. We continue to believe that the
unrealized losses on these securities are not predictive of the ultimate
performance.
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.
The following table contains the individual securities with the largest
unrealized losses as of December 31, 2008. No other fixed income or equity
security had an unrealized loss greater than $28 million or 0.3% of the total
unrealized loss on fixed income and equity securities.
<Table>
<Caption>
FAIR VALUE
UNREALIZED FAIR NAIC UNREALIZED HIERARCHY
($ IN MILLIONS) LOSS VALUE RATING LOSS CATEGORY LEVEL
---------------- ------------ ------------ ----------------- ----------------
Municipal $ (61) $ 13 2 II 2
Other CMBS (44) 18 1 II 2
CMBS subordinated (38) 7 1 III 3
Diversified banking institution (37) 33 2 II 2
Municipal (33) 107 1 II 2
Other CMBS (31) 12 1 II 2
Other CMBS (29) 10 1 III 3
Special purpose entity (29) 1 2 III 3
------- -----
Total $ (302) $ 201
======= =====
</Table>
We also 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.
55
<Page>
The following table summarizes problem, restructured and potential problem
fixed income securities and bank loans, which are reported in other investments,
at December 31.
<Table>
<Caption>
($ IN MILLIONS) 2008
---------------------------------------------------------------------------
PERCENT OF
AMORTIZED TOTAL FIXED
COST AS A FAIR VALUE AS INCOME AND
PAR AMORTIZED PERCENT OF FAIR A PERCENT OF BANK LOAN
VALUE (1) COST (1) PAR VALUE VALUE PAR VALUE PORTFOLIOS
--------- -------- --------- ----- --------- ----------
Restructured $ 71 $ 57 80.3% $ 57 80.3% 0.1%
Problem 837 188 22.5 147 17.6 0.3
Potential problem 1,194 432 36.2 297 24.9 0.7
--------- -------- ------ -----
Total net carrying value $ 2,102 $ 677 32.2 $ 501 23.8 1.1%
========= ======== ====== =====
Cumulative write-
downs recognized (2) $ 1,294
========
<Caption>
($ IN MILLIONS) 2007
---------------------------------------------------------------------------
PERCENT OF
AMORTIZED TOTAL FIXED
COST AS A FAIR VALUE AS INCOME AND
PAR AMORTIZED PERCENT OF FAIR A PERCENT OF BANK LOAN
VALUE COST PAR VALUE VALUE PAR VALUE PORTFOLIOS
----- ---- --------- ----- --------- ----------
Restructured $ 9 $ 5 55.6% $ 6 66.7% --%
Problem 237 14 5.9 14 5.9 --
Potential problem 277 218 78.7 172 62.1 0.3
------ ------- ----- -----
Total net carrying value $ 523 $ 237 45.3 $ 192 36.7 0.3%
====== ======= ===== =====
Cumulative write-
downs recognized (2) $ 261
=======
</Table>
- ----------
(1) The difference between par value and amortized cost of $1.43 billion at
December 31, 2008 is primarily attributable to write-downs. Par value
has been reduced by principal payments.
(2) Cumulative write-downs recognized only reflects impairment write-downs
related to investments within the problem, potential problem and
restructured categories.
At December 31, 2008, amortized cost for the problem category was $188
million and was comprised of $80 million of corporates (primarily privately
placed), $48 million of financial sector-related holdings, $19 million of real
estate investment trusts and $9 million of bank loans. Also included were $18
million of market value CDO, $10 million of ABS CDO, $3 million of ABS RMBS, and
$1 million of Alt-A. The increase over December 31, 2007 is attributable to the
addition of fixed income and bank loan holdings that either are in default with
respect to principal or interest and/or are investments issued by companies that
went into bankruptcy during the period. The amortized cost of problem
investments with a fair value less than 70% of amortized cost totaled $64
million, with unrealized losses of $29 million and fair value of $35 million.
At December 31, 2008, amortized cost for the potential problem category was
$432 million and was comprised of $130 million of other CDO, $79 million of
Alt-A, $48 million of ABS RMBS and $13 million of other ABS. Also included were
$65 million of corporates (primarily privately placed home builders and
suppliers), $41 million of financial sector-related holdings, $37 million of
foreign government holdings, $13 million of bank loans and $6 million of CRE
CDO. The increase over December 31, 2007 is primarily attributable to the
additions of certain real estate-related holdings, including securities
collateralized by residential and commercial mortgage loans, as well as market
value, cash flow and synthetic CDO. Also contributing to the increase were
financial sector-related holdings and corporates, primarily privately placed.
The amortized cost of potential problem investments with a fair value less than
70% of amortized cost totaled $194 million, with unrealized losses of $127
million and fair value of $67 million.
We evaluated each of these investments through our portfolio monitoring
process at December 31, 2008 and recorded write-downs when appropriate. We
further concluded that any remaining unrealized losses on these investments were
temporary in nature and that we have the intent and ability to hold the
securities until recovery.
56
<Page>
NET INVESTMENT INCOME The following table presents net investment income for the
years ended December 31.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
Fixed income securities $ 3,112 $ 3,589 $ 3,505
Mortgage loans 580 552 508
Equity securities 7 4 2
Limited partnership interests 29 87 42
Other 121 243 257
---------- ---------- ----------
Investment income, before expense 3,849 4,475 4,314
Investment expense (129) (270) (257)
---------- ---------- ----------
Net investment income (1) $ 3,720 $ 4,205 $ 4,057
========== ========== ==========
</Table>
- ----------
(1) Beginning in the fourth quarter of 2008, income from EMA LP is
reported in realized capital gains and losses. EMA LP income for
periods prior to the fourth quarter of 2008 is reported in net
investment income. The amount of EMA LP income included in net
investment income was $14 million in 2008, $50 million in 2007 and
$15 million in 2006. The amount of EMA LP loss included in realized
capital gains and losses was $14 million in 2008.
Total investment expenses decreased $141 million in 2008 compared to 2007,
after increasing $13 million in 2007 compared to 2006. The 2008 decrease was
primarily due to lower expenses associated with a lower amount of collateral
received in connection with securities lending transactions. The average amount
of collateral held in connection with securities lending was approximately $1.65
billion in 2008 compared to approximately $2.79 billion in 2007, as a result of
actions to reduce our securities lending balances.
NET REALIZED CAPITAL GAINS AND LOSSES The following table presents the
components of realized capital gains and losses and the related tax effect for
the years ended December 31.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
Sales (1) $ 184 $ 70 $ (29)
Impairment write-downs (2) (1,227) (118) (21)
Change in intent write-downs (1) (3) (1,207) (92) (60)
Valuation of derivative instruments (985) (63) (17)
EMA LP income (4) (14) -- --
Settlement of derivative instruments 197 6 48
---------- ---------- ----------
Realized capital gains and losses, pre-tax (3,052) (197) (79)
Income tax benefit 1,067 69 28
---------- ---------- ----------
Realized capital gains and losses, after-tax $ (1,985) $ (128) $ (51)
========== ========== ==========
</Table>
- ----------
(1) To conform to the current period presentation, certain amounts in
the prior periods have been reclassified.
(2) Impairment write-downs reflect issue specific
other-than-temporary declines in fair value, including instances
where we could not reasonably assert that the recovery period
would be temporary.
(3) Change in intent write-downs reflect instances where we cannot
assert a positive intent to hold until recovery.
(4) Beginning in the fourth quarter of 2008, income from EMA LP is
reported in realized capital gains and losses. EMA LP income for
periods prior to the fourth quarter of 2008 is reported in net
investment income.
SALES net realized gains in 2008 were primarily due to net realized gains
on fixed income securities of $239 million comprised of gross gains of $626
million and gross losses of $387 million. The net realized gains on sales in
2007 were primarily due to net realized gains on limited partnership interests
of $44 million comprised of gross gains of $45 million and gross losses of $1
million.
The ten largest losses from sales of individual securities for the year
ended December 31, 2008 totaled $77 million and ranged from $4 million to $15
million. One security totaling $11 million was in an unrealized loss position
greater than or equal to 20% of amortized cost for fixed income securities or
cost for equity securities for a period of less than six consecutive months. Two
securities totaling $18 million were in an unrealized loss position greater than
or equal to 20% of amortized cost for fixed income securities or cost for equity
securities for a period of more than six but less than twelve consecutive
months.
57
<Page>
Our largest aggregate loss on sales and write-downs are shown in the
following table by issuer and its affiliates. No other issuer together with its
affiliates had an aggregated loss on sales and write-downs greater than 1.2% of
the total gross loss on sales and write-downs on fixed income and equity
securities.
<Table>
<Caption>
FAIR VALUE GAIN/ DECEMBER 31, NET
AT SALES LOSS ON WRITE- 2008 UNREALIZED
($ IN MILLIONS) ("PROCEEDS") SALES DOWNS HOLDINGS (1) GAIN (LOSS)
------------ ------ ------- ------------- -----------
Finance company $ 136 $ (6) $ (69) $ 6 $ --
Savings and loan 17 -- (72) -- --
Synthetic CDO -- -- (50) 14 (10)
Savings and loan -- -- (45) -- --
Large international insurer 68 1 (38) 38 (7)
Residential mortgage investor -- -- (35) 6 (2)
UK homebuilder -- -- (34) 22 --
Door and window manufacturer -- -- (31) 37 7
Private equity property fund 8 -- (31) -- --
-------- ------ ------- -------- -------
Total $ 229 $ (5) $ (405) $ 123 $ (12)
======== ====== ======= ======== =======
</Table>
- ----------
(1) Holdings include fixed income securities at amortized cost or equity
securities at cost.
The circumstances of the above losses are considered to be security or
issue specific and are not expected to have a material effect on other holdings
in our portfolio.
We may sell or change our intent to hold a security until recovery for
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 amortized cost or cost, in situations where
significant unanticipated new facts and circumstances emerge or existing facts
and circumstances increase in significance and are anticipated to adversely
impact a security's future valuations more than previously expected; including
negative developments that would change the view of long term investors and
their intent to continue to hold the investment, subsequent credit deterioration
of an issuer or holding, subsequent further deterioration in capital markets
(i.e. debt and equity) and of economic conditions, subsequent further
deterioration in the financial services and real estate industries, liquidity
needs, unanticipated federal income tax situations involving capital gains and
capital loss carrybacks and carryforwards with specific expiration dates,
investment risk mitigation actions, and other new facts and circumstances that
would cause a change in our previous intent to hold a security to recovery or
maturity.
Upon approval of programs involving the expected disposition of
investments, 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. Further unrealized loss positions that develop
subsequent to the original write-down are recognized in the reporting period in
which they occur through the date the program is closed. The program is closed
when the objectives of the program are accomplished or a decision is made not to
fully complete it, at which time an evaluation is performed of any remaining
securities and where appropriate they are redesignated as having the intent to
hold to recovery. Reasons resulting in a decision not to complete an approved
program include matters such as the mitigation of concerns that led to the
initial decision, changes in priorities or new complications that emerge from
significant unanticipated developments, such as subsequent significant
deterioration which we view to be temporary in nature, to the point at which
securities could only be sold at prices below our view of their intrinsic
values, or subsequent favorable developments that support a return to having the
intent to hold to recovery. Subsequent other-than-temporary impairment
evaluations utilize the amortized cost or cost basis that reflect the
write-downs. Fixed income securities subject to change in intent write-downs,
including those redesignated as intent to hold, continue to earn investment
income and any discount or premium from the amortized cost basis that reflects
the write-downs is recognized using the effective yield method over the expected
life of the security.
As previously described above, it is not possible to reliably identify a
reasonably likely circumstance that would result in a change in intent to hold
securities to recovery leading to the reporting of additional realized capital
losses, since they result from significant unanticipated changes. Our fixed
income securities and equity securities have gross unrealized losses of $8.61
billion and $25 million, respectively, at December 31, 2008 that we concluded
were temporary in nature and we have the intent and ability to hold the
securities until recovery.
58
<Page>
IMPAIRMENT WRITE-DOWNS for the years ended December 31 are presented in the
following table.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------- ------------ -----------
Fixed income securities $ (1,123) $ (104) $ (14)
Equity securities (7) -- (2)
Limited partnership interests (66) (10) --
Short-term investments -- (1) (3)
Other investments (31) (3) (2)
---------- --------- --------
Total impairment write-downs $ (1,227) $ (118) $ (21)
========== ========= ========
</Table>
$803 million or 71.5% of the fixed income security write-downs in 2008
related to impaired securities that were performing in line with anticipated or
contractual cash flows, but which were written down primarily because of
expected deterioration in the performance of the underlying collateral or our
assessment of the probability of future default. As of December 31, 2008, for
these securities, there have been no defaults or defaults impacting classes
lower in the capital structure. $92 million of the fixed income security
write-downs in 2008 primarily related to securities experiencing a significant
departure from anticipated cash flows; however, we believe they retain economic
value and $105 million related to securities for which future cash flows are
very uncertain. Equity securities were written down primarily due to the length
of time and extent fair value was below cost, considering our assessment of the
financial condition, near-term and long-term prospects of the issuer, including
relevant industry conditions and trends.
59
<Page>
Impairment write-downs and cash received, inclusive of sales, on these
investments for the year ended December 31, 2008 are presented in the following
table. Notwithstanding our intent and ability to hold these securities with
impairment write-downs, we concluded that we could not reasonably assert that
the recovery period would be temporary.
<Table>
<Caption>
($ IN MILLIONS) DECEMBER 31, 2008
----------------------------------
PERFORMING IN ACCORDANCE WITH ANTICIPATED OR IMPAIRMENT CASH
CONTRACTUAL CASH FLOWS WRITE-DOWNS RECEIVED(3)
--------------- --------------
Alt-A
No defaults in underlying collateral $ (30) $ 15
Defaults lower in capital structure (14) 9
--------------- --------------
(44) 24
ABS RMBS (142) 13
ABS CDO (63) 5
CMBS and CRE CDO (46) 6
Other CDO (88) 14
Synthetic CDO (186) 8
Corporate
Automotive (2) 4
Bond reinsurer - convertible to perpetual security (22) 1
Financials (69) 6
Gaming (3) --
Home construction (64) 8
Oil and gas (2) 1
Publishing (4) --
Real estate and Real Estate Investment Trust (43) 3
Telecommunications (10) --
--------------- --------------
Subtotal (219) 23
Other (15) 13
--------------- --------------
SUBTOTAL (1) (803) 106
DEPARTURE FROM ANTICIPATED OR CONTRACTUAL CASH FLOWS
Future cash flows expected -
ABS RMBS (23) 6
Corporate
Broadcasting (23) 1
Equity structured note (30) --
Financials (16) 8
--------------- --------------
SUBTOTAL (2) (92) 15
Future cash flows very uncertain -
Other CDO (33) 1
ABS RMBS (4) 1
Corporate
Food manufacturer (10) --
Financials (58) 9
--------------- --------------
SUBTOTAL (105) 11
Investments disposed (123) 106
--------------- --------------
TOTAL FIXED INCOME SECURITIES (4) $ (1,123) (4) $ 238
=============== ==============
TOTAL EQUITY SECURITIES $ (7) $ 14
=============== ==============
TOTAL LIMITED PARTNERSHIP INTERESTS $ (66) $ 13
=============== ==============
TOTAL OTHER INVESTMENTS $ (31) $ 6
=============== ==============
</Table>
- ----------
(1) Written down primarily because of expected deterioration in
the performance of the underlying collateral or our
assessment of the probability of future default. As of
December 31, 2008, for the securities with direct interest in
the lender, there have been no defaults. For securities
supported by collateral, there have been no defaults or
defaults have occurred in classes lower in the capital
structure.
(2) Experienced a significant departure from anticipated residual
cash flows. While these fixed income security write-downs were
valued at a significant discount to cost, we believe these
securities retain economic value.
(3) Cash received includes both income and principal collected
during the period and proceeds upon sale.
(4) Impairment write-downs on our illiquid portfolios were $654
million.
60
<Page>
CHANGE IN INTENT WRITE-DOWNS totaling $1.21 billion in 2008 included $1.12
billion for fixed income securities, $14 million for equity securities and $73
million for mortgage loans compared to $64 million for fixed income securities
and $28 million for mortgage loans in 2007. The change in intent write-downs in
2008 were a result of our risk mitigation and return optimization programs and
ongoing comprehensive reviews of our portfolios.
Change in intent write-downs for the year ended December 31, 2008 are
presented in the table below.
<Table>
<Caption>
FAIR VALUE OF
($ IN MILLIONS) OUTSTANDING
SFAS NO. 157 CHANGE IN INTENT NET REALIZED
CRITERIA SECURITY TYPE LEVEL ASSETS CAPITAL LOSS (3)
- -------- ------------- --------- ---------- ----------------
RISK MITIGATION
Targeted reductions (1) in commercial real CRE CDO 3 $ 27 $ (330)
estate exposure where it is anticipated that
future downside risk remains. Considerations CMBS 2 -- (22)
included position held in the capital structure, 3 29 (203)
vintage year, illiquidity and deteriorating
fundamentals. Mortgage loans 3 127 (71)
Targeted reductions (1) in residential real
estate where management believes there is a risk Prime 2 -- (6)
of future material declines in price in the 3 -- (5)
event of continued deterioration in the
economy. Considerations included position held Alt-A 3 20 (44)
in the capital structure, projected performance
of the collateral, and expected internal rates ABS RMBS 3 33 (200)
of return.
Targeted reductions (1) in financial sector Financial sector 2 14 (154)
exposure included securities issued by certain 3 -- (29)
regional banks and certain large financial
institutions.
Other 2 4 (18)
-------- ---------
Total risk mitigation 254 (1,082)
Individual identification 520 (116)
Other -- (9)
-------- ---------
Total $ 774 $ (1,207) (2)
======== =========
</Table>
- ----------
(1) Targeted reductions are made from identified specific investments.
(2) Change in intent write-downs on our illiquid portfolios were $811
million.
(3) Change in intent write-downs are related to the risk mitigation
targeted reduction for this security type for the year and not for
the outstanding change in intent assets at December 31, 2008.
61
<Page>
Investments for which we had changed our intent to hold to recovery as of
June 30, 2008 totaled $2.97 billion and included $2.64 billion as part of the
risk mitigation and return optimization programs and $329 million related to
individual securities. The following table summarizes the activity related to
investments for which we had changed our intent to hold.
<Table>
<Caption>
($ IN MILLIONS)
Carrying value as of June 30, 2008 $ 2,966
Re-designated as intent to hold to recovery as of October 1, 2008 (1) (834)
Sales:
Risk mitigation and return optimization program (2) (1,029)
Other programs (231)
Net realized capital gains and losses on sales:
Risk mitigation and return optimization program (2) (72)
Other programs (8)
Additional change in intent designations (3) 516
Write-downs (4) (552)
Other 18
------------
Carrying value as of December 31, 2008 $ 774
============
</Table>
- ----------
(1) Net unrealized capital losses on these re-designated
investments were $202 million as of December 31, 2008.
(2) Net proceeds from the sales of risk mitigation and return
optimization actions totaled $1.03 billion with an
additional loss of $72 million or 93% of fair values
reported at June 30, 2008.
(3) Comprised $275 million and $241 million for which we
changed our intent to hold in the third and fourth quarter
of 2008, respectively, due to unanticipated changes in
facts and circumstances.
(4) Includes change in intent write-downs of $262 million and
$191 million in the third and fourth quarter of 2008,
respectively, and impairment write-downs of $91 million and
$8 million in the third and fourth quarter of 2008,
respectively.
Our original objective in our June 30, 2008 risk mitigation and return
optimization program was to reduce our exposure to the identified investments in
an orderly fashion prior to additional significant negative impacts. Though we
were able to complete a considerable portion of the reduction, approximately
$1.03 billion of this program, during the third and fourth quarters of 2008 the
financial markets experienced additional and severe dislocation. A series of
events, which includes the effects of failures of large financial institutions
and intermediaries and various intervention by the government, significantly
increased the level of uncertainty in the market. These conditions drove
significant volatility in the levels of liquidity and put additional and
immediate downward pressures on prices of certain of these investments in
respect to our estimated intrinsic values. As a result of these market
conditions, which have worsened, we determined that we would not be able to sell
certain of these investments at our view of their intrinsic values.
Investments re-designated at October 1, 2008 as having the intent to hold
to recovery due to our inability to dispose of them for values equal to or
greater than our view of their intrinsic value are presented in the following
table.
<Table>
<Caption>
AMORTIZED AMORTIZED
FAIR VALUE AT COST AT FAIR VALUE AT COST AT
OCTOBER 1, OCTOBER 1, DECEMBER 31, DECEMBER 31,
($ IN MILLIONS) 2008 2008 2008 2008
--------------- -------------- ---------------- ----------------
ABS RMBS $ 441 $ 439 $ 350 $ 453
Finance sector (1) 293 291 188 248
Alt-A 31 31 18 29
CMBS 30 30 10 35
Prime 21 21 18 21
Corporate publicly placed securities 17 17 17 17
Mortgage loans 5 5 5 5
--------------- -------------- ---------------- ----------------
Total $ 838 $ 834 $ 606 $ 808
=============== ============== ================ ================
</Table>
- ----------
(1) Includes corporate and corporate privately placed securities with
financial sector exposure.
62
<Page>
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.
VALUATION AND SETTLEMENT OF DERIVATIVE INSTRUMENTS net realized capital
losses totaling $788 million for the year ended December 31, 2008 included $985
million of losses on the valuation of derivative instruments, including $367
million of losses for the accounting valuation of embedded options in equity
indexed notes and convertible fixed income securities, partially offset by $197
million of gains on the settlement of derivative instruments. For the year ended
December 31, 2007, net realized capital loss on the valuation and settlement of
derivative instruments totaled $57 million.
At December 31, 2008, our securities with embedded options totaled $972
million and decreased in fair value from December 31, 2007 by $532 million,
comprised of realized capital losses on valuation of $367 million, net sales
activity of $153 million, and unrealized net capital losses reported in other
comprehensive income ("OCI") of $12 million for the host securities. Net
unrealized capital losses were further decreased by $4 million due to
amortization and impairment write-downs on the host securities. The change in
fair value of embedded options is bifurcated from the host securities,
separately valued and reported in realized capital gains and losses, while the
change in value of the host securities is reported in OCI. Total fair value
exceeded amortized cost by $17 million at December 31, 2008. Valuation gains and
losses are converted into cash for securities with embedded options upon our
election to sell these securities. In the event the economic value of the
options is not realized, we will recover the par value if held to maturity
unless the issuer of the note defaults. Total par value exceeded fair value by
$206 million at December 31, 2008.
Losses on derivatives used for interest rate risk management but which have
not been designated as accounting hedges, primarily in our duration management
programs, were related to changing interest rates.
A changing interest rate environment will drive changes in our portfolio
duration targets at a tactical level. A duration target and range is established
with an economic view of liabilities relative to a long-term investment
portfolio view. Tactical duration management is accomplished through both cash
market transactions including new purchases and derivative activities that
generate realized gains and losses. As a component of our approach to managing
portfolio duration, realized gains and losses on certain derivative instruments
are most appropriately considered in conjunction with the unrealized gains and
losses on the fixed income portfolio. This approach mitigates the impacts of
general interest rate changes to the overall financial condition of the Company.
63
<Page>
The table below presents the realized capital gains and losses (pre-tax) on
the valuation and settlement of derivative instruments shown by underlying
exposure and derivative strategy for the years ended December 31.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006 2008 EXPLANATIONS
-------------------------------- ------- ------- ----------------------------------------------------
VALUATION SETTLEMENTS TOTAL TOTAL TOTAL
----------- ----------- ------- ------- -------
RISK REDUCTION
Duration gap
management $ (543) $ 40 $ (503) $ (27) $ (51) Interest rate caps, floors and swaps are used to
align interest-rate sensitivities of our assets
and liabilities. The contracts settle based on
differences between current market rates and a
contractually specified fixed rate through
expiration. The contracts can be terminated and
settled at anytime with a minimal additional cost.
The maximum loss on caps and floors would be
limited to the amount of premium paid for the
protection. The change in valuation reflects the
changing value of expected future settlements from
changing interest rates, which may vary over the
period of the contracts. The 2008 year to date
("YTD") losses, resulting from decreasing interest
rates, are offset in unrealized gains in OCI to
the extent it relates to changes in risk-free
rates; however, the impact of widening credit
spreads more than offset this benefit.
Anticipatory hedging (1) 154 153 (30) 17 Futures are used to protect investment spread from
interest rate changes for mismatches in the timing
of cash flows between product sales and the
related investment activity. The futures contracts
are exchange traded, daily cash settled and can be
exited at any time for minimal additional cost. If
the cash flow mismatches are such that a positive
net investment position is being hedged, there is
an offset for the related investments unrealized
loss in OCI. The 2008 YTD amounts reflect
decreases in risk-free interest rates on a net
long position as liability issuances exceeded
asset acquisitions.
Hedging of interest Value of expected future settlements and the
rate exposure in associated value of future credited interest,
annuity contracts (22) (7) (29) (22) 1 which is reportable in future periods when
incurred, decreased due to declining interest
Hedging unrealized rates.
gains on equity
indexed notes -- 7 7 -- --
Hedge ineffectiveness (2) (2) (4) (13) (7) The hedge ineffectiveness of ($2 million) includes
$416 million in realized capital losses on swaps
that were offset by $414 million in realized
capital gains on the hedged risk.
Foreign currency
contracts -- (1) (1) (13) (5)
Credit risk reduction 20 (3) 17 -- -- Valuation gain is the results of widening credit
spreads on referenced credit entities.
Other 1 -- 1 -- --
----------- ----------- ------- ------- -------
TOTAL RISK
REDUCTION $ (547) $ 188 $ (359) $ (105) $ (45)
INCOME GENERATION
Asset replication - Credit default swaps are used to replicate fixed
credit exposure $ (71) $ 9 $ (62) $ (18) $ 4 income securities and 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 credit default swaps typically
have five year term for which we receive periodic
premiums through expiration. The 2008 YTD changes
in valuation are due to the widening credit
spreads, and would only be converted to cash upon
disposition which can be done at any time, or if
the credit event specified in the contract occurs.
The maximum exposure is equal to the notional
amount of the credit derivative. If the credit
event specified in the contract occurs, we are
obligated to pay the counterparty the notional
amount of the contract and receive in return the
referenced defaulted security or similar security.
As of December 31, 2008, we had $517 million of
notional outstanding.
----------- ----------- ------- ------- -------
TOTAL INCOME
GENERATION $ (71) $ 9 $ (62) $ (18) $ 4
----------- ----------- ------- ------- -------
</Table>
64
<Page>
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006 2008 EXPLANATIONS
--------------------------------- ------- ------- ----------------------------------------------------
VALUATION SETTLEMENTS TOTAL TOTAL TOTAL
----------- ----------- ------- ------- -------
ACCOUNTING
Equity indexed notes $ (290) $ -- $ (290) $ 38 $ 35 Equity-indexed notes are fixed income securities
that contain embedded options. The changes in
valuation of the embedded equity indexed call
options are reported in realized capital gains and
losses. The results generally track the
performance of underlying equity indices. During
2008, one of the embedded options was valued at $0
due to the counterparty's bankruptcy. As a result,
an additional $21 million of losses was reported
in realized capital gains and losses. Valuation
gains and losses are converted into cash upon sale
or maturity. In the event the economic value of
the options is not realized, we will recover the
par value of the host fixed income security if
held to maturity unless the issuer of the note
defaults. Par value exceeded fair value by $167
million at December 31, 2008. Equity-indexed notes
are subject to our comprehensive portfolio
monitoring and watchlist processes to identify and
evaluate when the carrying value may be
other-than-temporarily impaired. The following
table compares the December 31, 2008 and December
31, 2007 holdings, respectively.
<Caption>
($ in millions) December 31, December 31,
2008 CHANGE 2007
---- ------ ----
Par value $ 800 $ -- $ 800
===== ====== =====
Amortized cost
of host contract $ 486 $ (11) $ 497
Fair value
of equity-indexed
call option 132 (290) 422
---- ------ -----
Total amortized
cost $ 618 $(301) $ 919
===== ====== =====
Total fair value $ 633 $(291) $ 924
===== ====== =====
Unrealized gain/
loss $ 15 $ 10 $ 5
Conversion options in
fixed income Convertible bonds are fixed income securities that
securities (77) -- (77) 28 37 contain embedded options. Changes in valuation of
the embedded option are reported in realized
capital gains and losses. The results generally
track the performance of underlying equities.
Valuation gains and losses are converted into cash
upon our election to sell these securities. In the
event the economic value of the options is not
realized, we will recover the par value of the
host fixed income security if held to maturity
unless the issuer of the note defaults. Par value
exceeded fair value by $39 million at December 31,
2008. Convertible bonds are subject to our
comprehensive portfolio monitoring and watchlist
processes to identify and evaluate when the
carrying value may be other-than-temporarily
impaired. As a result of this process, four issues
were written-down during 2008. The following table
compares the December 31, 2008 and December 31,
2007 holdings, respectively.
<Caption>
Change
December Change due to December
($ in millions) 31, in Fair Net Sale 31,
2008 Value Activity 2007
---- ----- -------- ----
Par value $ 378 $ -- $(181) $ 559
===== ===== ====== =====
Amortized cost
of host
contract $ 247 $ 7 $(147) $ 387
Fair value
of conversion
option 90 (77) (23) 190
----- ----- ------ -----
Total
amortized
cost $ 337 $(70) $(170) $ 577
===== ===== ====== =====
Total fair value $ 339 $(88) $(153) $ 580
===== ===== ====== =====
Unrealized $ 2 $(18) $ 17 $ 3
gain/loss
----------- ----------- ------- ------- -------
TOTAL ACCOUNTING $ (367) $ -- $ (367) $ 66 $ 72
----------- ----------- ------- ------- -------
TOTAL $ (985) $ 197 $ (788) $ (57) $ 31
=========== =========== ======= ======= =======
</Table>
Included in the table above are net realized capital gains on the
valuation and settlement of derivative instruments related to credit spread risk
hedging from our risk mitigation and return optimization programs initiated in
2008 totaling $7 million for the year ended December 31, 2008.
65
<Page>
FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES
The following table provides additional details regarding Level 1, 2 and 3
financial assets and financial liabilities by their classification in the
Consolidated Statement of Financial Position at December 31, 2008. For further
discussion of Level 1, 2 and 3 financial assets and financial liabilities, see
Note 2 of the consolidated financial statements and the Application of Critical
Accounting Estimates section of the MD&A.
<Table>
<Caption>
($ IN MILLIONS) QUOTED PRICES
IN ACTIVE SIGNIFICANT
MARKETS FOR OTHER SIGNIFICANT
IDENTICAL OBSERVABLE UNOBSERVABLE OTHER BALANCE AS OF
ASSETS INPUTS INPUTS VALUATIONS DECEMBER 31,
(LEVEL 1) (LEVEL 2) (LEVEL 3) AND NETTING 2008
-------------- ------------- ------------- -------------- --------------
FINANCIAL ASSETS
Fixed income securities:
Corporate $ -- $ 11,460 $ 449 $ 11,909
Corporate privately placed
securities -- 2,942 9,418 12,360
Municipal -- 2,605 50 2,655
Municipal - ARS -- -- 653 653
U.S. government and agencies 276 3,411 -- 3,687
ABS RMBS -- -- 1,248 1,248
Alt-A -- -- 315 315
Other CDO -- -- 752 752
Other ABS -- -- 402 402
ABS CDO -- -- 6 6
CRE CDO -- -- 27 27
CMBS -- 3,320 383 3,703
Preferred stock -- 9 1 10
MBS -- 2,162 242 2,404
Foreign government -- 2,100 -- 2,100
ABS - Credit card, auto and
student loans -- 28 187 215
-------------- ------------- ------------- --------------
Total fixed income securities 276 28,037 14,133 42,446
Equity securities:
U.S. equities 1 -- 15 16
International equities -- 11 11 22
Other -- 43 1 44
-------------- ------------- ------------- --------------
Total equity securities 1 54 27 82
Short-term investments:
Commercial paper and other -- 3,516 -- 3,516
Money market funds 342 -- -- 342
-------------- ------------- ------------- --------------
Total short-term investments 342 3,516 -- 3,858
Other investments:
Free-standing derivatives -- 605 13 618
-------------- ------------- ------------- --------------
Total other investments -- 605 13 618
-------------- ------------- ------------- --------------
TOTAL RECURRING BASIS ASSETS 619 32,212 14,173 47,004
Non-recurring basis -- -- 244 244
Valued at cost, amortized cost or
using the equity method $ 13,004 13,004
Counterparty and cash collateral
netting (1) (480) (480)
-------------- ------------- ------------- -------------- --------------
TOTAL INVESTMENTS 619 32,212 14,417 12,524 59,772
-------------- ------------- ------------- --------------
Separate account assets 8,239 -- -- -- 8,239
Other assets (1) -- 1 -- --
-------------- ------------- ------------- -------------- --------------
TOTAL FINANCIAL ASSETS $ 8,857 $ 32,212 $ 14,418 $ 12,524 $ 68,011
============== ============= ============= ============== ==============
% of total financial assets 13.0% 47.4% 21.2% 18.4% 100.0%
FINANCIAL LIABILITIES
Contractholder funds:
Derivatives embedded in annuity
contracts $ -- $ (37) $ (265) $ (302)
Other liabilities:
Free-standing derivatives -- (1,118) (106) (1,224)
Non-recurring basis -- -- -- --
Counterparty and cash collateral
netting (1) $ 460 460
-------------- ------------- ------------- -------------- --------------
TOTAL FINANCIAL LIABILITIES $ -- $ (1,155) $ (371) $ 460 $ (1,066)
============== ============= ============= ============== ==============
% of total financial liabilities --% 108.4% 34.8% (43.2)% 100.0%
</Table>
- ----------
(1) In accordance with Financial Accounting Standards Board ("FASB") Staff
Position No. FIN 39-1, AMENDMENT OF FASB INTERPRETATION NO. 39, we net all
fair value amounts recognized for derivative instruments and fair value
amounts recognized for the right to reclaim cash collateral or the
obligation to return cash collateral executed with the same counterparty
under a master netting agreement. At December 31, 2008, the right to
reclaim cash collateral was offset by securities held, and the obligation
to return collateral was $20 million.
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The following table provides a summary of changes in fair value during the
year ended December 31, 2008 of Level 3 financial assets and financial
liabilities held at fair value on a recurring basis at December 31, 2008.
<Table>
<Caption>
TOTAL REALIZED AND UNREALIZED
GAINS (LOSSES) INCLUDED IN:
---------------------------------
OCI ON PURCHASES,
BALANCE AS OF STATEMENT OF SALES, ISSUANCES
JANUARY 1, FINANCIAL AND SETTLEMENTS,
($ IN MILLIONS) 2008 NET INCOME (1) POSITION NET
--------------- --------------- -------------- ------------------
FINANCIAL ASSETS
Fixed income securities:
Corporate $ 747 $ (94) $ (50) $ (354)
Corporate privately
placed securities 11,098 (226) (1,097) (665)
Municipal 68 -- (7) 48
Municipal - ARS 163 -- (65) (60)
ABS RMBS 2,382 (351) (409) (374)
Alt-A 588 (92) (90) (91)
Other CDO 1,961 (305) (854) (30)
Other ABS 720 (23) (109) (239)
ABS CDO 36 (63) 37 (4)
CRE CDO 566 (415) 161 (285)
CMBS 224 (38) (473) (106)
Preferred stock -- 1 -- --
MBS 28 (1) (49) (22)
Foreign government -- -- -- (5)
ABS - Credit card, auto
and student loans 249 (10) (24) (135)
--------------- --------------- ------------- -----------------
Total fixed income securities 18,830 (1,617) (3,029) (2,322)
Equity securities 61 (3) (12) 20
Other investments:
Free-standing
derivatives, net (6) (125) -- 38
--------------- --------------- ------------- -----------------
TOTAL INVESTMENTS 18,885 (1,745) (3,041) (2,264)
Other assets 2 (1) -- --
--------------- --------------- ------------- -----------------
TOTAL RECURRING LEVEL 3
FINANCIAL ASSETS $ 18,887 $ (1,746) $ (3,041) $ (2,264)
=============== =============== ============= =================
FINANCIAL LIABILITIES
Contractholder funds:
Derivatives embedded in annuity
contracts $ 4 $ (270) $ -- $ 1
--------------- -------------- ------------- -----------------
TOTAL RECURRING LEVEL 3
FINANCIAL LIABILITIES $ 4 $ (270) $ -- $ 1
=============== =============== ============= =================
<Caption>
TOTAL
GAINS (LOSSES)
INCLUDED IN
NET INCOME FOR
NET INSTRUMENTS
TRANSFERS IN BALANCE AS OF STILL HELD AT
AND/OR (OUT) DECEMBER 31, DECEMBER 31,
($ IN MILLIONS) OF LEVEL 3 2008 2008 (4)
------------- -------------- ---------------
FINANCIAL ASSETS
Fixed income securities:
Corporate $ 200 $ 449 $ (102)
Corporate privately
placed securities 308 9,418 (265)
Municipal (59) 50 --
Municipal - ARS 615 653 --
ABS RMBS -- 1,248 (330)
Alt-A -- 315 (71)
Other CDO (20) 752 (307)
Other ABS 53 402 (10)
ABS CDO -- 6 (63)
CRE CDO -- 27 (179)
CMBS 776 383 (13)
Preferred stock -- 1 --
MBS 286 242 --
Foreign government 5 -- --
ABS - Credit card, auto
and student loans 107 187 --
------------- -------------- ---------------
Total fixed income securities 2,271 14,133 (1,340)
Equity securities (39) 27 (3)
Other investments:
Free-standing
derivatives, net -- (93) (2) (37)
------------- -------------- ---------------
TOTAL INVESTMENTS 2,232 14,067 (3) (1,380)
Other assets -- 1 (1)
------------- -------------- ---------------
TOTAL RECURRING LEVEL 3
FINANCIAL ASSETS $ 2,232 $ 14,068 $ (1,381)
============= ============== ===============
FINANCIAL LIABILITIES
Contractholder funds:
Derivatives embedded in annuity
contracts $ -- $ (265) $ (270)
------------- -------------- ---------------
TOTAL RECURRING LEVEL 3
FINANCIAL LIABILITIES $ -- $ (265) $ (270)
============= ============== ===============
</Table>
- ----------
(1) The effect to net income of financial assets and financial liabilities
totals $(2.02) billion and is reported in the Consolidated Statements of
Operations as follows: $(1.83) billion in realized capital gains and losses;
$91 million in net investment income; $(6) million in interest credited to
contractholder funds; and $(270) million in contract benefits.
(2) Comprises $13 million of financial assets and $(106) million of financial
liabilities.
(3) Comprises $14.17 billion of investments and $(106) million of free-standing
derivatives included in financial liabilities.
(4) The amounts represent gains and losses included in net income for the period
of time that the financial asset or financial liability was determined to be
in Level 3. These gains and losses total $(1.65) billion and are reported in
the Consolidated Statements of Operations as follows: $(1.45) billion in
realized capital gains and losses; $75 million in net investment income;
$(1) million in interest credited to contractholder funds; and $(270)
million in contract benefits.
Due to the reduced availability of actual market prices or relevant
observable inputs as a result of the decrease in liquidity that has been
experienced in the market, all ABS RMBS, Alt-A, ARS backed by student loans,
other CDO. certain ABS and certain CMBS are categorized as Level 3. Transfers
into and out of Level 3 during the twelve months ended December 31, 2008 are
attributable to a change in the availability of market observable information
for individual securities within the respective categories. Due to the continued
lack of liquidity for the segment of the ARS market backed by student loans,
certain market observable data utilized for valuation purposes became
unavailable during 2008, resulting in the transfer of securities to Level 3. As
of December 31, 2008, $653 million or 100.0% of our total ARS holdings were thus
valued using a discounted cash flow model. Certain inputs to the valuation model
that are significant to the overall valuation and not market observable
included: estimates of future coupon rates if auction failures continue,
maturity assumptions, and illiquidity premium. These same securities were
classified as Level 2 measurements as of January 1, 2008. As a result of a
significant decline in market liquidity during the fourth quarter of 2008,
securities in our Prime 2005 through 2007 vintages, ABS auto
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<Page>
Aaa-rated, and our below Aaa-rated CMBS were transferred to Level 3. For further
discussion of transfers into and out of Level 3, see Note 7 of the consolidated
financial statements.
The following table presents fair value as a percent of par value and
amortized cost for Level 3 investments at December 31, 2008.
<Table>
<Caption>
FAIR VALUE FAIR VALUE
AS A AS A
PERCENT OF PERCENT OF
($ IN MILLIONS) FAIR VALUE PAR VALUE AMORTIZED COST
----------- ------------ ----------------
Fixed income securities:
Corporate $ 449 74.0% 91.8%
Corporate privately placed securities 9,418 86.2 91.1
Municipal 50 83.3 100.0
Municipal - ARS 653 90.1 90.1
ABS RMBS 1,248 53.3 62.4
Alt-A 315 61.4 72.9
Other CDO 752 33.8 40.5
Other ABS 402 62.0 75.6
ABS CDO 6 4.4 60.0
CRE CDO 27 13.4 108.0
CMBS 383 30.8 33.2
Preferred stock 1 100.0 100.0
MBS 242 71.2 72.2
ABS - Credit card, auto and student loans 187 80.6 86.2
-----------
Total fixed income securities 14,133 70.0 77.8
-----------
Equity securities:
U.S. equities 15 N/A 100.0
International equities 11 137.5 78.6
Other 1 33.3 100.0
-----------
Total equity securities 27 N/A 90.0
-----------
Other investments:
Free-standing derivatives 13 N/A N/A
-----------
Total other investments 13 N/A N/A
-----------
Sub-total recurring Level 3
investments 14,173 70.1 77.9
Non-recurring basis 244 N/A 100.0
-----------
TOTAL LEVEL 3 INVESTMENTS $ 14,417 71.3 78.1
===========
</Table>
Non-recurring investments include certain mortgage loans, limited
partnership interests and other investments remeasured at fair value due to our
change in intent write-downs and other-than-temporary impairments at December
31, 2008.
MARKET RISK
Market risk is the risk that we will incur losses due to adverse changes in
equity, interest, credit spreads, 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, insolvency or financial distress of key market makers
or participants or changes in market perceptions of credit worthiness and/or
risk tolerance. Our primary market risk exposures are to changes in interest
rates, credit spreads 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 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.
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<Page>
Investment policies define the overall framework for managing market and
other investment risks, including accountability and controls over risk
management activities. These investment policies, which have been approved by
our board of directors, 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.
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 is intended to result 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-sensitive liabilities. Interest rate risk includes risks related
to changes in U.S. Treasury yields and other key risk-free reference yields.
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, 2008, the
difference between our asset and liability duration was approximately 0.61,
compared to a 0.63 gap at December 31, 2007. 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 duration
targets for fixed income investments in addition to 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 $28 million as of December 31, 2008. For OTC
derivative transactions including interest rate swaps, foreign currency swaps,
interest rate caps, interest rate floors, 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, 2008, we held cash of $20 million pledged by
counterparties as collateral for OTC instruments; we pledged securities of $544
million as collateral to counterparties.
We performed a sensitivity analysis on OTC derivative collateral
requirements by assuming a hypothetical reduction in our S&P's insurance
financial strength ratings from AA- to A and a 100 basis point decline in
interest rates. The analysis indicated that we would have to post an estimated
$449 million in additional collateral. The selection of these hypothetical
scenarios should not be construed as our prediction of future events, but only
as an illustration of the estimated potential effect of such events. We also
actively manage our counterparty credit risk exposure by monitoring the level of
collateral posted by our counterparties with respect to our receivable
positions.
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
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<Page>
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 annuity
liabilities and other interest-sensitive 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, 2008, 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
$169 million, compared to $449 million at December 31, 2007. In calculating the
impact of a 100 basis point increase on the value of the derivatives, 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 $6.19 billion of assets supporting life
insurance products such as 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 $6.19 billion of assets excluded from the
calculation has decreased from the $7.05 billion reported at December 31, 2007
due to capital market changes. 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 $487 million,
compared to a decrease of $521 million at December 31, 2007.
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.
CREDIT SPREAD RISK is the risk that we will incur a loss due to adverse changes
in credit spreads ("spreads"). This risk arises from many of our primary
activities, as we invest substantial funds in spread-sensitive fixed income
assets.
We manage the spread risk in our assets. One of the measures used to
quantify this exposure is spread duration. Spread duration measures the price
sensitivity of the assets to changes in spreads. For example, if spreads
increase 100 basis points, the fair value of an asset exhibiting a spread
duration of 5 is expected to decrease in value by approximately 5%.
Spread duration is calculated similarly to interest rate duration. At
December 31, 2008, the spread duration of assets was 4.3. Based upon the
information and assumptions we use in this spread duration calculation, and
spreads in effect at December 31, 2008, we estimate that a 100 basis point
immediate, parallel increase in spreads across all asset classes, industry
sectors and credit ratings ("spread shock") would decrease the net fair value of
the assets by approximately $2.19 billion, compared to $3.12 billion at December
31, 2007. Reflected in the duration calculation are the effects of our risk
mitigation actions that use credit default swaps to manage spread risk. Based on
contracts in place at December 31, 2008, we would recognize realized capital
gains totaling $35 million in the event of a 100 basis point immediate, parallel
spread increase and $35 million in realized capital losses in the event of a 100
basis point immediate, parallel spread decrease. The selection of a 100 basis
point immediate parallel change in spreads should not be construed as our
prediction of future market events, but only as an illustration of the potential
effect of such an event.
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, 2008, we held
approximately $1.86 billion in securities with equity risk (including primarily
convertible securities, limited partnership interests, non-redeemable preferred
securities and equity-linked notes), compared to $1.82 billion at December 31,
2007. Additionally, we had 508 contracts in short equity index futures at
December 31, 2008 with a fair value of $23 million.
At December 31, 2008, our portfolio of securities with equity risk had a
cash market portfolio beta of approximately 0.45, compared to a beta of
approximately 0.89 at December 31, 2007. Beta represents a widely used
methodology to describe, quantitatively, an investment's market risk
characteristics relative to an index such as the 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
4.5%, respectively. Based upon the information and assumptions we used to
calculate beta at December 31, 2008, including the effect of the equity index
futures, 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 $82 million, compared to $164 million at December 31, 2007, and an
immediate increase in the S&P 500 of 10% would increase the net fair value by
$82 million compared to $164 million at December 31,
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<Page>
2007. In calculating the impact of a 10% S&P index perturbation on the value of
the futures, we have assumed index volatility remains constant. Based on the
equity index futures in place at December 31, 2008, we would recognize losses
totaling $2 million in the event of a 10% increase in the S&P 500 index and $2
million in gains in the event of a 10% decrease. 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 using Barra's
predictive beta. This beta is based on a company's fundamental data. The
illustrations noted above may not reflect our actual experience if the future
composition of the portfolio (hence its beta) and correlation relationships
differ from the historical relationships.
At December 31, 2008 and 2007, we had separate accounts assets related to
variable annuity and variable life contracts with account values totaling $8.24
billion and $14.93 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 2008 and 2007 were $95 million and $92
million, respectively. Separate account liabilities related to variable life
contracts were $561 million and $905 million in December 31, 2008 and 2007,
respectively.
At December 31, 2008 and 2007 we had approximately $4.11 billion and $3.98
billion, respectively, in equity-indexed annuity liabilities that provide
customers with interest crediting rates based on the performance of the S&P 500.
We 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 hedge the foreign currency risk of these funding
agreements and fixed income securities. At December 31, 2008 and 2007, we had
approximately $713 million and $924 million, respectively, in funding agreements
denominated in foreign currencies.
At December 31, 2008, the foreign component of our limited partnership
interests totaled approximately $228 million, compared to $158 million at
December 31, 2007. Based upon the information and assumptions used at December
31, 2008, 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
of the foreign component of our limited partnership interests by approximately
$23 million, compared with an estimated $16 million decrease at December 31,
2007. 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 33 currencies, compared to 27 currencies at December 31,
2007. Our largest individual foreign currency exposures at December 31, 2008
were to the Euro (35.5%) and the British Pound (16.1%). The largest individual
foreign currency exposures at December 31, 2007 were to the Euro (41.1%) and the
British Pound (21.7%). Our primary regional exposure is to Western Europe,
approximately 61.1% at December 31, 2008, compared to 65.0% at December 31,
2007.
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.
DEFERRED TAXES
The total deferred tax valuation allowance is $9 million at December 31,
2008. We evaluate whether a valuation allowance is required each reporting
period. A valuation allowance is established if, based on the weight of
available evidence, it is more likely than not that some portion or all of the
deferred income tax asset will not be realized. In determining whether a
valuation allowance is needed, all available evidence is considered. This
includes the potential for capital and ordinary loss carryback, future reversals
of existing taxable temporary differences, tax planning strategies and future
taxable income exclusive of reversing temporary differences.
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<Page>
With respect to our evaluation of the need for a valuation allowance
related to the deferred tax asset on unrealized losses on fixed income
securities, we rely on our assertion that we have the intent and ability to hold
the securities to recovery. As a result, the unrealized losses on these
securities would not be expected to materialize and no valuation allowance on
the associated deferred tax asset is needed.
With respect to our evaluation of the need for a valuation allowance
related to other capital losses that have not yet been recognized for tax
purposes, we utilize prudent and feasible tax planning strategies. These include
strategies that optimize The Allstate Corporation's (the "Corporation's")
ability to carry back capital losses as well as the ability to offset future
capital losses with capital gains that could be recognized for tax purposes.
Changes in the market value of our investments may impact the level of
capital gains and losses that can be used in the tax planning strategies. The
$9 million valuation allowance at December 31, 2008 relates to the deferred tax
asset on capital losses that have not yet been recognized for tax purposes.
CAPITAL RESOURCES AND LIQUIDITY
CAPITAL RESOURCES consist of shareholder's equity and debt, representing funds
deployed or available to be deployed to support business operations. The
following table summarizes our capital resources at December 31.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
Redeemable preferred stock $ -- $ -- $ 5
Common stock, retained income
and additional capital paid-in 4,546 4,847 5,168
Accumulated other comprehensive (loss) income (2,337) (84) 325
---------- ---------- ----------
Total shareholder's equity 2,209 4,763 5,498
Debt/surplus notes 650 200 706
---------- ---------- ----------
Total capital resources $ 2,859 $ 4,963 $ 6,204
========== ========== ==========
</Table>
SHAREHOLDER'S EQUITY decreased in 2008 due to increased unrealized net
capital losses on investments and a net loss, partially offset by capital
contributions from Allstate Insurance Company ("AIC", the Company's parent).
Shareholder's equity decreased in 2007 due to dividends and unrealized net
capital losses on fixed income securities. The Company paid dividends of $725
million to AIC in 2007.
DEBT/SURPLUS NOTES increased $450 million in 2008 due to the issuance of
surplus notes to related parties. In 2008, the Company issued two $400 million
surplus notes to AIC, and issued and transferred a $50 million surplus note to
an unconsolidated affiliate. One of the $400 million surplus notes issued to AIC
was cancelled and forgiven in 2008. For further details on the surplus notes
issued in 2008, see Note 5 of the consolidated financial statements.
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.
FINANCIAL RATINGS AND STRENGTH The following table summarizes our financial
strength ratings.
<Table>
<Caption>
RATING AGENCY RATING
------------- ------
A.M. Best Company, Inc. A+ ("Superior")
Standard & Poor's Ratings Services AA- ("Very Strong")
Moody's Investors Service, Inc. A1 ("Good")
</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.
On February 2, 2009, A.M. Best affirmed our A+ financial strength rating.
On January 29, 2009, S&P downgraded our financial strength rating to AA- from
AA. The outlook for the rating remained negative. In October 2008, the outlook
had been revised to negative from stable. On January 29, 2009, Moody's
downgraded our financial strength rating to A1 from Aa3. The outlook for the
rating was revised to stable from negative. In October 2008, Moody's downgraded
our financial strength rating to Aa3 from Aa2.
Effective May 8, 2008, the Company, AIC and the Corporation entered into a
one-year Amended and Restated Intercompany Liquidity Agreement ("Liquidity
Agreement") replacing the Intercompany Liquidity Agreement between the Company
and AIC dated January 1, 2008. The Liquidity Agreement 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. The Company
and AIC each serve as a lender and borrower and the Corporation serves only as a
lender. The Company also has a capital support agreement with
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AIC effective December 14, 2007. Under the capital support agreement, AIC is
committed to provide capital to the Company to allow for profitable growth while
maintaining an adequate capital level. The maximum amount of potential funding
under the intercompany liquidity and capital support agreements is $1.00
billion. See Note 5 to the consolidated financial statements for further
details.
Our life insurance 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. Statutory surplus
is a measure that is often used as a basis for determining dividend paying
capacity, operating leverage and premium growth capacity, and it is also
reviewed by rating agencies in determining their ratings. As of December 31,
2008, ALIC's statutory surplus is $3.25 billion at December 31, 2008, compared
to $2.62 billion at December 31, 2007.
We have received approval from the Illinois Division of Insurance for the
use of two permitted practices in the statutory-basis financial statements
related to areas in which statutory accounting is not reflective of the
underlying economics during this period of extreme market conditions caused by
the current economic crisis. The first permitted practice relates to the
statutory accounting for deferred taxes and applies to ALIC. Specifically, this
permitted practice increased the amount of deferred income tax asset that can be
recognized in the statutory-basis financial statements and included in statutory
surplus from the lesser of the amounts that can be realized in one year or 10%
of adjusted statutory surplus to the lesser of deferred taxes that can be
realized within 3 years or 15% of adjusted statutory surplus. The permitted
practice resulted in an increase in ALIC's statutory surplus of $140 million as
of December 31, 2008. Admitted statutory-basis deferred tax assets totaled $421
million after the permitted practice reflecting 52% of total potential
statutory-basis deferred tax assets before non-admission limitations. The second
permitted practice relates to statutory accounting for market value adjusted
annuities ("MVAA") whose related assets are held in a separate account in the
statutory-basis financial statements and applies to ALIC. Specifically, this
permitted practice resulted in the MVAA related investments being recorded at
amortized cost, which is consistent with statutory accounting for other fixed
income investments and the book value method of accounting required under
Illinois Code for MVAA investments held in a general account. The permitted
practice was requested because the Illinois Code is silent on MVAA that are
issued by a separate account. In the extreme market conditions of the economic
crisis, the market value method of accounting reduced statutory surplus due to
unrealized losses on investments caused by wide credit spreads and the liquidity
based dislocations in the investment markets in a manner not representative of
the economics of the related liabilities. The effect of the permitted practice,
which is to value the invested assets and insurance reserves on a book value
basis instead of the formerly used market value basis, was $394 million based on
October 1, 2008 valuations and grew to $1.24 billion at December 31, 2008 due to
an increase of $720 million in the investment unrealized loss position, while
the market-based reserves increased $130 million relative to book-basis
reserves. The permitted practice eliminated the inconsistent impacts in the
amounts determined by the valuation methodologies for invested assets and
insurance reserves and resulted in invested assets being valued at $8.07 billion
and reserves at $9.17 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, 2008, the
RBC for each of our insurance companies was within the range that we target.
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.
73
<Page>
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,
and line of credit agreements
- Intercompany loans
- Capital contributions from parent
- Tax refunds/settlements
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,
and line of credit agreements
- Payment or repayment of intercompany loans
- Dividends to parent
- Debt service expenses and repayment
We actively manage our financial position and liquidity levels in light of
changing market, economic, and business conditions. In 2008, in anticipation of
continued volatility and illiquidity in the financial markets, we took actions
to enhance our economic and liquidity position pending a return to normal
capital market conditions. These actions included:
- Managing our gross exposure to our largest tail risk exposure,
interest rate risk, through active management of our investment and
product portfolios as well as further mitigation through hedging.
- Accumulating higher cash and short-term investment positions easily
convertible to cash from asset sales, principal and interest
receipts, calls, maturities and other cash inflows from our
investment portfolio.
- Reducing our securities lending program to $364 million as of
December 31, 2008 from $1.78 billion as of December 31, 2007. By
reducing the securities lending program, we gained additional
direct access to our liquid investments.
- Proactively selling securities we think will become less liquid.
We believe that these actions will provide us with a greater level of
flexibility necessary to operate in the current market environment. If market
conditions warrant, we may take additional actions to enhance our liquidity
position including:
- Continued retention of portfolio cash flows including approximately
$7.20 billion of expected inflows from upcoming maturities, calls
and prepayments on fixed income securities, mortgage loans and
bank loans, and interest receipts on investments over the next
twelve months. Expected interest receipts include amounts related
to floating rate investments for which the interest rate fluctuates
in accordance with market interest rates. Our expectation is based
on market interest rates as of December 31, 2008. Further, these
expected portfolio cash flows are based on investments as of
December 31, 2008 and were determined without regard to increases
in the portfolio for reasons such as the reinvestment of portfolio
cash flows or decreases due to reductions in outstanding
contractholder funds obligations.
- The sale of fixed income securities (government, municipal and
investment grade corporate bonds) with unrealized capital gains at
December 31, 2008.
74
<Page>
With a focus on preserving capital, we consider investments which are
convertible to cash without generating significant additional net realized
capital losses as liquidity sources. The following table presents cash and
short-term positions easily convertible to cash, and certain other liquid
investments meeting these criteria.
<Table>
<Caption>
AS OF
($ IN MILLIONS) DECEMBER 31, 2008
-------------------
Cash and short-term positions easily
convertible to cash available
same day/next day $ 2,648
Other highly liquid investments (1) 1,271
Other liquid investments (2) 2,219
------------
Total liquid $ 6,138
============
Percent of total consolidated
cash and investments 10.3%
</Table>
- ----------
(1) Other highly liquid investments are defined as assets
that are generally saleable within one week, and
primarily include U.S. government and agencies bonds
of $598 million, short-term investments of $234
million, corporate bonds of $206 million, agency pass
through securities of $109 million and foreign
sovereign securities of $100 million. The amounts
shown in the table above represent the amount of our
holdings in these assets, excluding any holdings with
restrictions.
(2) Other liquid investments are defined as assets that
are saleable within one quarter, and primarily include
short-term investments of $703 million, corporate
bonds of $679 million, U.S. government and agencies
bonds of $350 million and agency pass through
securities of $109 million. The amounts shown in the
table above represent the amount that we believe could
be sold during the first quarter of 2009, excluding
any holdings with restrictions.
The above analysis identifies our access to internal sources of liquidity.
We believe we have sufficient liquidity to address current planned needs from
investments other than those for which we have asserted the intent to hold until
recovery combined with targeted sales of certain products. Additionally, we have
existing intercompany agreements in place that facilitate liquidity management.
To increase new money for investing, we have initiated actions to
accelerate the recovery of approximately $500 million of tax refunds from the
overpayment of 2008 estimated taxes as well as the carryback of 2008 ordinary
losses to prior tax years. $60 million in refunds were received in March 2009
and we expect the remaining refunds to be received in the first half of 2009.
ALLSTATE PARENT COMPANY CAPITAL CAPACITY The Allstate Corporation has at
the parent holding company level, deployable cash and investments totaling $3.64
billion as of December 31, 2008. These assets include highly liquid securities
that are generally saleable within one week totaling $2.29 billion, additional
liquid investments that are saleable within one quarter totaling $972 million,
and $381 million of investments that trade in illiquid markets. The substantial
earnings capacity of the operating subsidiaries is the primary source of capital
generation for the Corporation. In 2009, AIC will have the capacity to pay
dividends currently estimated at $1.30 billion without prior regulatory
approval. We do not anticipate that the Company will pay dividends to AIC in
2009. In addition, the Corporation has access to $1.00 billion of funds from
either commercial paper issuance or an unsecured revolving credit facility. This
provides capital for the parent company's relatively low fixed charges,
estimated at $650 million in 2009, and $750 million of debt maturing in December
2009, to the extent not refinanced prior to maturity.
In October 2008, the Corporation completed its previously approved capital
contribution of $1.00 billion of invested assets to AIC. In November 2008, AIC
purchased a $400 million surplus note from the Company and made a capital
contribution of $600 million to the Company. An additional amount of
approximately $250 million remains under the authority granted by the
Corporation and AIC boards on October 15, 2008 and October 20, 2008,
respectively, to make capital contributions in the form of cash and securities,
by providing a guaranty or guaranties, or by purchasing one or more surplus
notes or other securities on or before April 30, 2009.
Moreover, in addition to these historic external sources of capital, access
to funding from additional sources, including participation in programs offered
by the U.S. Treasury and other governmental organizations, are potentially
available to the Corporation and its operating subsidiaries for capital and
liquidity needs.
The Company has access to additional borrowing to support liquidity through
the Corporation as follows:
- - A commercial paper facility with a borrowing limit of $1.00 billion to
cover short-term cash needs. As of December 31, 2008, there were no
balances outstanding and therefore the remaining borrowing capacity was
$1.00 billion; however, the outstanding balance fluctuates daily.
- - A primary credit facility is available for short-term liquidity
requirements and backs a commercial paper facility. The $1.00 billion
unsecured revolving credit facility, has an initial term of five years
expiring in 2012 with two
75
<Page>
optional one-year extensions that can be exercised at the end of any of the
remaining four years of the facility upon approval of existing or
replacement lenders providing more than two-thirds of the commitments to
lend. The program is fully subscribed among 11 lenders with the largest
commitments being $185 million. The commitments of the lenders are several
and no lender is responsible for any other lender's commitment if such
lender fails to make a loan under the facility. None of the borrowing
capacity under this credit facility has been utilized. 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. This facility has
a financial covenant requiring that the Corporation not exceed a 37.5% debt
to capital resources ratio as defined in the agreement. This ratio at
December 31, 2008 was 20.5%. 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
the Corporation's senior, unsecured, nonguaranteed long-term debt. There
were no borrowings under this line of credit during 2008. 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 by the Corporation with
the Securities and Exchange Commission ("SEC") in May 2006 and will expire
May 2009. In April 2009, the Corporation expects to ask its board of
directors for authority to file a replacement universal shelf registration.
The Corporation can use the current shelf registration to issue an
unspecified amount of debt securities, common stock (including 364 million
shares of treasury stock as of December 31, 2008), preferred stock,
depositary shares, warrants, stock purchase contracts, stock purchase units
and securities of subsidiaries. The specific terms of any securities the
Corporation issues under this registration statement will be provided in
the applicable prospectus supplements.
LIQUIDITY EXPOSURE Contractholder funds as of December 31, 2008 were $56.78
billion. The following table summarizes contractholder funds by their
contractual withdrawal provisions at December 31, 2008.
<Table>
<Caption>
% TO
($ IN MILLIONS) TOTAL
----------
Not subject to discretionary withdrawal $ 13,337 23.5%
Subject to discretionary withdrawal with adjustments:
Specified surrender charges (1) 25,440 44.8
Market value adjustments (2) 9,586 16.9
Subject to discretionary withdrawal without adjustments (3) 8,417 14.8
----------- ----------
Total contractholder funds (4) $ 56,780 100.0%
=========== ==========
</Table>
- ----------
(1) Includes approximately $10.99 billion of liabilities with a
contractual surrender charge of less than 5% of the account
balance.
(2) Approximately $7.96 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.
(3) Includes extendible funding agreements backing medium-term notes
outstanding with a par value of $1.45 billion that have been
non-extended, of which $1.21 billion has been called and will be
retired in March 2009 and the remainder will become due by July
31, 2009. We have accumulated, and expect to maintain, short-term
and other maturing investments to fund the retirement of these
obligations.
(4) Includes approximately $1.47 billion of contractholder funds on
variable annuities reinsured to Prudential effective June 1,
2006.
While we are able to quantify scheduled maturities for our institutional
products of $3.25 billion in 2009, anticipating retail product surrenders is
less precise. Retail life and annuity products may be surrendered by customers
for a variety of reasons. Reasons unique to individual customers include a
current or unexpected need for cash or a change in life insurance coverage
needs. Other key factors that may impact the likelihood of customer surrender
include the level of the contract surrender charge, the length of time the
contract has been in force, distribution channel, market interest rates, equity
market conditions and potential tax implications. In addition, the propensity
for retail life insurance policies to lapse is lower than it is for fixed
annuities because of the need for the insured to be re-underwritten upon policy
replacement. Surrenders and partial withdrawals for our retail annuities
decreased 13.9% in 2008 compared to 2007. The annualized surrender and partial
withdrawal rate on deferred annuities and interest-sensitive life insurance
products, based on the beginning of year contractholder funds, was 10.3% and
11.6% in 2008 and 2007, respectively. The Company strives to promptly pay
customers who request cash surrenders, however, statutory regulations generally
provide up to six months in most states to fulfill surrender requests.
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<Page>
Our institutional products are primarily funding agreements backing
medium-term notes. As of December 31, 2008, total institutional products
outstanding were $8.94 billion. The following table presents the scheduled
maturities for our institutional products outstanding as of December 31, 2008.
<Table>
<Caption>
($ IN MILLIONS)
2009 $ 3,249
2010 3,059
2011 760
2012 40
2013 1,750
2016 85
-------------
$ 8,943
=============
</Table>
Our asset-liability management practices limit the differences between the
cash flows generated by our investment portfolio and the expected cash flow
requirements of our life insurance, annuity and institutional product
obligations.
Certain events and circumstances could constrain our, the Corporation's
or AIC's liquidity. Those events and circumstances include, for example, a
catastrophe resulting in extraordinary losses, a downgrade in the
Corporation's long-term debt rating of A3, A- and a- (from Moody's, S&P's and
A.M. Best, respectively) to non-investment grade status of below
Baa3/BBB-/bb, a downgrade in AIC's financial strength rating from Aa3, AA-
and A+ (from Moody's, S&P's and A.M. Best, respectively) to below
Baa2/BBB/A-, or a downgrade in our financial strength ratings from A1, AA-
and A+ (from Moody's, S&P's and A.M. Best, respectively) to below A1/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.
CASH FLOWS As reflected in our Consolidated Statements of Cash Flows, lower
operating cash flows in 2008, compared to 2007, were primarily related to a
decrease in investment income, partially offset by higher premiums and income
tax refunds in 2008 compared to income taxes paid in 2007. 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.
Cash flows provided by investing activities increased in 2008 compared to
2007, primarily due to decreased purchases of fixed income securities and
mortgage loans, partially offset by lower investment collections and net change
in short-term investments. Cash flows from investing activities increased in
2007, compared to 2006, primarily due to increased cash provided by operating
activities, partially offset by increased cash used in financing activities.
Higher cash flows used in financing activities in 2008 compared to 2007
were primarily due to higher maturities and retirements of institutional
products, partially offset by higher contractholder fund deposits. Cash flows
used in financing activities increased in 2007, compared to 2006, primarily due
to lower contractholder fund deposits. For further quantification of the changes
in contractholder funds, see the Operations section of MD&A.
There were no dividends paid by the Company in 2008. In 2007 and 2006,
financing cash flows were impacted by dividends paid totaling $725 million and
$675 million, respectively. Cash flows from financing activities were impacted
by funds paid by AIC to the Company totaling $1.41 billion in 2008. The $1.41
billion includes capital contributions paid in cash totaling $607 million and
the issuance of two surplus notes, each with a principal sum of $400 million, to
AIC in exchange for cash totaling $800 million. Cash flows from financing
activities exclude capital contributions comprising the transfer to the Company
from AIC of non-cash assets totaling $342 million and the transfer of a $50
million surplus note to Kennett Capital Inc. from the Company in exchange for a
note receivable with a principal sum equal to that of the surplus note, which
was originally issued to ALIC by a subsidiary. One of the surplus notes issued
to AIC in 2008 was subsequently canceled and forgiven by AIC resulting in the
recognition of capital contribution equal to the outstanding principal balance
of the surplus note of $400 million. There were no capital contributions to the
Company in 2007 and 2006.
77
<Page>
CONTRACTUAL OBLIGATIONS AND COMMITMENTS Our contractual obligations as of
December 31, 2008 and the payments due by period are shown in the following
table.
<Table>
<Caption>
LESS THAN OVER 5
($ IN MILLIONS) TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
------------ ------------ ------------ ------------ ------------
Liabilities for collateral and repurchase agreements (1) $ 340 $ 340 $ -- $ -- $ --
Contractholder funds (2) (3) 74,953 9,935 23,962 10,442 30,614
Reserve for life-contingent contract benefits (2) (4) 31,365 1,178 3,554 2,306 24,327
Surplus notes due to related parties (5) 1,594 42 84 84 1,384
Payable to affiliates, net 142 142 -- -- --
Other liabilities and accrued expenses (6) (7) 545 520 10 4 11
------------ ------------ ------------ ------------ ------------
Total contractual cash obligations $ 108,939 $ 12,157 $ 27,610 $ 12,836 $ 56,336
============ ============ ============ ============ ============
</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. We are able to
quantify scheduled payments related to our immediate annuities without life
contingencies and institutional products with reasonable certainty,
however, estimates of anticipated payments related to interest-sensitive
life, fixed deferred annuities, traditional life and immediate annuities
with life contingencies are subject to contractholder discretion and are
therefore more variable. 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 maturity date accelerated in
accordance with the contractholders' election to not extend the 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 $56.78 billion for contractholder
funds and $12.26 billion for reserve for life-contingent contract benefits
as included in the Consolidated Statements of Financial Position as of
December 31, 2008. 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) Amounts estimated to be paid out of contractholder funds in 1-3 years
totaling $23.96 billion includes amounts expected to be paid in 2010 of
$8.90 billion, 2011 of $8.48 billion and 2012 of $6.58 billion.
(4) Amounts estimated to be paid out of reserve for life-continent contract
benefits in 1-3 years totaling $3.55 billion includes amounts expected to
be paid in 2010 of $1.20 billion, 2011 of $1.17 billion and 2012 of $1.18
billion.
(5) Amount differs from the balance presented on the Consolidated Statements of
Financial Position as of December 31, 2008 because the surplus notes due to
related parties as presented in the table above includes interest.
(6) Other liabilities primarily include accrued expenses, claim payments and
other checks outstanding.
(7) Balance sheet liabilities not included in the table above include unearned
and advanced premiums of $40 million and deferred tax liabilities of $801
million netted in the net deferred tax asset of $1.38 billion. 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 $746 million were not included in the table above because
they did not represent a contractual obligation or the amount and timing of
their eventual payment was sufficiently uncertain.
The following is a distribution in U.S. Dollars of funding agreements
(non-putable) by currency at December 31. All foreign currency denominated
funding agreements have been swapped to U.S. Dollars.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007
---------- ----------
CURRENCY
United States Dollar $ 8,230 $ 12,000
British Pound 435 646
Swiss Franc 278 278
---------- ----------
$ 8,943 $ 12,924
========== ==========
</Table>
78
<Page>
Our contractual commitments as of December 31, 2008 and the periods in
which the commitments expire are shown in the following table.
<Table>
<Caption>
LESS THAN OVER 5
($ IN MILLIONS) TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
----- ------ --------- --------- -----
Other commitments - conditional $ 3 $ 3 $ -- $ -- $ --
Other commitments - unconditional (1) 1,077 95 573 379 30
---------- ---------- ---------- ---------- ----------
Total commitments $ 1,080 $ 98 $ 573 $ 379 $ 30
========== ========== ========== ========== ==========
</Table>
- ----------
(1) Unconditional other contractual commitments scheduled to expire in 1-3
years totaling $573 million includes amounts scheduled to expire in 2010 of
$136 million, 2011 of $200 million and 2012 of $237 million.
Contractual commitments in the table above represent commitments to invest
in limited partnership interests and commitments to extend mortgage loans. The
funding of these commitments is largely contingent upon circumstances or events
outside of our control, including those at the discretion of our counterparties.
As a result, the timing of the funding of these commitments cannot be estimated
and may occur at anytime prior to the expiration.
We have agreements in place for services we conduct, generally at cost,
between subsidiaries relating to insurance, reinsurance, loans and
capitalization. All material intercompany transactions have appropriately been
eliminated in consolidation. Intercompany 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 the caption "Market Risk" in Part II, Item 7 of this report.
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<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) 2008 2007 2006
---------- ---------- ----------
REVENUES
Premiums (net of reinsurance ceded of $534, $625 and $617) $ 585 $ 502 $ 576
Contract charges (net of reinsurance ceded of $340, $315 and $170) 911 942 1,009
Net investment income 3,720 4,205 4,057
Realized capital gains and losses (3,052) (197) (79)
---------- ---------- ----------
2,164 5,452 5,563
COSTS AND EXPENSES
Contract benefits (net of reinsurance recoveries of $1,099, $646 and $548) 1,397 1,364 1,372
Interest credited to contractholder funds (net of reinsurance recoveries
of $43, $47 and $41) 2,356 2,628 2,543
Amortization of deferred policy acquisition costs 643 518 538
Operating costs and expenses 400 340 398
---------- ---------- ----------
4,796 4,850 4,851
Loss on disposition of operations (4) (10) (88)
---------- ---------- ----------
(LOSS) INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE (2,636) 592 624
---------- ---------- ----------
Income tax (benefit) expense (946) 180 196
---------- ---------- ----------
NET (LOSS) INCOME (1,690) 412 428
---------- ---------- ----------
OTHER COMPREHENSIVE LOSS, AFTER-TAX
Change in:
Unrealized net capital gains and losses (2,253) (409) (263)
---------- ---------- ----------
OTHER COMPREHENSIVE LOSS, AFTER-TAX (2,253) (409) (263)
---------- ---------- ----------
COMPREHENSIVE (LOSS) INCOME $ (3,943) $ 3 $ 165
========== ========== ==========
</Table>
See notes to consolidated financial statements.
80
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
<Table>
<Caption>
DECEMBER 31,
-------------------------
2008 2007
---------- ----------
($ IN MILLIONS, EXCEPT SHARE AND PAR VALUE DATA)
ASSETS
Investments
Fixed income securities, at fair value (amortized cost $49,136 and $58,020) $ 42,446 $ 58,469
Mortgage loans 10,012 9,901
Equity securities, at fair value (cost $106 and $102) 82 102
Limited partnership interests 1,187 994
Short-term, at fair value (amortized cost $3,855 and $386) 3,858 386
Policy loans 813 770
Other 1,374 1,792
---------- ----------
Total investments 59,772 72,414
Cash 93 185
Deferred policy acquisition costs 6,701 3,905
Reinsurance recoverables 3,923 3,410
Accrued investment income 542 652
Deferred income taxes 1,382 --
Other assets 1,294 622
Separate Accounts 8,239 14,929
---------- ----------
TOTAL ASSETS $ 81,946 $ 96,117
========== ==========
LIABILITIES
Contractholder funds $ 56,780 $ 60,464
Reserve for life-contingent contract benefits 12,256 12,598
Unearned premiums 32 33
Payable to affiliates, net 142 206
Other liabilities and accrued expenses 1,638 2,823
Deferred income taxes -- 101
Surplus notes due to related parties 650 200
Separate Accounts 8,239 14,929
---------- ----------
TOTAL LIABILITIES 79,737 91,354
---------- ----------
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 issued -- --
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 2,475 1,108
Retained income 2,066 3,734
Accumulated other comprehensive loss:
Unrealized net capital gains and losses (2,337) (84)
---------- ----------
Total accumulated other comprehensive loss (2,337) (84)
---------- ----------
TOTAL SHAREHOLDER'S EQUITY 2,209 4,763
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 81,946 $ 96,117
========== ==========
</Table>
See notes to consolidated financial statements.
81
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------------------
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
REDEEMABLE PREFERRED STOCK - SERIES A
Balance, beginning of year $ -- $ 5 $ 5
Redemption of stock -- (5) --
---------- ---------- ----------
Balance, end of year -- -- 5
---------- ---------- ----------
REDEEMABLE PREFERRED STOCK - SERIES B -- -- --
---------- ---------- ----------
COMMON STOCK 5 5 5
---------- ---------- ----------
ADDITIONAL CAPITAL PAID-IN
Balance, beginning of year 1,108 1,108 1,108
Capital contributions 1,349 -- --
Gain on reinsurance transaction with affiliate (see Note 5) 18 -- --
---------- ---------- ----------
Balance, end of year 2,475 1,108 1,108
---------- ---------- ----------
RETAINED INCOME
Balance, beginning of year 3,734 4,055 4,302
Net (loss) income (1,690) 412 428
Gain on purchase of investments from AIC (see Note 5) 22 -- --
Dividends -- (725) (675)
Cumulative effect of a change in accounting principle -- (8) --
---------- ---------- ----------
Balance, end of year 2,066 3,734 4,055
---------- ---------- ----------
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
Balance, beginning of year (84) 325 588
Change in unrealized net capital gains and losses (2,253) (409) (263)
---------- ---------- ----------
Balance, end of year (2,337) (84) 325
---------- ---------- ----------
TOTAL SHAREHOLDER'S EQUITY $ 2,209 $ 4,763 $ 5,498
========== ========== ==========
</Table>
See notes to consolidated financial statements.
82
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------------------
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income $ (1,690) $ 412 $ 428
Adjustments to reconcile net (loss) income to net cash provided
by operating activities:
Amortization and other non-cash items (423) (289) (280)
Realized capital gains and losses 3,052 197 79
Loss on disposition of operations 4 10 88
Interest credited to contractholder funds 2,356 2,628 2,543
Changes in:
Policy benefit and other insurance reserves (446) (290) (199)
Unearned premiums (2) (1) (1)
Deferred policy acquisition costs 47 (29) (205)
Reinsurance recoverables (167) (276) (218)
Income taxes (828) 112 (122)
Other operating assets and liabilities -- 104 93
---------- ---------- ----------
Net cash provided by operating activities 1,903 2,578 2,206
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales:
Fixed income securities 11,083 11,222 12,290
Equity securities 131 73 23
Limited partnership interests 100 181 114
Mortgage loans 248 -- --
Other investments 135 156 265
Investment collections:
Fixed income securities 2,530 2,981 2,727
Mortgage loans 800 1,506 1,618
Other investments 95 383 447
Investment purchases:
Fixed income securities (6,498) (12,096) (16,246)
Equity securities (133) (101) (282)
Limited partnership interests (410) (673) (22)
Mortgage loans (1,115) (2,637) (2,159)
Other investments (120) (693) (754)
Change in short-term investments, net (4,529) 31 362
Change in other investments, net (359) 30 9
Disposition of operations (3) (5) (826)
---------- ---------- ----------
Net cash provided by (used in) investing activities 1,955 358 (2,434)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of surplus notes to related parties 800 -- --
Capital contributions 607 -- --
Note payable to parent -- (500) 500
Redemption of redeemable preferred stock -- (11) (26)
Contractholder fund deposits 9,253 7,948 9,546
Contractholder fund withdrawals (14,610) (9,736) (8,998)
Dividends paid -- (725) (675)
---------- ---------- ----------
Net cash (used in) provided by financing activities (3,950) (3,024) 347
---------- ---------- ----------
NET (DECREASE) INCREASE IN CASH (92) (88) 119
CASH AT BEGINNING OF YEAR 185 273 154
---------- ---------- ----------
CASH AT END OF YEAR $ 93 $ 185 $ 273
========== ========== ==========
</Table>
See notes to consolidated financial statements.
83
<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"), which is wholly owned by Allstate Insurance Holdings,
LLC, 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) 2008 2007 2006
---------- ---------- ----------
PREMIUMS
Traditional life insurance (1) $ 368 $ 260 $ 257
Immediate annuities with life contingencies 132 204 278
Accident, health and other 85 38 41
---------- ---------- ----------
TOTAL PREMIUMS 585 502 576
CONTRACT CHARGES
Interest-sensitive life insurance (1) 855 862 797
Fixed annuities 55 79 73
Variable annuities 1 1 139
---------- ---------- ----------
TOTAL CONTRACT CHARGES 911 942 1,009
---------- ---------- ----------
TOTAL PREMIUMS AND CONTRACT CHARGES $ 1,496 $ 1,444 $ 1,585
========== ========== ==========
</Table>
----------
(1) Beginning in 2008, certain ceded reinsurance premiums
previously included as a component of traditional life
insurance premiums were reclassified prospectively to be
reported as a component of interest-sensitive life insurance
contract charges. In 2007 and 2006, these ceded reinsurance
premiums were $90 million and $53 million, respectively.
The Company, through several subsidiaries, is authorized to sell life
insurance, retirement and investment products in all 50 states, the District of
Columbia, Puerto Rico, the U.S. Virgin Islands and Guam. For 2008, the top
geographic locations for statutory premiums and annuity considerations were
Delaware, California, Florida 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), financial service firms, such as banks and
broker-dealers, and specialized structured settlement brokers.
The Company has exposure to market risk as a result of its investment
portfolio. Market risk is the risk that the Company will incur realized and
unrealized net capital losses due to adverse changes in equity, interest, credit
spreads or currency exchange rates and prices. The Company's primary market risk
exposures are to changes in interest rates and equity prices. Interest rate risk
is the risk that the Company will incur a loss due to adverse changes in
interest rates relative to the interest rate characteristics of its interest
bearing assets and liabilities. This risk arises from many of the Company's
primary activities, as it invests substantial funds in interest-sensitive assets
84
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and issues interest-sensitive liabilities. Interest rate risk includes risks
related to changes in U.S. Treasury yields and other key risk-free reference
yields, as well as changes in interest rates resulting from widening credit
spreads and credit exposure. Equity price risk is the risk that the Company will
incur losses due to adverse changes in the general levels of the equity markets
or equity-like investments.
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 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 difference between amortized cost and fair value, net of deferred income
taxes, certain deferred policy acquisition costs ("DAC"), certain deferred sales
inducement costs ("DSI"), 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 Statements 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 an interest rate step-up feature which is intended
to incent the issuer to redeem the security at a specified call date. Hybrid
securities are carried at fair value and amounted to $1.36 billion and $2.67
billion at December 31, 2008 and 2007, respectively.
Equity securities primarily include common and non-redeemable preferred
stocks and real estate investment trust equity investments. Common and
non-redeemable preferred stocks and real estate investment trust equity
investments 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, private equity/debt funds, real estate funds and
hedge funds 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, including money market funds, commercial paper and
other short-term investments, are carried at fair value. Policy loans are
carried at the respective 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.
85
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, securities
sold under agreements to repurchase and collateral received from counterparties
related to derivative transactions, the Company records an offsetting liability
in other liabilities and accrued expenses or other investments for the Company's
obligation to return the collateral or funds received.
Investment income consists primarily of interest and dividends, income from
certain 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 beneficial interests in securitized financial
assets not of high credit quality 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. Accrual of income is suspended for fixed income securities,
mortgage loans and bank loans that are in default or when receipt of interest
payments is in doubt. Income from investments in limited partnership interests
accounted for on the cost basis is recognized upon receipt of amounts
distributed by the partnerships as investment income. Subsequent to October 1,
2008, income from investments in limited partnership interests accounted for
utilizing the equity method of accounting ("EMA LP") is reported in realized
capital gains and losses.
Realized capital gains and losses include gains and losses on investment
sales, write-downs in value due to other-than-temporary declines in fair value,
periodic changes in the fair value and settlements of certain derivatives
including hedge ineffectiveness, and income from certain limited partnership
interests. Realized capital gains and losses on investment sales include calls
and prepayments and are determined on a specific identification basis. 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, and is recognized on
a delay due to the availability of the related financial statements. The
recognition of income on hedge funds is primarily on a one month delay and the
income recognition on private equity/debt funds and real estate funds are
generally on a three month delay.
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 including when the Company cannot
assert a positive intent to hold an impaired security until recovery (see Note
6). Fixed income securities subject to change in intent write-downs continue to
earn investment income (other than discussed above), and any discount or premium
is recognized using the effective yield method over the expected life of the
security.
FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES
The Company adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS No. 157"), as of
January 1, 2008 for its financial assets and financial liabilities that are
measured at fair value. SFAS No. 157 defines 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, and establishes
a framework for measuring fair value. The adoption did not have a material
effect on the Company's determination of fair value.
In determining fair value, the Company principally uses the market approach
which generally utilizes market transaction data for the same or similar
instruments. To a lesser extent, the Company uses the income approach which
involves determining fair values from discounted cash flow methodologies. SFAS
No. 157 establishes a hierarchy for inputs used in determining fair value that
maximize the use of observable inputs and minimizes the use of unobservable
inputs by requiring that observable inputs be used when available.
Observable inputs are those used by market participants in valuing
financial instruments that are developed based on market data obtained from
independent sources. In the absence of sufficient observable inputs,
unobservable inputs reflect the Company's estimates of the assumptions market
participants would use in valuing financial assets and financial liabilities and
are developed based on the best information available in the circumstances. The
Company uses prices and inputs that are current as of the measurement date,
including during
86
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
periods of market disruption. In periods of market disruption, the ability to
observe prices and inputs may be reduced for many instruments. This condition
could cause an instrument to be reclassified from Level 1 to Level 2, or from
Level 2 to Level 3.
Financial assets and financial liabilities recorded on the Consolidated
Statements of Financial Position at fair value as of December 31, 2008 are
categorized in the fair value hierarchy based on the observability of inputs to
the valuation techniques as follows:
LEVEL 1: Financial assets and financial liabilities whose values are based on
unadjusted quoted prices for identical assets or liabilities in an
active market that the Company can access.
LEVEL 2: Financial assets and financial liabilities whose values are based on
the following:
a) Quoted prices for similar assets or liabilities in active
markets;
b) Quoted prices for identical or similar assets or liabilities in
non-active markets; or
c) Valuation models whose inputs are observable, directly or
indirectly, for substantially the full term of the asset or
liability.
LEVEL 3: Financial assets and financial liabilities whose values are based on
prices or valuation techniques that require inputs that are both
unobservable and significant to the overall fair value measurement.
These inputs reflect the Company's estimates of the assumptions that
market participants would use in valuing the financial assets and
financial liabilities.
The availability of observable inputs varies by instrument. In situations
where fair value is based on internally developed pricing models or inputs that
are unobservable in the market, the determination of fair value requires more
judgment. The degree of judgment exercised by the Company in determining fair
value is typically greatest for instruments categorized in Level 3. In many
instances, valuation inputs used to measure fair value fall into different
levels of the fair value hierarchy. The category level in the fair value
hierarchy is determined based on the lowest level input that is significant to
the fair value measurement in its entirety.
Certain financial assets are not carried at fair value on a recurring
basis, including investments such as mortgage loans, limited partnership
interests, bank loans and policy loans. Accordingly, such investments are only
included in the fair value hierarchy disclosure when the investment is subject
to remeasurement at fair value after initial recognition and the resulting
remeasurement is reflected in the consolidated financial statements. In
addition, equity options embedded in fixed income securities are not disclosed
in the hierarchy with free-standing derivatives as the embedded derivatives are
presented with the host contract in fixed income securities.
SUMMARY OF SIGNIFICANT VALUATION TECHNIQUES FOR FINANCIAL ASSETS AND FINANCIAL
LIABILITIES ON A RECURRING BASIS
LEVEL 1 MEASUREMENTS
- FIXED INCOME SECURITIES: U.S. treasuries are in Level 1 and valuation is
based on unadjusted quoted prices for identical assets in active markets
that the Company can access.
- EQUITY SECURITIES: Comprise actively traded, exchange-listed U.S. and
international equity securities. Valuation is based on unadjusted quoted
prices for identical assets in active markets that the Company can access.
- SHORT-TERM: Comprise actively traded money market funds that have daily
quoted net asset values for identical assets that the Company can access.
- SEPARATE ACCOUNT ASSETS: Comprise actively traded mutual funds that have
daily quoted net asset values for identical assets that the Company can
access. Net asset values for the actively traded mutual funds in which the
separate account assets are invested are obtained daily from the fund
managers.
LEVEL 2 MEASUREMENTS
- FIXED INCOME SECURITIES:
CORPORATE, INCLUDING PRIVATELY PLACED: Valued based on inputs including
quoted prices for identical or similar assets in markets that are not
active. Also includes privately placed securities which have
market-observable external ratings from independent third party rating
agencies.
87
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MUNICIPAL: Externally rated municipals are valued based on inputs including
quoted prices for identical or similar assets in markets that are not
active. Included in municipals are auction rate securities ("ARS") other
than those backed by student loans. ARS backed by student loans are
included in Level 3.
U.S. GOVERNMENT AND AGENCIES: Valued based on inputs including quoted
prices for identical or similar assets in markets that are not active.
COMMERCIAL MORTGAGE-BACKED SECURITIES ("CMBS"): Valuation is principally
based on inputs including quoted prices for identical or similar assets in
markets that are not active.
PREFERRED STOCK; MORTGAGE-BACKED SECURITIES ("MBS"); FOREIGN GOVERNMENT;
ASSET-BACKED SECURITIES ("ABS") - CREDIT CARD: Valued based on inputs
including quoted prices for identical or similar assets in markets that are
not active.
- EQUITY SECURITIES: Valued based on inputs including quoted prices for
identical or similar assets in markets that are not active.
- SHORT-TERM: Commercial paper and other short-term investments are valued
based on quoted prices for identical or similar assets in markets that are
not active or amortized cost.
- OTHER INVESTMENTS: Free-standing exchange listed derivatives that are not
actively traded are valued based on quoted prices for identical instruments
in markets that are not active.
Over-the-counter ("OTC") derivatives, including interest rate swaps,
foreign currency swaps, foreign exchange forward contracts, and certain
credit default swaps, are valued using models that rely on inputs such as
interest rate yield curves, currency rates and adjustment for counterparty
credit risks that are observable for substantially the full term of the
contract. The valuation techniques underlying the models are widely
accepted in the financial services industry and do not involve significant
judgment.
- CONTRACTHOLDER FUNDS: Derivatives embedded in certain annuity contracts are
valued based on internal models that rely on inputs such as interest rate
yield curves and equity index volatility assumptions that are market
observable for substantially the full term of the contract. The valuation
techniques are widely accepted in the financial services industry and do
not include significant judgment.
LEVEL 3 MEASUREMENTS
- FIXED INCOME SECURITIES:
CORPORATE: Valued based on non-binding broker quotes and are categorized
as Level 3.
CORPORATE PRIVATELY PLACED: Valued based on non-binding broker quotes and
models that are widely accepted in the financial services industry and
use internally assigned credit ratings as inputs and instrument specific
inputs. Instrument specific inputs used in internal fair value
determinations include coupon rate, coupon type, weighted average life,
sector of the issuer and call provisions. Privately placed securities are
categorized as Level 3 as a result of the significance of non-market
observable inputs. The internally modeled securities are valued based on
internal ratings, which are not observable in the market. Multiple
internal ratings comprise a National Association of Insurance
Commissioners ("NAIC") rating category and when used in the internal
model provide a more refined determination of fair value. The Company's
internal ratings are primarily consistent with the NAIC ratings which are
generally updated annually.
MUNICIPAL: ARS primarily backed by student loans that have become
illiquid due to failures in the auction market and municipal bonds that
are not rated by third party credit rating agencies but are generally
rated by the NAIC are included in Level 3. ARS backed by student loans
are valued based on a discounted cash flow model with certain inputs to
the valuation model that are significant to the valuation, but are not
market observable, including estimates of future coupon rates if auction
failures continue, maturity assumptions, and illiquidity premium.
Non-rated municipal bonds are valued based on valuation models that are
widely accepted in the financial services industry and require
projections of future cash flows that are not market-observable, and are
categorized as Level 3 as a result of the significance of non-market
observable inputs.
ABS RESIDENTIAL MORTGAGE-BACKED SECURITIES ("ABS RMBS"); ALT-A
RESIDENTIAL MORTGAGE-BACKED SECURITIES ("ALT-A"): ABS RMBS and Alt-A are
principally valued based on inputs including quoted prices for identical
or similar assets in markets that exhibit less liquidity relative to
those markets supporting Level 2
88
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
fair value measurements. Certain ABS RMBS and Alt-A are valued based on
non-binding broker quotes. Due to the reduced availability of actual
market prices or relevant observable inputs as a result of the decrease
in liquidity that has been experienced in the market for these
securities, all ABS RMBS and Alt-A are categorized as Level 3.
OTHER COLLATERALIZED DEBT OBLIGATIONS ("CDO"); ABS COLLATERALIZED DEBT
OBLIGATIONS ("ABS CDO"): Valued based on non-binding broker quotes
received from brokers who are familiar with the investments. Due to the
reduced availability of actual market prices or relevant observable
inputs as a result of the decrease in liquidity that has been experienced
in the market for these securities, all collateralized loan obligations
("CLO"), ABS CDO, and synthetic collateralized debt obligations are
categorized as Level 3.
CMBS; COMMERCIAL REAL ESTATE COLLATERALIZED DEBT OBLIGATIONS ("CRE CDO"):
CRE CDO, which are reported as CMBS, and other CMBS, are either valued
based on non-binding broker quotes or based on inputs including quoted
prices for identical or similar assets in markets that exhibit less
liquidity relative to those markets supporting Level 2 fair value
measurements. Due to the reduced availability of actual market prices or
relevant observable inputs as a result of the decrease in liquidity that
has been experienced in the market for these securities, certain CMBS are
categorized as Level 3.
ABS - CREDIT CARD, AUTO AND STUDENT LOANS: Valued based on inputs
including quoted prices for identical or similar assets in markets that
are not active. Due to the reduced availability of actual market prices
or relevant observable inputs as a result of the decrease in liquidity
that has been experienced in the market for these securities, they are
categorized as Level 3.
- OTHER INVESTMENTS: Certain free-standing OTC derivatives, such as caps,
floors, certain credit default swaps and OTC options (including
swaptions), are valued using valuation models that are widely accepted in
the financial services industry. Inputs include non-market observable
inputs such as volatility assumptions that are significant to the
valuation of the instruments.
- CONTRACTHOLDER FUNDS: Derivatives embedded in annuity contracts are
valued internally using models widely accepted in the financial services
industry that determine a single best estimate of fair value for the
embedded derivatives within a block of contractholder liabilities. The
models use stochastically determined cash flows based on the contractual
elements of embedded derivatives and other applicable market data. These
are categorized as Level 3 as a result of the significance of non-market
observable inputs.
FINANCIAL ASSETS AND FINANCIAL LIABILITIES ON A NON-RECURRING BASIS
Mortgage loans and other investments written-down to fair value in
connection with recognizing other-than-temporary impairments are valued using
valuation models that are widely accepted in the financial services industry.
Inputs to the valuation models include non-market observable inputs such as
credit spreads. Limited partnership interests written-down to fair value in
connection with recognizing other-than-temporary impairments are valued using
net asset values and other sources. At December 31, 2008, mortgage loans,
limited partnership interests and other investments with a fair value of $244
million were included in the fair value hierarchy in Level 3, since they were
subject to remeasurement at fair value at December 31, 2008.
FAIR VALUE MEASUREMENT PRIOR TO ADOPTION OF SFAS NO. 157
Prior to the adoption of SFAS No. 157 on January 1, 2008, the fair value of
fixed income securities was based upon observable market quotations, other
market observable data or was derived from such quotations and market observable
data. The fair value of privately placed fixed income securities was generally
based on widely accepted pricing valuation models, which were developed
internally. The valuation models used 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
the overall spread for the specific security.
DERIVATIVE AND EMBEDDED DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments include interest rate swaps, credit
default swaps, futures (interest rate and equity), options (including
swaptions), interest rate caps and floors, warrants, 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).
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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 contract benefits,
interest credited to contractholder funds or realized capital gains and losses.
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 Statements of Cash Flows.
Cash flows from other derivatives are reported in cash flows from investing
activities within the Consolidated Statements of Cash Flows.
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 for fair value hedges. 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 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 $4 million, $13 million and $7 million in 2008, 2007 and 2006,
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.
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 items. 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 representing the effective portion of the hedge 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
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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, the adjustment made to the amortized cost for
fixed income securities or the carrying value for mortgage loans 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. 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.
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
options and futures, financial futures contracts, interest rate cap and floor
agreements, swaptions, foreign currency forward and option contracts and credit
default swaps.
In addition to the use of credit default swaps for credit risk management
strategies, 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 during the reporting period: net investment income, realized
capital gains and losses, operating costs and expenses, contract benefits or
interest credited to contractholder funds.
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 cash collateral for securities loaned in an amount
generally equal to 102% of the fair value of securities and records the related
obligations to return the collateral in other liabilities and accrued
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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 banks.
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 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. Profits
from these policies come from investment income, which is recognized over the
life of the contract.
Interest-sensitive life contracts, such as universal life and single
premium 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), contract administration and early surrender. These
contract charges are recognized as revenue when assessed against the
contractholder account balance. 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 and indexed funding agreements are generally based on a specified
interest rate index, such as LIBOR, or an equity index, such as the Standard &
Poor's ("S&P") 500 Index. Interest credited also includes amortization of DSI
expenses. DSI is amortized into interest credited using the same method used to
amortize 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.
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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, and certain underwriting
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 is included in amortization of
deferred policy acquisition costs on the Consolidated Statements of Operations
and Comprehensive Income and is described in more detail below. DSI is 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
periods for these policies 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 period 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 during the surrender charge period. The rate of amortization during
this term is matched to the recognition pattern of total gross profits.
AGP and EGP consist primarily of the following components: contract charges
for the cost of insurance less mortality costs and other benefits; investment
income and realized capital gains and losses less interest credited; and
surrender and other contract charges less 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 contractholders, and the effects of persistency, mortality,
expenses and hedges, if applicable.
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
capital gains or losses had those gains or losses actually been realized during
the reporting period is recorded net of tax in other comprehensive income.
Recapitalization of DAC and DSI is limited to the originally deferred costs plus
interest.
Customers of the Company may exchange one insurance policy or investment
contract for another offered by the Company, or make modifications to an
existing life or investment 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 contracts 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 contract. For interest-sensitive life insurance and investment
contracts, the EGP of the replacement contract is treated as a revision to the
EGP of the replaced contract in the determination of amortization of DAC and
DSI. For traditional life insurance policies, any
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 $19 million and $21 million at December 31,
2008 and 2007, respectively. Amortization expense on the present value of future
profits was $5 million, $5 million and $6 million for the years ended December
31, 2008, 2007 and 2006, respectively.
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. 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.
GOODWILL
Goodwill represents the excess of amounts paid for acquiring businesses
over the fair value of the net assets acquired. The goodwill balance was $5
million at both December 31, 2008 and 2007. The Company annually evaluates
goodwill for impairment using both a discounted cash flow analysis and a trading
multiple analysis, which are widely accepted valuation techniques 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,
2008 or 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, differences in tax
bases of 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 immediate
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 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.
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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. 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 and are carried at an amount equal
to the separate accounts 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 is
reinsured to Prudential beginning in 2006.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
Commitments to invest, commitments to purchase private placement
securities, commitments to extend mortgage loans and financial 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).
ADOPTED ACCOUNTING STANDARDS
SECURITIES AND EXCHANGE COMMISSION ("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,
"Accounting for Derivative Instruments and Hedging Activities" ("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 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 was not permitted. The adoption of SAB 109 did not 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 Financial Accounting Standards Board ("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. 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. In February 2008, the FASB issued FASB Staff
Position No. 157-2, "Effective Date of FASB Statement No. 157" ("FSP FAS
157-2"), 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 adopted the provisions of
SFAS No. 157 for financial assets and financial liabilities recognized or
disclosed at fair value on a recurring or non-recurring basis as
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of January 1, 2008. Consistent with the provisions of FSP FAS 157-2, the Company
decided to defer the adoption of SFAS No. 157 for non-financial assets and
liabilities measured at fair value on a non-recurring basis until January 1,
2009. In October 2008, the FASB issued FASB Staff Position No. FAS 157-3,
"Determining the Fair Value of a Financial Asset When the Market for That Asset
Is Not Active" ("FSP FAS 157-3"), which clarifies the application of SFAS 157 in
a market that is not active. The Company adopted the provisions of FSP FAS 157-3
as of September 30, 2008. The adoption of SFAS No. 157 and FSP FAS 157-3 did not
have a material effect on the Company's results of operations or financial
position (see Note 7).
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, on an ongoing basis, an option to report selected financial assets,
including investment securities, and financial liabilities, including most
insurance contracts, at fair value through earnings. 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 was effective as of the beginning
of a reporting entity's first fiscal year beginning after November 15, 2007. The
Company did not apply the fair value option to any existing financial assets or
liabilities as of January 1, 2008 and did not elect to apply the option
prospectively to any financial assets or liabilities acquired during 2008.
Consequently, the adoption of SFAS No. 159 had 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 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 was effective for fiscal years beginning after November
15, 2007, with early adoption permitted. The adoption of FSP FIN 39-1 did not
have a material impact on the Company's results of operations or financial
position.
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 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 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; 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,
96
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 (COLLECTIVELY "FIN 48")
The FASB issued the interpretation in July 2006 and the related 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).
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.
FASB STAFF POSITION NO. FAS 115-1/124-1, THE MEANING OF OTHER-THAN-TEMPORARY
IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS ("FSP FAS 115-1/124-1")
FSP FAS 115-1/124-1 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 115-1/124-1 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 115-1/124-1 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.
FSP NO. FAS 133-1 AND FIN 45-4, DISCLOSURES ABOUT CREDIT DERIVATIVES AND CERTAIN
GUARANTEES: AN AMENDMENT OF FASB STATEMENT NO. 133 AND FASB INTERPRETATION NO.
45; AND CLARIFICATION OF THE EFFECTIVE DATE OF FASB STATEMENT NO. 161 ("FSP
FAS 133-1 AND FIN 45-4")
In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, which amends
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities"
("SFAS No. 133"), and FIN 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" ("FIN 45"), to
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
both enhance and synchronize the disclosure requirements of the two statements
with respect to the potential for adverse effects of changes in credit risk on
the financial statements of the sellers of credit derivatives and certain
guarantees. SFAS No. 133 was amended to require disclosures by sellers of credit
derivatives, including credit derivatives embedded in a hybrid instrument. FIN
45 was amended to require an additional disclosure about the current status of
the payment/performance risk of a guarantee. The FSP clarifies the FASB's intent
that the disclosures required by SFAS No. 161 should be provided for any
reporting period (annual or quarterly interim) beginning after November 15,
2008. The provisions of this FASB staff position that amend SFAS No. 133 and FIN
45 are effective for reporting periods ending after November 15, 2008, and the
provisions that clarify the effective date SFAS No. 161 are effective upon the
adoption of that statement; therefore, the disclosure requirements, which have
no impact to the Company's results of operations or financial position, were
adopted at December 31, 2008.
FSP NO. EITF 99-20-1, AMENDMENTS TO THE IMPAIRMENT GUIDANCE OF EITF ISSUE NO.
99-20 ("FSP EITF 99-20-1")
In January 2009, the FASB issued FSP EITF 99-20-1, which amends FASB
Emerging Issues Task Force ("EITF") No. 99-20 "Recognition of Interest Income
and Impairment on Purchased Beneficial Interest and Beneficial Interests That
Continue to Be Held by a Transferor or in Securitized Financial Assets," ("EITF
99-20"), to align the impairment guidance in EITF 99-20 with the impairment
guidance and related implementation guidance in SFAS No. 115 "Accounting for
Certain Investments in Debt and Equity Securities". The provisions of this FASB
staff position are effective for reporting periods ending after December 15,
2008. The adoption of FSP EITF 99-20-1 did not have a material 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, 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
No. 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 Statements of Operations and Comprehensive Income. 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, when control over a subsidiary is relinquished and the subsidiary
is deconsolidated, SFAS No. 160 requires a parent to recognize a gain or loss in
net income 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 adoption of SFAS No. 160 is not expected to have a material effect on the
Company's results of operations or financial position.
SFAS NO. 161, DISCLOSURES ABOUT DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES -
AN AMENDMENT OF FASB STATEMENT NO. 133 ("SFAS NO. 161")
In March 2008, the FASB issued SFAS No. 161, which amends and expands the
disclosure requirements for derivatives currently accounted for in accordance
with SFAS No. 133. The new disclosures are designed to enhance the understanding
of how and why an entity uses derivative instruments and how derivative
instruments affect an
98
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
entity's financial position, results of operations, and cash flows. The standard
requires, on a quarterly basis, quantitative disclosures about the potential
cash outflows associated with the triggering of credit-related contingent
features, if any; tabular disclosures about the classification and fair value
amounts of derivative instruments reported in the statement of financial
position; disclosure of the location and amount of gains and losses on
derivative instruments reported in the statement of operations; and qualitative
information about how and why an entity uses derivative instruments and how
derivative instruments and related hedged items affect the entity's financial
statements. SFAS No. 161 is effective for fiscal periods beginning after
November 15, 2008, and is to be applied on a prospective basis only. SFAS No.
161 affects disclosures and therefore implementation will not impact the
Company's results of operations or financial position.
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 the Company's 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 $1.57 billion and $1.26 billion as of December 31, 2008
and 2007, 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 the variable annuity
business of ALIC and ALNY 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, ALIC, ALNY and the Corporation have indemnified
Prudential for certain pre-closing contingent liabilities (including
extra-contractual liabilities of ALIC and ALNY and liabilities specifically
excluded from the transaction) that ALIC and ALNY have agreed to retain. In
addition, ALIC, ALNY and the Corporation will indemnify Prudential for certain
post-closing liabilities that may arise from the acts of ALIC, ALNY and their
agents, including in connection with ALIC's and ALNY'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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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".
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 which ended May 2008, the
Company continued to issue new variable annuity contracts, accept additional
deposits on existing business from existing contractholders on behalf of
Prudential and service the reinsured business while Prudential prepared 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 $79 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 disposition 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
and amounted to $5 million, $6 million and $(61) million, after-tax during 2008,
2007 and 2006, respectively. Gain (loss) on disposition of operations on the
Consolidated Statements of Operations and Comprehensive Income included
amortization of ALIC's deferred gain, after-tax, of $5 million, $5 million and
$1 million for the years ended December 31, 2008, 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 $7.53 billion and $13.76 billion as of December 31, 2008 and
2007, respectively. Separate account balances totaling approximately $711
million and $1.17 billion at December 31, 2008 and 2007, 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.
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 and limited partnerships, totaled $17 million, $72 million and $39
million for the years ended December 31, 2008, 2007 and 2006, 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 $320 million, $1.75
billion and $1.94 billion at December 31, 2008, 2007 and 2006, respectively, and
are reported in other liabilities and accrued expenses in the Consolidated
Statements of Financial Position. Obligations to return cash collateral for OTC
derivatives were $20 million, $72 million and $357 million at December 31, 2008,
2007 and 2006, respectively, and are reported in other liabilities and accrued
expenses or other investments. Consistent with our adoption of FSP FIN 39-1 in
2008, the $20 million of obligations to return cash collateral as of December
31, 2008 are netted against derivative positions and reported in other
liabilities and accrued expenses.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying cash flows are included in cash flows from operating
activities in the Consolidated Statements of Cash Flows along with the
activities resulting from management of the proceeds, which for the years ended
December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------- ---------- ---------
NET CHANGE IN PROCEEDS MANAGED
Net change in fixed income securities $ 348 $ 34 $ 96
Net change in short-term investments 1,129 443 (159)
---------- ---------- ---------
Operating cash flow provided (used) $ 1,477 $ 477 $ (63)
========== ========== =========
NET CHANGE IN LIABILITIES
Liabilities for collateral and security repurchase,
beginning of year $ (1,817) $ (2,294) $ (2,231)
Liabilities for collateral and security repurchase,
end of year (340) (1,817) (2,294)
---------- ---------- ---------
Operating cash flow (used) provided $ (1,477) $ (477) $ 63
========== ========== =========
</Table>
In 2008, the Company recorded non-cash capital contributions totaling $742
million, including the transfer from AIC of non-cash assets totaling $342
million and the forgiveness by AIC of an outstanding surplus note with an unpaid
principal sum of $400 million (see Note 5).
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 $467 million, $477 million and $494
million in 2008, 2007 and 2006, 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 $73 million, $74 million and $72 million of structured
settlement annuities, a type of immediate annuity, in 2008, 2007 and 2006,
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, $12 million, $11 million and $10 million relate to structured
settlement annuities with life contingencies and are included in premium income
for 2008, 2007 and 2006, 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
$4.85 billion and $4.89 billion at December 31, 2008 and 2007, 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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
agencies. For these services, the Company incurred $19 million, $27 million and
$44 million of commission and other distribution expenses for the years ending
December 31, 2008, 2007 and 2006, respectively.
REINSURANCE TRANSACTIONS
Effective January 1, 2008, the Company's coinsurance reinsurance agreement
with its unconsolidated affiliate American Heritage Life Insurance Company
("AHL"), which went into effect in 2004, was amended to include the assumption
by the Company of certain accident and health insurance policies. In accordance
with this amendment, the Company recorded cash of $16 million, premium
installment receivables of $5 million, DAC of $32 million, reserve for
life-contingent contract benefits of $24 million and accrued liabilities of $2
million. Since the Company received assets in excess of net liabilities from an
affiliate under common control, the Company recognized a gain of $27 million
($18 million after-tax), which was recorded as an increase to additional capital
paid-in on the Company's Consolidated Statements of Financial Position.
ALIC enters into certain intercompany reinsurance transactions with its
wholly owned subsidiaries. ALIC enters into these transactions in order to
maintain underwriting control and spread risk among various legal entities.
These reinsurance agreements have been approved by the appropriate regulatory
authorities. All significant intercompany transactions have been eliminated in
consolidation.
INCOME TAXES
The Company is a party to a federal income tax allocation agreement with
the Corporation (see Note 12).
SURPLUS NOTES DUE TO RELATED PARTIES
Surplus notes due to related parties outstanding at December 31 consisted of
the following:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007
------------ ------------
5.06% Surplus Notes (1), due 2035 $ 100 $ 100
6.18% Surplus Notes (1), due 2036 100 100
5.93% Surplus Notes (1), due 2038 50 --
7.00% Surplus Notes (1), due 2028 400 --
------------ ------------
Surplus notes due to related parties $ 650 $ 200
============ ============
</Table>
----------
(1) No payment of principle or interest is permitted on the
surplus notes without the written approval from the proper
regulatory authority (see Note 5). The regulatory authority
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 2008 and 2007 on all notes except the $400
million note for which approval has not been sought.
On August 1, 2005, ALIC entered into an agreement with Kennett Capital Inc.
("Kennett"), an unconsolidated affiliate of ALIC, whereby ALIC sold to Kennett a
$100 million 5.06% surplus note due July 1, 2035 issued by ALIC Reinsurance
Company ("ALIC Re"), a wholly owned subsidiary of ALIC. 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 surplus notes due to related parties in the Consolidated
Statements of Financial Position. In 2008, 2007 and 2006, the Company incurred
$5 million each year of interest expense related to this surplus note, which is
reflected as a component of operating costs and expenses in the Consolidated
Statements of Operations and Comprehensive Income. Additionally, in 2008, 2007
and 2006, the Company recorded net investment income on the note due from
Kennett of $5 million in each year.
On June 30, 2006, under the existing agreement with Kennett discussed
above, ALIC sold Kennett a $100 million redeemable surplus note issued by ALIC
Re. 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 surplus notes due to
102
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
related parties in the Consolidated Statements of Financial Position. In 2008,
2007 and 2006, the Company incurred $6 million, $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 in the Consolidated
Statements of Operations and Comprehensive Income. Additionally, in 2008, 2007
and 2006, the Company recorded net investment income on the note due from
Kennett of $6 million, $6 million and $3 million, respectively.
On June 30, 2008, under the existing agreement with Kennett, ALIC sold
Kennett a $50 million redeemable surplus note issued by ALIC Re. The surplus
note is due June 1, 2038 with an initial rate of 5.93% that will reset every ten
years to the then current ten year CMT, plus 2.09%. As payment, Kennett issued
on June 30, 2008 a full recourse note due June 1, 2038 to ALIC for the same
amount with an initial interest rate of 5.73% that will reset every ten years to
the then current ten year CMT, plus 1.89%. The note due from Kennett is
classified as other investments and the related surplus note is classified as
surplus notes due to related parties in the Consolidated Statements of Financial
Position. In 2008, the Company incurred interest expense on this surplus note of
$2 million, which is included as a component of operating costs and expenses in
the Consolidated Statements of Operations and Comprehensive Income.
Additionally, in 2008, the Company recorded net investment income on the note
due from Kennett of $1 million.
On August 29, 2008, the Company issued a surplus note to AIC with a
principal sum of $400 million in exchange for cash. On December 29, 2008, AIC
agreed to cancel and forgive the principal and any related interest obligations
associated with this surplus note. The forgiveness of the principal was
recognized as a capital contribution resulting in an increase to additional
capital paid-in of $400 million.
On November 17, 2008, the Company issued a surplus note to AIC with a
principal sum of $400 million in exchange for cash. This surplus note accrues
interest at a rate of 7.00% annually, which is due on the first day of April and
October in each year beginning 2009 until maturity on November 17, 2028. The
payment of interest and principal is subject to prior written approval from the
Director of Insurance of the State of Illinois and can only be paid out of the
Company's statutory-basis surplus that is in excess of certain amounts specified
in the surplus note. This surplus note is included as a component of surplus
notes due to related parties in the Consolidated Statements of Financial
Position. In 2008, the Company incurred interest expense on this surplus note of
$3 million, which is included as a component of operating costs and expenses in
the Consolidated Statements of Operations and Comprehensive Income.
NOTE PAYABLE TO PARENT
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%. Interest expense on this note, which totaled
$5 million in 2007, is included as a component of operating costs and expenses
in the Consolidated Statements of Operations and Comprehensive Income.
REDEEMABLE PREFERRED STOCK
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 were
incurred and paid during 2006, and included as a component of operating costs
and expenses on the Consolidated Statements of Operations and Comprehensive
Income. During 2006, $26 million of mandatorily redeemable preferred stock was
redeemed. All remaining redeemable preferred stock was redeemed in 2007.
LIQUIDITY AND INTERCOMPANY LOAN AGREEMENT
Effective May 8, 2008, the Company, AIC and the Corporation entered into a
one-year Amended and Restated Intercompany Liquidity Agreement ("Liquidity
Agreement") replacing the Intercompany Liquidity Agreement between the Company
and AIC, dated January 1, 2008. The Liquidity Agreement 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. The Company
and AIC each serve as a lender and borrower and the Corporation serves only as a
lender. The maximum amount of advances each party may make
103
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 principal 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.
In addition to the Liquidity Agreement, 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, 2008 and 2007.
The Corporation may use commercial paper borrowings, bank lines of credit and
repurchase agreements to fund intercompany borrowings.
INVESTMENT PURCHASES
In September 2008, in accordance with two sale agreements with AIC, the
Company purchased investments from AIC. The Company paid $944 million in cash
for the investments, which included mortgage loans and privately placed
corporate fixed income securities with a fair value on the date of sale of $613
million and $325 million, respectively, and $6 million of accrued investment
income. Since the transaction was between affiliates under common control, the
mortgage loans were recorded at the outstanding principal balance, net of
unamortized premium or discount, on the date of sale of $634 million and the
privately placed corporate fixed income securities were recorded at the
amortized cost basis on the date of sale of $338 million. The difference between
the fair value and the outstanding principal balance, net of unamortized premium
or discount, for the mortgage loans, and the amortized cost basis for the
privately placed corporate fixed income securities, on the date of sale, was
recorded as an increase to retained income of $22 million after-tax ($34 million
pre-tax).
CAPITAL CONTRIBUTIONS
In June 2008, the Company received a capital contribution from AIC of $349
million, which was recorded as additional capital paid-in on the Consolidated
Statements of Financial Position. The capital contribution included fixed income
securities of $337 million, accrued investment income of $5 million and cash of
$7 million.
In November 2008, the Company received a capital contribution from AIC of
$600 million, which was paid in cash and recorded as additional capital paid-in
on the Consolidated Statements of Financial Position.
In December 2008, a surplus note issued to AIC in August 2008 was cancelled
and forgiven by AIC. The forgiveness of the principal was recognized as a
capital contribution resulting in an increase to additional capital paid-in of
$400 million.
The Company and AIC have a Capital Support Agreement that went into effect
in 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 under the agreement is limited to
an aggregate amount of $1 billion. Discretionary capital contributions made by
AIC outside of the terms of this agreement, including the $349 million
contribution made in June 2008, the $600 million contribution made in November
2008 and the forgiveness of the $400 million surplus note in December 2008, do
not reduce AIC's $1 billion obligation. In exchange for providing this capital,
the Company will pay AIC an annual commitment fee of 1% of the amount of the
Capital and Surplus maximum that remains available on January 1 of such year.
The Company or AIC have the right to terminate this agreement when: 1) the
Company qualifies for a financial strength rating from Standard and Poor's,
Moody's or A.M. Best, without giving weight to the existence of this agreement,
that is the same or better than its rating with such support; 2) the Company's
RBC ratio is at least 300%; or 3) AIC no longer directly or indirectly owns at
least 50% of the voting stock of the Company. At December 31, 2008, no capital
had been provided by AIC under this agreement.
104
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INVESTMENTS
FAIR VALUES
The amortized cost, gross unrealized gains and losses, and fair value
for fixed income securities are as follows:
<Table>
<Caption>
GROSS UNREALIZED
($ IN MILLIONS) AMORTIZED --------------------------- FAIR
COST GAINS LOSSES VALUE
------------ ------------ ------------ ------------
AT DECEMBER 31, 2008
U.S. government and agencies $ 2,792 $ 895 $ -- $ 3,687
Municipal 3,976 28 (696) 3,308
Corporate 27,416 408 (3,555) 24,269
Foreign government 1,652 513 (65) 2,100
Mortgage-backed securities 2,923 59 (263) 2,719
Commercial mortgage-backed securities 5,712 10 (1,992) 3,730
Asset-backed securities 4,649 8 (2,034) 2,623
Redeemable preferred stock 16 -- (6) 10
------------ ------------ ------------ ------------
Total fixed income securities $ 49,136 $ 1,921 $ (8,611) $ 42,446
============ ============ ============ ============
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
============ ============ ============ ============
</Table>
SCHEDULED MATURITIES
The scheduled maturities for fixed income securities are as follows at
December 31, 2008:
<Table>
<Caption>
AMORTIZED FAIR
($ IN MILLIONS) COST VALUE
------------ ------------
Due in one year or less $ 2,156 $ 2,154
Due after one year through two years 2,118 2,017
Due after two years through three years 2,649 2,507
Due after three years through four years 2,868 2,707
Due after four years through five years 2,895 2,652
Due after five years through ten years 10,855 10,448
Due after ten years 18,023 14,619
------------ ------------
41,564 37,104
Mortgage- and asset-backed securities 7,572 5,342
------------ ------------
Total $ 49,136 $ 42,446
============ ============
</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. Periodic
interest receipts on fixed income securities represent a substantial additional
source of cash flow over the years presented, but are not included in the
contractual maturities table above.
105
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NET INVESTMENT INCOME
Net investment income for the years ended December 31 is as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------ ------------ ------------
Fixed income securities $ 3,112 $ 3,589 $ 3,505
Mortgage loans 580 552 508
Equity securities 7 4 2
Limited partnership interests 29 87 42
Other investments 121 243 257
------------ ------------ ------------
Investment income, before expense 3,849 4,475 4,314
Investment expense (129) (270) (257)
------------ ------------ ------------
Net investment income $ 3,720 $ 4,205 $ 4,057
============ ============ ============
</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) 2008 2007 2006
------------ ------------ ------------
Fixed income securities $ (2,004) $ (172) $ (157)
Equity securities (29) 6 2
Limited partnership interests (76) 34 2
Derivatives (815) (57) 31
Other (128) (8) 43
------------ ------------ ------------
Realized capital gains and losses,
pre-tax (3,052) (197) (79)
Income tax benefit 1,067 69 28
------------ ------------ ------------
Realized capital gains and losses,
after-tax $ (1,985) $ (128) $ (51)
============ ============ ============
</Table>
Realized capital gains and losses by transaction type for the years ended
December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------ ------------ ------------
Sales (1) $ 184 $ 70 $ (29)
Impairment write-downs (2) (1,227) (118) (21)
Change in intent write-downs (1) (3) (1,207) (92) (60)
Valuation of derivative instruments (985) (63) (17)
EMA LP income (4) (14) -- --
Settlement of derivative instruments 197 6 48
------------ ------------ ------------
Realized capital gains and losses,
pre-tax (3,052) (197) (79)
Income tax benefit 1,067 69 28
------------ ------------ ------------
Realized capital gains and losses,
after-tax $ (1,985) $ (128) $ (51)
============ ============ ============
</Table>
- ----------
(1) To conform to the current year presentation, certain amounts in
the prior years have been reclassified.
(2) Impairment write-downs reflect issue specific other-than-temporary
declines in fair value, including instances where we could not
reasonably assert that the recovery period would be temporary.
(3) Change in intent write-downs reflects instances where we cannot
assert a positive intent to hold until recovery.
(4) Subsequent to October 1, 2008, income from investments in limited
partnership interests accounted for utilizing the equity method of
accounting is reported in realized capital gains and losses.
Gross gains of $579 million, $131 million and $102 million and gross losses
of $380 million, $186 million and $231 million were realized on sales of fixed
income securities during 2008, 2007 and 2006, respectively.
106
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
UNREALIZED NET CAPITAL GAINS AND LOSSES
Unrealized net capital gains and losses included in accumulated other
comprehensive income are as follows:
<Table>
<Caption>
GROSS UNREALIZED
FAIR ------------------------ UNREALIZED NET
($ IN MILLIONS) VALUE GAINS LOSSES GAINS (LOSSES)
----------- ----------- ----------- ------------------
AT DECEMBER 31, 2008
Fixed income securities $ 42,446 $ 1,921 $ (8,611) $ (6,690)
Equity securities 82 1 (25) (24)
Short-term investments 3,858 4 (1) 3
Derivative instruments (1) 16 23 (9) 14
------------------
Unrealized net capital gains and losses, pre-tax (6,697)
Amounts recognized for:
Insurance reserves (2) (378)
DAC and DSI (3) 3,493
------------------
Amounts recognized 3,115
Deferred income taxes 1,245
------------------
Unrealized net capital gains and losses, after-tax $ (2,337)
==================
</Table>
- ----------
(1) Included in the fair value of derivative securities are $4 million
classified as assets and $(12) million classified as liabilities.
(2) The insurance reserves adjustment represents the amount by which the
reserve balance would increase if the net unrealized gains in the
applicable product portfolios were realized and reinvested at current lower
interest rates, resulting in a premium deficiency. Although we evaluate
premium deficiencies on the combined performance of our life insurance and
immediate annuities with life contingencies, the adjustment primarily
relates to structured settlement annuities with life contingencies, in
addition to annuity buy-outs and certain payout annuities with life
contingencies.
(3) The DAC and DSI adjustment represents the amount by which the amortization
of DAC and DSI would increase or decrease if the unrealized gains or losses
in the respective product portfolios were realized.
<Table>
<Caption>
GROSS UNREALIZED
FAIR ------------------------ UNREALIZED NET
($ IN MILLIONS) VALUE GAINS LOSSES GAINS (LOSSES)
----------- ----------- ----------- ------------------
AT DECEMBER 31, 2007
Fixed income securities $ 58,469 $ 2,260 $ (1,811) $ 449
Equity securities 102 5 (5) --
Derivative instruments (1) (32) -- (32) (32)
------------------
Unrealized net capital gains and losses, pre-tax 417
Amounts recognized for:
Insurance reserves (1,059)
DAC and DSI 513
------------------
Amounts recognized (546)
Deferred income taxes 45
------------------
Unrealized net capital gains and losses, after-tax $ (84)
==================
</Table>
- ----------
(1) Included in the fair value of derivative securities are $(9) million
classified as assets and $23 million classified as liabilities.
CHANGE IN UNREALIZED NET CAPITAL GAINS AND LOSSES
The change in unrealized net capital gains and losses for the years ended
December 31 is as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
----------- ----------- -----------
Fixed income securities $ (7,139) $ (1,139) $ (672)
Equity securities (24) (11) 6
Short-term investments 3 -- --
Derivative instruments 46 (16) (10)
----------- ----------- -----------
Total (7,114) (1,166) (676)
Amounts recognized for:
Insurance reserves 681 70 214
DAC and DSI 2,980 467 58
----------- ----------- -----------
Increase in amounts recognized 3,661 537 272
Deferred income taxes 1,200 220 141
----------- ----------- -----------
Change in unrealized net capital gains
and losses $ (2,253) $ (409) $ (263)
=========== =========== ===========
</Table>
107
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PORTFOLIO MONITORING
Inherent in the Company's evaluation of a particular security are
assumptions and estimates about the financial condition of the issue or 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 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
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.
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
OF ISSUES VALUE LOSSES OF ISSUES VALUE LOSSES LOSSES
--------- -------- ----------- ---------- ----------- ----------- -----------
AT DECEMBER 31, 2008
Fixed income securities
Municipal 400 $ 2,460 $ (653) 26 $ 199 $ (43) $ (696)
Corporate 1,282 12,781 (1,779) 446 4,344 (1,776) (3,555)
Foreign government 43 304 (53) 2 13 (12) (65)
MBS 129 724 (142) 57 233 (121) (263)
CMBS 289 2,646 (786) 176 901 (1,206) (1,992)
ABS 141 778 (251) 335 1,666 (1,783) (2,034)
Redeemable preferred stock 3 9 (6) -- -- -- (6)
--------- -------- ---------- --------- ---------- ---------- ----------
Total fixed income securities 2,287 19,702 (3,670) 1,042 7,356 (4,941) (8,611)
Equity securities 39 55 (25) -- -- -- (25)
--------- -------- ---------- --------- ---------- ---------- ----------
Total fixed income and equity
securities 2,326 $ 19,757 $ (3,695) 1,042 $ 7,356 $ (4,941) $ (8,636)
========= ======== ========== ========= ========== ========== ==========
Investment grade fixed income securities 2,104 $ 18,791 $ (3,343) 906 $ 6,757 $ (4,481) $ (7,824)
Below investment grade fixed income
securities 183 911 (327) 136 599 (460) (787)
--------- -------- ---------- --------- ---------- ---------- ----------
Total fixed income securities 2,287 $ 19,702 $ (3,670) 1,042 $ 7,356 $ (4,941) $ (8,611)
========= ======== ========== ========= ========== ========== ==========
AT DECEMBER 31, 2007
Fixed income securities
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)
MBS 122 1,145 (31) 433 686 (15) (46)
CMBS 306 3,074 (345) 133 1,137 (41) (386)
ABS 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) 973 6,212 (279) (1,811)
Equity securities 9 64 (5) -- -- -- (5)
--------- -------- ---------- --------- ---------- ---------- ----------
Total fixed income and equity
securities 1,839 $ 19,033 $ (1,537) 973 $ 6,212 $ (279) $ (1,816)
========= ======== ========== ========= ========== ========== ==========
Investment grade fixed income securities 1,629 $ 17,675 $ (1,396) 929 $ 5,882 $ (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) 973 $ 6,212 $ (279) $ (1,811)
========= ======== ========== ========= ========== ========== ==========
</Table>
As of December 31, 2008, $1.71 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 $1.71 billion, $1.63 billion
are related to unrealized losses on investment grade fixed income securities.
Investment grade is 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, a rating of AAA, AA, A or BBB
from Standard & Poor's ("S&P"), 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. 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, 2008, the remaining $6.93 billion of unrealized losses
are related to securities in unrealized loss positions greater than or equal to
20% of cost or amortized cost. Of the $6.93 billion, $705 million are related to
below investment grade fixed income securities and $22 million are related to
equity securities. Of these
108
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
amounts, $13 million of the 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, 2008. Unrealized losses on below investment grade
securities are principally related to rising interest rates or changes in credit
spreads. Unrealized losses on equity securities are primarily related to equity
market fluctuations. The Company expects eventual recovery of these securities.
Every security was included in our portfolio monitoring process.
The securities comprising the $6.93 billion 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.
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, 2008, 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, 2008 and 2007, equity method limited partnership
interests totaled $627 million and $485 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 2008 and 2007, the Company had write-downs of $13 million and $9
million, respectively, related to equity method limited partnership interests.
No write-downs were recognized in 2006.
As of December 31, 2008 and 2007, the carrying value for cost method
limited partnership interests was $560 million and $509 million, respectively,
which primarily included limited partnership interests in fund investments. To
determine if an other-than-temporary impairment has occurred, 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 statements 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 2008, 2007 and 2006 the Company had write-downs of $53 million, $0.3 million
and $0.1 million, respectively, 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, 2008 and 2007 was
$159 million and $2 million, respectively. Valuation allowances of $3 million
were held at December 31, 2008 reflecting a charge to operations related to
impaired mortgage loans. No valuation allowances were held at December 31, 2007
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 or 2006. Realized capital losses due to changes in intent
to hold mortgage loans to maturity totaled $73 million and $28 million for the
years ended December 31, 2008 and 2007, respectively.
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 $6 million, $0.2
million and $0.4 million during 2008, 2007 and 2006, respectively. The average
balance of impaired loans was $43 million, $3 million and $5 million in 2008,
2007 and 2006, respectively.
109
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTMENT CONCENTRATION FOR MUNICIPAL BOND AND COMMERCIAL MORTGAGE PORTFOLIOS
The Company maintains a diversified portfolio of municipal bonds. The
following table shows the principal geographic distribution of municipal bond
issuers represented in the Company's portfolio. No other state represents more
than 5% of the portfolio at December 31.
<Table>
<Caption>
(% OF MUNICIPAL BOND PORTFOLIO CARRYING VALUE) 2008 2007
---------- ---------
California 18.3 % 19.7 %
Delaware 9.3 8.1
Texas 8.9 9.0
New York 8.9 9.5
New Jersey 7.2 7.1
Virginia 6.0 4.7
Oregon 5.3 5.2
</Table>
The Company's mortgage loans are collateralized by a variety of commercial
real estate property types located throughout the United States. Substantially
all of the commercial mortgage loans are non-recourse to the borrower. The
following table shows the principal geographic distribution of commercial real
estate represented in the Company's mortgage portfolio. No other state
represented more than 5% of the portfolio at December 31.
<Table>
<Caption>
(% OF COMMERCIAL MORTGAGE PORTFOLIO CARRYING VALUE) 2008 2007
---------- ----------
California 21.0 % 22.7 %
Illinois 9.0 8.7
Texas 7.0 7.3
Pennsylvania 6.2 5.5
New Jersey 6.1 5.5
New York 5.8 5.7
</Table>
The types of properties collateralizing the commercial mortgage loans at
December 31 are as follows:
<Table>
<Caption>
(% OF COMMERCIAL MORTGAGE PORTFOLIO CARRYING VALUE) 2008 2007
---------- ---------
Office buildings 32.5 % 35.3 %
Retail 24.5 23.1
Warehouse 22.6 21.3
Apartment complex 15.5 15.8
Other 4.9 4.5
---------- ---------
Total 100.0 % 100.0 %
========== =========
</Table>
The contractual maturities of the commercial mortgage loan portfolio as of
December 31, 2008 for loans that were not in foreclosure are as follows:
<Table>
<Caption>
NUMBER CARRYING
($ IN MILLIONS) OF LOANS VALUE PERCENT
------------ ------------ ----------
2009 81 $ 746 7.5 %
2010 94 1,182 11.8
2011 106 1,434 14.3
2012 106 1,321 13.2
2013 82 780 7.8
Thereafter 445 4,549 45.4
------------ ------------ ----------
Total 914 $ 10,012 100.0 %
============ ============ ==========
</Table>
In 2008, $423 million of commercial mortgage loans were contractually due.
Of these, 79% were paid as due, 2% were refinanced at prevailing market terms
and 18% were extended generally for less than one year. 1% was in the process
of foreclosure, and none were foreclosed or in the process of refinancing or
restructuring discussions.
110
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONCENTRATION OF CREDIT RISK
At December 31, 2008, other than U.S. government and agencies, the
Company's exposure to credit concentration risk to a single issuer and its
affiliaties of greater than 10% of shareholder's equity includes the following:
<Table>
<Caption>
($ IN MILLIONS) PERCENTAGE OF PERCENTAGE OF
CARRYING STOCKHOLDER'S TOTAL
VALUE EQUITY INVESTMENTS
--------------- ------------------ -------------------
Federal Home Loan Mortgage Corporation
("Freddie Mac")
Fixed income securities $ 61
Mortgage loans 30
Short-term investments 199
---------------
Total Freddie Mac $ 290 13.1% 0.5%
===============
Bank of America Corporation
Fixed income securities $ 283
Equity securities 7
Derivative instruments (2)
---------------
Total Bank of America
Corporation $ 288 13.0 0.5
===============
Federal National Mortgage Association
("Fannie Mae")
Fixed income securities $ 267
---------------
Total Fannie Mae $ 267 12.1 0.4
===============
Wells Fargo & Company
Fixed income securities $ 227
Derivative instruments (1)
---------------
Total Wells Fargo & Company $ 226 10.2 0.4
===============
</Table>
SECURITIES LOANED
The Company's business activities include securities lending programs with
third parties, mostly large banks. At December 31, 2008 and 2007, fixed income
and equity securities with a carrying value of $307 million and $1.70 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 $34 million, $11
million and $5 million, for the years ended December 31, 2008, 2007 and 2006,
respectively.
OTHER INVESTMENT INFORMATION
Included in fixed income securities are below investment grade assets
totaling $1.73 billion and $2.66 billion at December 31, 2008 and 2007,
respectively.
At December 31, 2008, fixed income securities with a carrying value of $66
million were on deposit with regulatory authorities as required by law.
At December 31, 2008, the carrying value of fixed income securities that
were non-income producing was $4 million. No other investments were non-income
producing at December 31, 2008.
7. FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets, incurs various financial liabilities and enters into agreements
involving derivative financial instruments and other off-balance-sheet financial
instruments.
111
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the Company's financial assets and financial
liabilities measured at fair value on a recurring and non-recurring basis as of
December 31, 2008:
<Table>
<Caption>
QUOTED PRICES SIGNIFICANT
IN ACTIVE OTHER SIGNIFICANT
MARKETS FOR OBSERVABLE UNOBSERVABLE BALANCE AS OF
IDENTICAL ASSETS INPUTS INPUTS OTHER VALUATIONS DECEMBER 31,
($ IN MILLIONS) (LEVEL 1) (LEVEL 2) (LEVEL 3) AND NETTING 2008
----------------- ------------- ---------------- ----------------- ----------------
FINANCIAL ASSETS:
Fixed income securities $ 276 $ 28,037 $ 14,133 $ 42,446
Equity securities 1 54 27 82
Short-term investments 342 3,516 -- 3,858
Other investments:
Free-standing derivatives -- 605 13 618
----------------- ------------- ---------------- ----------------
TOTAL RECURRING BASIS ASSETS 619 32,212 14,173 47,004
Non-recurring basis -- -- 244 244
Valued at cost, amortized cost or
using the equity method $ 13,004 13,004
Counterparty and cash collateral
netting (1) (480) (480)
----------------- ------------- ---------------- ----------------- ----------------
TOTAL INVESTMENTS 619 32,212 14,417 12,524 59,772
----------------- ------------- ---------------- ----------------- ----------------
Separate account assets 8,239 -- -- -- 8,239
Other assets (1) -- 1 -- --
----------------- ------------- ---------------- ----------------- ----------------
TOTAL FINANCIAL ASSETS $ 8,857 $ 32,212 $ 14,418 $ 12,524 $ 68,011
================= ============= ================ ================= ================
% of Total financial assets 13.0% 47.4% 21.2% 18.4% 100.0%
FINANCIAL LIABILITIES:
Contractholder funds:
Derivatives embedded in
annuity contracts $ -- $ (37) $ (265) $ (302)
Other liabilities:
Free-standing derivatives -- (1,118) (106) (1,224)
Non-recurring basis -- -- -- --
Counterparty and cash collateral
netting (1) $ 460 460
----------------- ------------- ---------------- ----------------- ----------------
TOTAL FINANCIAL LIABILITIES $ -- $ (1,155) $ (371) $ 460 $ (1,066)
================= ============= ================ ================= ================
% of Total financial liabilities --% 108.4% 34.8% (43.2)% 100.0%
</Table>
- ----------
(1) In accordance with FSP FIN 39-1, the Company nets all fair value amounts
recognized for derivative instruments and fair value amounts recognized for
the right to reclaim cash collateral or the obligation to return cash
collateral executed with the same counterparty under a master netting
agreement. At December 31, 2008, the right to reclaim cash collateral was
offset by securities held, and the obligation to return collateral was $20
million.
As required by SFAS No. 157, when the inputs used to measure fair value
fall within different levels of the hierarchy, the level within which the fair
value measurement is categorized is based on the lowest level input that is
significant to the fair value measurement in its entirety. Thus, a Level 3 fair
value measurement may include inputs that are observable (Level 1 or Level 2)
and unobservable (Level 3). Gains and losses for such assets and liabilities
categorized within Level 3 may include changes in fair value that are
attributable to both observable inputs (Level 1 and Level 2) and unobservable
inputs (Level 3). Net transfers in and/or out of Level 3 are reported as having
occurred at the beginning of the quarter the transfer occurred; therefore, for
all transfers into Level 3, all realized and unrealized gains and losses in the
quarter of transfer are reflected in the table below. Further, it should be
noted that the following table does not take into consideration the effect of
offsetting Level 1 and Level 2 financial instruments entered into that
economically hedge certain exposures to the Level 3 positions.
112
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table provides a summary of changes in fair value during the
year ended December 31, 2008 of Level 3 financial assets and financial
liabilities held at fair value on a recurring basis at December 31, 2008.
<Table>
<Caption>
TOTAL REALIZED AND UNREALIZED
GAINS (LOSSES) INCLUDED IN:
------------------------------
OCI ON
STATEMENT OF PURCHASES, SALES,
BALANCE AS OF NET FINANCIAL ISSUANCES AND
($ IN MILLIONS) JANUARY 1, 2008 INCOME (1) POSITION SETTLEMENTS, NET
---------------- ------------ ------------- ------------------
FINANCIAL ASSETS
Fixed income securities $ 18,830 $ (1,617) $ (3,029) $ (2,322)
Equity securities 61 (3) (12) 20
Other investments:
Free-standing derivatives,
net (6) (125) -- 38
---------------- ------------ ------------- ------------------
TOTAL INVESTMENTS 18,885 (1,745) (3,041) (2,264)
Other assets 2 (1) -- --
---------------- ------------ ------------- ------------------
TOTAL RECURRING LEVEL 3
FINANCIAL ASSETS $ 18,887 $ (1,746) $ (3,041) $ (2,264)
================ ============ ============= ==================
FINANCIAL LIABILITIES
Contractholder funds:
Derivatives embedded in
annuity contracts $ 4 $ (270) $ -- $ 1
---------------- ------------ ------------- ------------------
TOTAL RECURRING LEVEL 3
FINANCIAL LIABILITIES $ 4 $ (270) $ -- $ 1
================ ============ ============= ==================
<Caption>
TOTAL
GAINS (LOSSES)
INCLUDED IN
NET NET INCOME FOR
TRANSFERS IN INSTRUMENTS
AND/OR BALANCE AS OF STILL HELD AT
(OUT) OF DECEMBER 31, DECEMBER 31,
($ IN MILLIONS) LEVEL 3 2008 2008 (4)
-------------- --------------- -----------------
FINANCIAL ASSETS
Fixed income securities $ 2,271 $ 14,133 $ (1,340)
Equity securities (39) 27 (3)
Other investments:
Free-standing derivatives,
net -- (93) (2) (37)
-------------- --------------- -----------------
TOTAL INVESTMENTS 2,232 14,067 (3) (1,380)
Other assets -- 1 (1)
-------------- --------------- -----------------
TOTAL RECURRING LEVEL 3
FINANCIAL ASSETS $ 2,232 $ 14,068 $ (1,381)
============== =============== =================
FINANCIAL LIABILITIES
Contractholder funds:
Derivatives embedded in
annuity contracts $ -- $ (265) $ (270)
-------------- --------------- -----------------
TOTAL RECURRING LEVEL 3
FINANCIAL LIABILITIES $ -- $ (265) $ (270)
============== =============== =================
</Table>
- ----------
(1) The effect to net income of financial assets and financial liabilities
totals $(2.02) billion and is reported in the Consolidated Statements of
Operations and Comprehensive Income as follows: $(1.83) billion in realized
capital gains and losses; $91 million in net investment income; $(6)
million in interest credited to contractholder funds; and $(270) million in
contract benefits.
(2) Comprises $13 million of financial assets and $(106) million of
financial liabilities.
(3) Comprises $14.17 billion of investments and $(106) million of free-standing
derivatives included in financial liabilities.
(4) The amounts represent gains and losses included in net income for the
period of time that the financial asset or financial liability was
determined to be in Level 3. These gains and losses total $(1.65) billion
and are reported in the Consolidated Statements of Operations and
Comprehensive Income as follows: $(1.45) billion in realized capital gains
and losses; $75 million in net investment income; $(1) million in interest
credited to contractholder funds and $(270) million in contract benefits.
Presented below are the fair value estimates of financial instruments
including those reported at fair value and discussed above and those reported
using other methods for which a description of the method to determine fair
value appears below the following tables.
FINANCIAL ASSETS
<Table>
<Caption>
DECEMBER 31, 2008 DECEMBER 31, 2007
----------------------- -----------------------
CARRYING FAIR CARRYING FAIR
($ IN MILLIONS) VALUE VALUE VALUE VALUE
---------- ---------- ---------- ----------
Fixed income securities (1) $ 42,446 $ 42,446 $ 58,469 $ 58,469
Equity securities (1) 82 82 102 102
Mortgage loans 10,012 8,700 9,901 9,804
Limited partnership interests - cost basis 560 541 509 525
Short-term investments (1) 3,858 3,858 386 386
Bank loans 981 675 1,128 1,085
Free-standing derivatives (1) 138 138 457 457
Intercompany notes 250 185 200 186
Separate accounts (1) 8,239 8,239 14,929 14,929
</Table>
- ----------
(1) Carried at fair value in the Consolidated Statements of Financial
Position.
The fair value of mortgage loans is based on discounted contractual cash
flows. Risk adjusted discount rates are selected using current rates at which
similar loans would be made to borrowers with similar characteristics, using
similar types of properties as collateral. The fair value of limited partnership
interests accounted for on the cost basis is determined using reported net asset
values of the underlying funds. The fair value of bank loans, which are
113
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
reported in other investments on the Consolidated Statements of Financial
Position, are valued based on broker quotes from brokers familiar with the
loans. The fair value of intercompany notes is based on discounted cash flow
calculations using current interest rates for instruments with comparable terms.
FINANCIAL LIABILITIES
<Table>
<Caption>
DECEMBER 31, 2008 DECEMBER 31, 2007
----------------------- -----------------------
CARRYING FAIR CARRYING FAIR
($ IN MILLIONS) VALUE VALUE VALUE VALUE
---------- ---------- ---------- -----------
Contractholder funds on investment contracts (2) $ 45,989 $ 42,484 $ 50,445 $ 49,117
Surplus notes due to related parties 650 566 200 189
Liability for collateral (1) 340 340 1,817 1,817
Free-standing derivatives (1) 744 744 292 292
</Table>
- ----------
(1) Carried at fair value in the Consolidated Statements of Financial
Position.
(2) As of December 31, 2008 and 2007, contractholder funds on investment
contracts exclude contractholder funds related to interest-sensitive life
insurance, variable annuities and variable life insurance totaling $10.79
billion and $10.02 billion, respectively.
Beginning in 2008, the fair value of contractholder funds on investment
contracts is based on the terms of the underlying contracts utilizing prevailing
market rates for similar contracts adjusted for credit risk. Deferred annuities
included in contractholder funds are valued using discounted cash flow models
which incorporate market value margins, which are based on the cost of holding
economic capital, and the Company's own credit risk. Immediate annuities without
life contingencies and fixed rate funding agreements are valued at the present
value of future benefits using market implied interest rates which include the
Company's own credit risk. In 2007, the fair value of investment contracts was
based on the terms of the underlying contracts. Fixed annuities were valued at
the account balance less surrender charges. Immediate annuities without life
contingencies and fixed rate funding agreements were valued at the present value
of future benefits using current interest rates. The fair value of variable rate
funding agreements approximated the carrying value. Market value adjusted
annuities' fair value was estimated to be the market adjusted surrender value.
Equity-indexed annuity contracts' fair value approximated the carrying value
since the embedded equity options are carried at fair value.
The fair value of surplus notes due to related parties is based on
discounted cash flow calculations using current interest rates for instruments
with comparable terms and considers the Company's own credit risk. The liability
for collateral is valued at carrying value due to its short-term nature.
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.
The Company uses derivatives to partially mitigate potential adverse
impacts from future increases in credit spreads. Credit default swaps are used
to mitigate the credit spread risk within the Company's fixed income portfolio.
Asset-liability management is a risk management strategy that is
principally employed to align the respective interest-rate sensitivities of the
Company's 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 within specific ranges 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 annuity product
contracts that offer equity returns to contractholders. In addition, the Company
also uses interest rate swaps to hedge interest rate risk inherent
114
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 securities, 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 options, which provide a coupon
payout based upon one or more equity-based indices.
The notional amounts specified in the contracts are used to calculate the
exchange of contractual payments under the agreements and are generally not
representative of the potential for gain or loss on these agreements. However,
the notional amounts specified in credit default swaps represent the maximum
amount of potential loss, assuming no recoveries.
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 valuation techniques are described in Note 2.
For certain exchange traded derivatives, the exchange requires margin deposits
as well as daily cash settlements of margin accounts. As of December 31, 2008,
the Company pledged $28 million of securities in the form of margin deposits.
Carrying value amounts include the fair value of the derivatives, including
the embedded derivatives, and exclude the accrued periodic settlements which are
short term in nature and are reported in accrued investment income or other
invested assets. The carrying value amounts for free-standing derivatives have
been further adjusted for the effects, if any, of legally enforceable master
netting agreements.
Derivative instruments are recorded at fair value and presented in the
Consolidated Statements of Financial Position as of December 31, as follows:
<Table>
<Caption>
CARRYING VALUE
--------------------------------------------------
ASSETS (LIABILITIES)
----------------------- ------------------------
($ IN MILLIONS) 2008 2007 2008 2007
---------- ---------- ---------- ----------
Fixed income securities $ 222 $ 612 $ -- $ --
Other investments 138 444 -- --
Other assets 3 2 -- --
Contractholder funds -- -- (302) (119)
Other liabilities and accrued expenses -- -- (744) (292)
---------- ---------- ---------- ----------
Total $ 363 $ 1,058 $ (1,046) $ (411)
========== ========== ========== ==========
</Table>
For cash flow hedges, unrealized net pre-tax losses included in accumulated
other comprehensive income were $16 million and $(32) million at December 31,
2008 and 2007, respectively. The net pre-tax changes in accumulated other
comprehensive income due to cash flow hedges were $48 million, $(16) million and
$(10) million in 2008, 2007 and 2006, respectively. Amortization of net gains
from accumulated other comprehensive income related to cash flow hedges is
expected to be $(1) million in 2009.
115
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the notional amount, fair value and carrying
value of the Company's derivative financial instruments at December 31, 2008.
<Table>
<Caption>
CARRYING VALUE
NOTIONAL FAIR ------------------------------
($ IN MILLIONS) AMOUNT VALUE ASSETS (LIABILITIES)
-------------- -------------- -------------- --------------
INTEREST RATE CONTRACTS
Interest rate swap agreements $ 10,354 $ (799) $ 22 $ (821)
Financial futures contracts and options 4,359 (1) -- (1)
Interest rate cap and floor agreements 5,688 (35) 2 (37)
-------------- -------------- -------------- --------------
Total interest rate contracts 20,401 (835) 24 (859)
EQUITY AND INDEX CONTRACTS
Options, financial futures, and warrants 5,056 49 97 (48)
FOREIGN CURRENCY CONTRACTS
Foreign currency swap agreements 1,233 222 9 213
Foreign currency forwards and options 10 -- -- --
-------------- -------------- -------------- --------------
Total foreign currency contracts 1,243 222 9 213
CREDIT DEFAULT SWAPS USED FOR ASSET REPLICATION
Credit default swaps - selling protection 517 (73) (1) (72)
EMBEDDED DERIVATIVE FINANCIAL INSTRUMENTS
Guaranteed accumulation benefits 985 (147) -- (147)
Guaranteed withdrawal benefits 744 (119) -- (119)
Conversion options in fixed income securities 378 90 90 --
Equity-indexed call options in fixed income
securities 800 132 132 --
Equity-indexed call options in fixed income
securities 4,150 (37) -- (37)
Other embedded derivative financial instruments 135 1 -- 1
-------------- -------------- -------------- --------------
Total embedded derivative financial 7,192 (80) 222 (302)
instruments
OTHER DERIVATIVE FINANCIAL INSTRUMENTS
Credit default swaps - buying protection 1,145 31 9 22
Other 81 3 3 --
-------------- -------------- -------------- --------------
Total other derivative instruments 1,226 34 12 22
-------------- -------------- -------------- --------------
TOTAL DERIVATIVE FINANCIAL INSTRUMENTS $ 35,635 $ (683) $ 363 $ (1,046)
============== ============== ============== ==============
</Table>
116
<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, 2007:
<Table>
<Caption>
CARRYING VALUE
NOTIONAL FAIR ------------------------------
($ IN MILLIONS) AMOUNT VALUE ASSETS (LIABILITIES)
------------- ------------- ------------- -------------
INTEREST RATE CONTRACTS
Interest rate swap agreements $ 14,886 $ (297) $ (117) $ (180)
Financial futures contracts and options 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
Credit default swaps - selling protection 631 (23) (10) (13)
EMBEDDED DERIVATIVE FINANCIAL INSTRUMENTS
Guaranteed accumulation benefits 1,592 -- -- --
Guaranteed withdrawal benefits 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
Other 87 2 2 --
------------- ------------- ------------- -------------
Total other derivative financial instruments 87 2 2 --
------------- ------------- ------------- -------------
TOTAL DERIVATIVE FINANCIAL INSTRUMENTS $ 45,879 $ 647 $ 1,058 $ (411)
============= ============= ============= =============
</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, forward 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, 2008, counterparties pledged $20 million
in cash collateral to the Company, and the Company pledged $544 million in
securities to counterparties. The Company has not incurred any losses on
derivative financial instruments due to counterparty nonperformance. Other
derivatives including futures and certain option contracts are traded on
organized exchanges, which require margin deposits and guarantee the execution
of trades, thereby mitigating any potential credit risk associated with
transactions executed on organized exchanges.
Credit exposure represents the Company's potential loss if all of the
counterparties concurrently fail to perform under the contractual terms of the
contracts and all collateral, if any, becomes worthless. This exposure is
measured by the fair value of free-standing derivative contracts with a positive
fair value at the reporting date reduced by the effect, if any, of legally
enforceable master netting agreements.
117
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the counterparty credit exposure by
counterparty credit rating at December 31, as it relates to interest rate swap,
foreign currency swap, interest rate cap, interest rate floor, credit default
swap and certain option agreements.
<Table>
<Caption>
($ IN MILLIONS) 2008 2007
---------------------------------------------------- -------------------------------------------------------
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 $ 84 $ -- $ -- 1 $ 228 $ -- $ --
AA+ -- -- -- -- 1 2,016 3 3
AA -- -- -- -- 7 11,652 65 8
AA- 3 6,539 5 5 4 5,532 11 1
A+ 5 6,195 8 8 3 11,398 187 --
A 4 6,001 35 15 -- -- -- --
A- 1 216 25 25 -- -- -- --
---------- ---------- ------------ ------------- ------------ --------- ------------ ---------------
Total 14 $ 19,035 $ 73 $ 53 16 $30,826 $ 266 $ 12
========== ========== ============ ============= ============ ========= ============ ===============
</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.
CREDIT DERIVATIVES - SELLING PROTECTION
Credit default swaps ("CDS") are utilized for selling credit protection
against a specified credit event. A credit default swap is a derivative
instrument, representing an agreement between two parties to exchange the credit
risk of a specified entity (or a group of entities), or an index based on the
credit risk of a group of entities (all commonly referred to as the "reference
entity" or a portfolio of "reference entities"), for a periodic premium. In
selling protection, CDS are used to replicate fixed income securities and 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. Credit risk includes both default risk and market value
exposure due to spread widening. CDS typically have a five-year term.
The following table shows the CDS notional amounts by credit rating and
fair value of protection sold as of December 31, 2008:
<Table>
<Caption>
NOTIONAL AMOUNT
CREDIT RATING UNDERLYING NOTIONAL
---------------------------------------------------
BB AND FAIR
($ IN MILLIONS) AAA AA A BBB LOWER TOTAL VALUE
------ ------ ------ ------ ------ ------ -------
SINGLE NAME
Investment grade
corporate debt $ 10 $ -- $ 115 $ 91 $ -- $ 216 $ (10)
High yield debt -- -- -- -- 6 6 (3)
Municipal -- 25 -- -- -- 25 (11)
Sovereign -- -- -- 20 5 25 (1)
------ ------ ------ ------ ------ ------ -------
Subtotal 10 25 115 111 11 272 (25)
FIRST-TO-DEFAULT
Investment grade
corporate debt -- -- 30 60 -- 90 (5)
Municipal -- 120 35 -- -- 155 (43)
------ ------ ------ ------ ------ ------ -------
Subtotal -- 120 65 60 -- 245 (48)
------ ------ ------ ------ ------ ------ -------
TOTAL $ 10 $ 145 $ 180 $ 171 $ 11 $ 517 $ (73)
====== ====== ====== ====== ====== ====== =======
</Table>
118
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In selling protection with CDS, the Company sells credit protection on an
identified single name, a basket of names in a first-to-default ("FTD")
structure or credit derivative index ("CDX") that is generally investment grade,
and in return receives periodic premiums through expiration or termination of
the agreement. With single name CDS, this premium or credit spread generally
corresponds to the difference between the yield on the referenced entity's
public fixed maturity cash instruments and swap rates, at the time the agreement
is executed. With FTD baskets, because of the additional credit risk inherent in
a basket of named credits, the premium generally corresponds to a high
proportion of the sum of the credit spreads of the names in the basket and the
correlation between the names. CDX index is utilized to take a position on
multiple (generally 125) reference entities. Credit events are typically defined
as bankruptcy, failure to pay, or restructuring, depending on the nature of the
reference credit. If a credit event occurs, the Company settles with the
counterparty, either through physical settlement or cash settlement. In a
physical settlement, a reference asset is delivered by the buyer of protection
to the Company, in exchange for cash payment at par, while in a cash settlement,
the Company pays the difference between par and the prescribed value of the
reference asset. When a credit event occurs in a single name or FTD basket (for
FTD, the first credit event occurring for any one name in the basket), the
contract terminates at time of settlement. For CDX index, the reference entity's
name incurring the credit event is removed from the index while the contract
continues until expiration. The maximum payout on a CDS is the contract notional
amount. A physical settlement may afford the Company with recovery rights as the
new owner of the asset.
The Company monitors risk associated with credit derivatives through
individual name credit limits at both a credit derivative and a combined cash
instrument/credit derivative level. The ratings of individual names for which
protection has been sold are also monitored.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND UNCONSOLIDATED INVESTMENTS IN VIES
The contractual amounts and fair values of off-balance-sheet financial
instruments at December 31 are as follows:
<Table>
<Caption>
2008 2007
--------------------------- ---------------------------
CONTRACTUAL FAIR CONTRACTUAL FAIR
($ IN MILLIONS) AMOUNT VALUE AMOUNT VALUE
------------ ------------ ------------ ------------
Commitments to invest in limited
partnership interests $ 1,075 $ -- $ 1,198 $ --
Commitments to invest - other 2 -- 12 --
Commitments to extend mortgage loans 3 -- 326 3
Private placement commitments -- -- 30 --
</Table>
In the preceding 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.
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.
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.
In 2006, the Company participated in the establishment of an investment
management variable interest entity ("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 primarily consisting of
119
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
investment securities and cash totaling $400 million and liabilities primarily
consisting of long-term debt totaling $378 million at December 31, 2008. The
Company does not consolidate the VIE because it is not the primary beneficiary.
The Company's maximum loss exposure related to the VIE is the amortized cost of
its investment, which was $7 million at December 31, 2008.
8. RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS AND CONTRACTHOLDER FUNDS
At December 31, the reserve for life-contingent contract benefits consists
of the following:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007
------------ -----------
Immediate fixed annuities:
Structured settlement annuities $ 6,628 $ 7,094
Other immediate fixed annuities 2,101 2,253
Traditional life insurance 2,538 2,397
Other 989 854
------------ -----------
Total reserve for life-contingent contract benefits $ 12,256 $ 12,598
============ ===========
</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 annuities U.S. population with projected calendar year Interest rate Present value of
improvements; mortality rates adjusted for each assumptions range contractually specified
impaired life based on reduction in life from 2.9% to 11.7% future benefits
expectancy
Other immediate fixed annuities 1983 group annuity mortality table; 1983 Interest rate Present value of expected
individual annuity mortality table; Annuity assumptions range future benefits based on
2000 mortality table with internal modifications from 1.6% to 11.5% historical experience
Traditional life insurance Actual company experience plus loading Interest rate Net level premium reserve
assumptions range method using the Company's
from 4.0% to 11.3% withdrawal experience rates
Other:
Variable annuity guaranteed 100% of Annuity 2000 mortality table Interest rate Projected benefit ratio
minimum death benefits (1) assumptions range applied to cumulative
from 5.3% to 5.9% assessments
Accident and health Actual company experience plus loading Unearned premium;
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 is recorded for certain immediate annuities with life
contingencies. A liability of $378 million and $1.06 billion is included in the
reserve for life-contingent contract benefits with respect to this deficiency as
of December 31, 2008 and 2007, respectively. The offset to this liability is
recorded as a reduction of the unrealized net capital gains included in
accumulated other comprehensive income.
120
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, contractholder funds consist of the following:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007
------------- -------------
Interest-sensitive life insurance $ 9,308 $ 8,896
Investment contracts:
Fixed annuities 37,625 38,100
Funding agreements backing medium-term notes 9,314 13,375
Other investment contracts 533 93
------------- -------------
Total contractholder funds $ 56,780 $ 60,464
============= =============
</Table>
The following table highlights the key contract provisions relating to
contractholder funds:
<Table>
<Caption>
PRODUCT INTEREST RATE WITHDRAWAL/SURRENDER CHARGES
- ----------------------------------- ----------------------------------- --------------------------------------------------
Interest-sensitive life insurance Interest rates credited range Either a percentage of account balance or
from 2.0% to 6.0% dollar amount grading off generally over 20
years
Fixed annuities Interest rates credited range Either a declining or a level percentage charge
from 1.3% to 11.5% for immediate generally over nine years or less.
annuities and 0% to 16.0% for Additionally, approximately 28.4% of fixed
other fixed annuities (which annuities are subject to market value
include equity-indexed annuities adjustment for discretionary withdrawals
whose returns are indexed to the
S&P 500)
Funding agreements backing Interest rates credited range Not applicable
medium-term notes from 0.5% to 6.5% (excluding
currency-swapped medium-term
notes)
Other investment contracts:
Variable guaranteed minimum Interest rates used in Withdrawal and surrender charges are based on
income, accumulation and establishing reserves range from the terms of the related interest-sensitive
withdrawal benefits (1) and 1.8% to 10.3% life insurance or fixed annuity contract
secondary guarantees on
interest-sensitive life
insurance and fixed annuities
</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) 2008 2007
----------- -----------
Balance, beginning of year $ 60,464 $ 60,565
Deposits 9,286 7,960
Interest credited 2,350 2,635
Benefits (1,701) (1,656)
Surrenders and partial withdrawals (4,329) (4,928)
Maturities of institutional products (8,599) (3,165)
Net transfers from separate accounts 19 13
Contract charges (819) (751)
Fair value hedge adjustments for institutional products (56) 34
Other adjustments 165 (243)
----------- -----------
Balance, end of year $ 56,780 $ 60,464
=========== ===========
</Table>
The Company offered various guarantees to variable annuity contractholders.
Liabilities for variable contract guarantees related to death benefits are
included in the reserve for life-contingent contract benefits and the
liabilities related to the income, withdrawal and accumulation benefits are
included in contractholder funds in the
121
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $7.07
billion and $13.32 billion of equity, fixed income and balanced mutual funds and
$730 million and $661 million of money market mutual funds at December 31, 2008
and 2007, respectively.
The table below presents information regarding the Company's variable
annuity contracts with guarantees. The Company's variable annuity contracts may
offer more than one type of guarantee in each contract; therefore, the sum of
amounts listed exceeds the total account balances of variable annuity contracts'
separate accounts with guarantees.
<Table>
<Caption>
($ IN MILLIONS) DECEMBER 31,
---------------------------
2008 2007
------------ ------------
IN THE EVENT OF DEATH
Separate account value $ 7,802 $ 13,939
Net amount at risk (1) $ 3,971 $ 956
Average attained age of contractholders 64 years 66 years
AT ANNUITIZATION (INCLUDES INCOME BENEFIT GUARANTEES)
Separate account value $ 1,846 $ 3,394
Net amount at risk (2) $ 1,459 $ 144
Weighted average waiting period until annuitization options available 4 years 3 years
FOR CUMULATIVE PERIODIC WITHDRAWALS
Separate account value $ 718 $ 1,218
Net amount at risk (3) $ 159 $ 4
ACCUMULATION AT SPECIFIED DATES
Separate account value $ 984 $ 1,587
Net amount at risk (4) $ 223 $ --
Weighted average waiting period until guarantee date 9 years 10 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 liability for guarantees is re-evaluated periodically, and adjustments are
made to the liability balance through a charge or credit to contract benefits.
122
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
LIABILITY FOR GUARANTEES
GUARANTEES LIABILITY FOR RELATED TO
RELATED TO DEATH GUARANTEES ACCUMULATION
BENEFITS AND RELATED TO AND
INTEREST-SENSITIVE INCOME WITHDRAWAL
($ IN MILLIONS) LIFE PRODUCTS BENEFITS BENEFITS TOTAL
--------------------- ------------------- ------------------ ------------
Balance at December 31, 2006 (1) $ 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 (2) $ 145 $ 45 $ -- $ 190
===================== =================== ================== ============
Less reinsurance recoverables (121) (26) -- (147)
Net balance at December 31, 2007 24 19 -- 43
Incurred guaranteed benefits 11 -- -- 11
Paid guarantee benefits (1) -- -- (1)
--------------------- ------------------- ------------------ ------------
Net change 10 -- -- 10
Net balance at December 31, 2008 34 19 -- 53
Plus reinsurance recoverables 81 200 266 547
--------------------- ------------------- ------------------ ------------
Balance, December 31, 2008(3) $ 115 $ 219 $ 266 $ 600
===================== =================== ================== ============
</Table>
- ----------
(1) 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 $(7) million, variable annuity withdrawal benefits of $(1)
million and other guarantees of $52 million.
(2) 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.
(3) Included in the total liability balance at December 31, 2008 are
reserves for variable annuity death benefits of $67 million, variable
annuity income benefits of $200 million, variable annuity accumulation
benefits of $147 million, variable annuity withdrawal benefits of $119
million and other guarantees of $67 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 ceded the mortality risk associated with coverage in
excess of $3 million per life for contracts issued to individuals age 70 and
over, and 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, the Company ceded 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 ceded the mortality risk
associated with coverage in excess of $5 million per life. For business sold
prior to October 1998, the Company ceded mortality risk in excess of specific
amounts up to $1 million for individual life.
In addition, the Company has used reinsurance to effect the acquisition or
disposition of certain blocks of business. The Company had reinsurance
recoverables of $1.57 billion and $1.26 billion at December 31, 2008 and 2007,
respectively, due from Prudential related to the disposal of substantially all
of its variable annuity business that was effected through Reinsurance
Agreements (see Note 3). In 2008, premiums and contract charges of $238
123
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
million, contract benefits of $467 million, interest credited to contractholder
funds of $36 million, and operating costs and expenses of $47 million were ceded
to Prudential pursuant to the Reinsurance Agreements. In 2007, premiums and
contract charges of $317 million, contract benefits of $59 million, interest
credited to contractholder funds of $43 million, and operating costs and
expenses of $72 million were ceded to Prudential pursuant to the Reinsurance
Agreements. In 2006, premiums and contract charges of $170 million, contract
benefits of $29 million, interest credited to contractholder funds of $35
million, and operating costs and expenses of $64 million were ceded to
Prudential pursuant to the Reinsurance Agreements. In addition, as of December
31, 2008 and 2007, the Company had reinsurance recoverables of $181 million and
$166 million, respectively, due from subsidiaries of Citigroup (Triton Insurance
and American Health and Life Insurance), and Scottish Re (U.S.) Inc. in
connection with the disposition of substantially all of the direct response
distribution business in 2003.
As of December 31, 2008, the gross life insurance in force was $528.22
billion of which $249.64 billion was ceded to unaffiliated reinsurers.
The effects of reinsurance on premiums and contract charges for the years
ended December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------- ------------- -------------
PREMIUMS AND CONTRACT CHARGES
Direct $ 2,275 $ 2,342 $ 2,326
Assumed
Affiliate 70 16 16
Non-affiliate 25 26 30
Ceded--non-affiliate (874) (940) (787)
------------- ------------- -------------
Premiums and contract charges, net of reinsurance $ 1,496 $ 1,444 $ 1,585
============= ============= =============
</Table>
The effects of reinsurance on contract benefits for the years ended
December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------- ------------- -------------
CONTRACT BENEFITS
Direct $ 2,428 $ 1,973 $ 1,886
Assumed
Affiliate 42 10 11
Non-affiliate 26 27 23
Ceded--non-affiliate (1,099) (646) (548)
------------- ------------- -------------
Contract benefits, net of reinsurance $ 1,397 $ 1,364 $ 1,372
============= ============= =============
</Table>
The effects of reinsurance on interest credited to contractholder funds for
the years ended December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------- ------------- -------------
INTEREST CREDITED TO CONTRACTHOLDER FUNDS
Direct $ 2,373 $ 2,644 $ 2,534
Assumed
Affiliate 11 13 24
Non-affiliate 15 18 26
Ceded--non-affiliate (43) (47) (41)
------------- ------------- -------------
Interest credited to contractholder funds, net of
reinsurance $ 2,356 $ 2,628 $ 2,534
============= ============= =============
</Table>
Reinsurance recoverables at December 31 are summarized in the following table.
<Table>
<Caption>
REINSURANCE RECOVERABLE ON
($ IN MILLIONS) PAID AND UNPAID BENEFITS
---------------------------
2008 2007
------------ ------------
Annuities $ 1,734 $ 1,423
Life insurance 1,465 1,365
Long-term care 630 526
Other 94 96
------------ ------------
Total $ 3,923 $ 3,410
============ ============
</Table>
124
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2008 and 2007, approximately 93% and 88%, respectively, 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) 2008 2007 2006
------------- ------------- -------------
Balance, beginning of year $ 3,905 $ 3,485 $ 3,948
Reinsurance assumed (1) 32 -- --
Impact of adoption of SOP 05-1 (2) -- (11) --
Disposition of operation (3) -- -- (726)
Acquisition costs deferred 596 547 742
Amortization charged to income (643) (518) (538)
Effect of unrealized gains and losses 2,811 402 59
------------- ------------- -------------
Balance, end of year $ 6,701 $ 3,905 $ 3,485
============= ============= =============
</Table>
- ----------
(1) In 2008, DAC increased as a result of a reinsurance transaction with AHL
(see Note 5).
(2) The adoption of SOP 05-1 resulted in an $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).
(3) 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 accretion of DAC amortization related to realized capital gains and
losses was $515 million, $17 million and $50 million in 2008, 2007 and 2006,
respectively.
As disclosed in Note 3, DAC and DSI balances were reduced during 2006
related to the disposal through reinsurance agreements of substantially all of
the variable annuity business.
DSI activity, which primarily relates to fixed annuities, for the years
ended December 31 was as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------- ------------- -------------
Balance, beginning of year $ 295 $ 225 $ 237
Impact of adoption of SOP 05-1 (1) -- (2) --
Disposition of operation (2) -- -- (70)
Sales inducements deferred 47 64 105
Amortization charged to income (53) (57) (48)
Effect of unrealized gains and losses 164 65 1
------------- ------------- -------------
Balance, end of year $ 453 $ 295 $ 225
============= ============= =============
</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 (see
Note 2).
(2) In 2006, DSI was reduced related to the disposition through
reinsurance agreements of substantially all of the Company's variable
annuity business (see Note 3).
11. COMMITMENTS, GUARANTEES AND CONTINGENT LIABILITIES
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 Company's policy is to accrue a guaranty fund assessment when
the entity for which the insolvency relates has been declared financially
insolvent by a court of competent jurisdiction and, in certain states, there is
also a final order of liquidation, and the amount of loss is reasonably
estimable. As of December 31, 2008 and 2007, the liability balance included in
other liabilities and accrued expenses was $30 million and $21 million,
respectively. The related premium tax offsets included in other assets were $29
million and $21 million as of December 31, 2008 and 2007, respectively.
The New York Liquidation Bureau (the "Bureau") has publicly reported that
Executive Life Insurance Company of New York ("Executive Life") is currently
under its jurisdiction as part of a 1992 court-ordered
125
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
rehabilitation plan and may only be able to meet future obligations of its
annuity contracts for the next fifteen years. However, Executive Life does not
have a liquidity problem at this time, and an order of liquidation has not been
sought by the Bureau. The shortfall was estimated by the Bureau to be $1.27
billion at October 29, 2008.
If Executive Life were to be declared insolvent in the future, the Company
may have exposure to future guaranty fund assessments. The Company's exposure
will ultimately depend on the level of guaranty fund system participation, as
well as the viability of a plan of the Bureau to obtain voluntary contributions,
primarily from the original insurance companies that acquired structured
settlement annuity contracts from Executive Life. 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 New York market share was
approximately 4.1% in 2007 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 $195 million at December 31, 2008. The
obligations associated with these fixed income securities expire at various
dates during the next six 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, 2008.
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" subsection 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.
- 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.
126
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- 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 the Company's 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. In March 2008, the Third Circuit
decided that the appeal should not summarily be dismissed and that the
question of whether the matter is appealable at this time will be
addressed by the Court along with the merits of the appeal.
- The EEOC also filed another lawsuit in 2004 alleging age discrimination
with respect to a policy 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
127
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to support the rehire policy. AIC's interlocutory appeal from the partial
summary judgment was granted. In June 2008, the Eighth Circuit Court of
Appeals affirmed summary judgment in the EEOC's favor. In September 2008,
the Court of Appeals granted AIC's petition for rehearing EN BANC and
vacated its earlier decision affirming the trial court's grant of summary
judgment in favor of the EEOC. The Court of Appeals then dismissed the
appeal, determining that it lacked jurisdiction to consider the appeal at
this stage in the litigation.
- AIC is also defending a certified class action filed by former employee
agents who terminated their employment prior to the agency program
reorganization. Plaintiffs allege that they were constructively
discharged so that AIC could avoid paying ERISA and other benefits
offered under the reorganization. They claim that the constructive
discharge resulted from the implementation of agency standards, including
mandatory office hours and a requirement to have licensed staff available
during business hours. The court approved the form of class notice which
was sent to approximately 1,800 potential class members in November 2007.
Fifteen individuals opted out. AIC's motions for judgment on the
pleadings were partially granted. In May 2008, the court granted summary
judgment in AIC's favor on all class claims. Plaintiffs moved for
reconsideration and in the alternative to decertify the class. AIC
opposed this motion and filed a motion for summary judgment with respect
to the remaining non-class claim. In August 2008, the court denied
plaintiffs' motion to reconsider and to decertify the class. In February
2009, plaintiffs moved to dismiss the sole remaining claim with prejudice
which the court promptly granted ending this litigation in the trial
court.
- 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. In March 2008, the Third
Circuit decided that the appeal should not summarily be dismissed and
that the question of whether the matter is appealable at this time will
be addressed by the Court along with the merits of the appeal.
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.
128
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Internal Revenue Service ("IRS") is currently examining the Allstate
Group's 2005 and 2006 federal income tax returns. The statute of limitations has
expired on years prior to 2005. 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.
The Company had no liability for unrecognized tax benefits at December 31,
2008 or 2007 or January 1, 2007, and believes it is reasonably possible that the
liability balance will not significantly increase 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) 2008 2007
------------ ------------
DEFERRED ASSETS
Life and annuity reserves $ 306 $ 588
Unrealized net capital losses 1,254 45
Difference in tax bases of investments 381 23
Net operating loss carryforward 208 --
Other assets 43 39
------------ ------------
Total deferred assets 2,192 695
Valuation allowance (9) --
------------ ------------
Net deferred assets 2,183 695
DEFERRED LIABILITIES
DAC (790) (787)
Other liabilities (11) (9)
------------ ------------
Total deferred liabilities (801) (796)
------------ ------------
Net deferred asset (liability) $ 1,382 $ (101)
============ ============
</Table>
Although realization is not assured, management believes it is more likely
than not that the deferred tax assets, net of valuation allowance, will be
realized based on the Company's assessment that the deductions ultimately
recognized for tax purposes will be able to be fully utilized. The valuation
allowance for deferred tax assets increased by $9 million in 2008.
The components of income tax (benefit) expense for the years ended December
31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
------------ ------------ ------------
Current $ (640) $ 111 $ 136
Deferred (including $208 million tax benefit of
operating loss carryforward in 2008) (306) 69 60
------------ ------------ ------------
Total income tax (benefit) expense $ (946) $ 180 $ 196
============ ============ ============
</Table>
As of December 31, 2008, the Company has a net operating loss carryforward
of approximately $593 million, which will be available to offset future taxable
income. This carryforward will expire at the end of 2023.
The Company received an income tax refund of $118 million in 2008. The
Company paid income taxes of $68 million and $317 million in 2007 and 2006,
respectively. The Company had a current income tax receivable of $529 million
and $6 million at December 31, 2008 and 2007, 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>
2008 2007 2006
------------ ------------ -----------
Statutory federal income tax rate - (benefit) expense (35.0) % 35.0 % 35.0 %
Dividends received deduction (0.5) (2.7) (2.7)
Tax credits (0.2) (2.3) (0.5)
Other (0.2) 0.4 (0.5)
------------ ------------ -----------
Effective income tax rate - (benefit) expense (35.9) % 30.4 % 31.3 %
============ ============ ===========
</Table>
129
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. CAPITAL STRUCTURE
DEBT OUTSTANDING
All of the Company's outstanding debt as of December 31, 2008 and 2007
relates to intercompany obligations. These obligations reflect surplus notes due
to related parties and are discussed in Note 5 to the consolidated financial
statements. The Company paid $13 million, $21 million and $13 million of
interest on debt in 2008, 2007 and 2006, 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 differ from GAAP primarily 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 certain investments and establishing deferred
taxes on a different basis.
Statutory net (loss) income of ALIC and its insurance subsidiaries for
2008, 2007 and 2006 was $(1.98) billion, $172 million and $252 million,
respectively. Statutory capital and surplus was $3.25 billion and $2.62 billion
as of December 31, 2008 and 2007, respectively.
The commissioner of the Illinois Division of Insurance has permitted ALIC
to record its market value adjusted annuity assets and liabilities at book value
pursuant to the Illinois Insurance Code which provides an alternative from
market value accounting with approval of the commissioner. This accounting
practice would have increased statutory capital and surplus by $394 million as
of October 1, 2008. On a pro-forma basis, this accounting practice increased
statutory capital and surplus by $1.24 billion at December 31, 2008 over what it
would have been had the permitted practice not been allowed. The increase from
October 1, 2008 was primarily the result of decreases in the fair value of the
investments, while the reserve balances were comparable.
The commissioner of the Illinois Division of Insurance has permitted ALIC
to admit deferred tax assets that are expected to be realized within three years
of the balance sheet date limited to 15% of statutory capital and surplus,
instead of deferred tax assets that are expected to be realized within one year
of the balance sheet date limited to 10% of statutory capital and surplus. This
accounting practice increased statutory capital and surplus by $140 million at
December 31, 2008 over what it would have been had the permitted practice not
been allowed. Admitted statutory-basis deferred tax assets totaled $421 million
or 52% of the gross deferred tax assets before non-admission limitations.
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. The amount of dividends is
further limited to the amount of unassigned funds, which is the portion of
statutory capital and surplus out of which dividends can be paid. Notification
and approval of intercompany lending activities is also required by the Illinois
Division 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 no dividends in 2008 and paid dividends of $725 million in 2007.
The 2007 dividends were in excess of the $336 million that was allowed under
Illinois insurance law based on the 2006 formula amount. ALIC received approval
from the IL DOI for the portion of the 2007 dividends in excess of this amount.
Based on ALIC's statutory capital and surplus, the maximum amount of dividends
ALIC will be able to pay without prior IL DOI
130
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
approval at a given point in time during 2009 is $325 million, less dividends
paid during the preceding twelve months measured at that point in time. This
value is further limited by the amount of unassigned funds at that point in
time. As of December 31, 2008, ALIC's unassigned funds was $136 million.
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 2008, 2007
and 2006 was $16 million, $24 million and $37 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 $4 million, $6 million and $7 million for postretirement benefits
other than pension plans in 2008, 2007 and 2006, respectively.
ALLSTATE 401(k) SAVINGS PLAN
Employees of AIC are eligible to become members of the Allstate 401(k)
Savings Plan. The Corporation's contributions are based on the Corporation's
matching obligation and certain performance measures. The Company's allocation
of profit sharing expense from the Corporation was $6 million, $12 million and
$13 million in 2008, 2007 and 2006, respectively.
16. OTHER COMPREHENSIVE LOSS
The components of other comprehensive loss on a pre-tax and after-tax basis
for the years ended December 31 are as follows:
<Table>
<Caption>
($ IN MILLIONS) 2008 2007 2006
---------------------------------- ------------------------------- -------------------------------
PRE- AFTER- PRE- AFTER- PRE- AFTER-
TAX TAX TAX TAX TAX TAX TAX TAX TAX
-------- -------- -------- -------- -------- -------- -------- -------- --------
Unrealized net
holding losses
arising during
the period, net
of related offsets $ (5,525) $ 1,925 $ (3,600) $ (492) $ 172 $ (320) $ (493) $ 172 $ (321)
Less: reclassification
adjustment of
realized capital
gains and losses (2,072) 725 (1,347) 137 (48) 89 (89) 31 (58)
-------- -------- -------- -------- -------- -------- -------- -------- --------
Unrealized net capital
gains and losses (3,453) 1,200 (2,253) (629) 220 (409) (404) 141 (263)
-------- -------- -------- -------- -------- -------- -------- -------- --------
Other comprehensive loss $ (3,453) $ 1,200 $ (2,253) $ (629) $ 220 $ (409) $ (404) $ 141 $ (263)
======== ======== ======== ======== ======== ======== ======== ======== ========
</Table>
131
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. QUARTERLY RESULTS (UNAUDITED)
<Table>
<Caption>
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
-------------------- -------------------- -------------------- --------------------
($ IN MILLIONS) 2008 2007 2008 2007 2008 2007 2008 2007
-------- -------- -------- -------- -------- -------- -------- --------
Revenues $ 916 $ 1,435 $ 362 $ 1,509 $ 710 $ 1,274 $ 176 $ 1,234
Net (loss) income (115) 149 (368) 187 (184) 56 (1,023) 20
</Table>
132
<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, 2008 and 2007, 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, 2008. 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, 2008 and 2007, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2008, 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 17, 2009
133
<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 15d-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, 2008 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, 2008.
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, 2008, 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.
134
<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, 2008 and 2007.
<Table>
<Caption>
2008 2007 (d)
--------------- ----------------
Audit fees (a) $ 3,429,870 $ 3,577,888
Audit related fees (b) 291,806 87,353
All other fees (c) 40,000 45,870
--------------- ----------------
TOTAL FEES $ 3,761,676 $ 3,711,111
=============== ================
</Table>
(a) Fees for audits of annual financial statements, 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 primarily to professional services such as
accounting consultations relating to new accounting standards.
<Table>
<Caption>
2008 2007
-------------- --------------
Adoption of new accounting standards $ 152,132 $ 57,353
Investment related research 65,236 --
Other 74,438 30,000
-------------- --------------
AUDIT RELATED FEES $ 291,806 $ 87,353
============== ==============
</Table>
(c) All other fees relate to benchmarking studies and coordination of work
for departments of insurance exams.
(d) Total fees for 2007 have been adjusted to add an additional $314,798
of fees and to reclassify certain fees to conform to the current year
presentation. The $314,798 is primarily comprised of audit fees not
charged until 2008.
(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 Registered Public
Accountant's 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 2007 and 2008
were approved by The Allstate Corporation and Allstate Life Audit Committees.
135
<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
Schedule V - Valuation Allowances and Qualifying Accounts S-3
</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
March 15, 2007. Incorporated herein by reference to Exhibit 3(ii) to Allstate
Life Insurance Company's Current Report on Form 8-K filed March 20, 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. Incorporated herein by reference to Exhibit 10.1 to Allstate
Life Insurance Company's Annual Report on Form 10-K for 2007.
10.2 Letter Agreement between Allstate Insurance Company, The Allstate Corporation
and certain affiliates, including Allstate Life Insurance Company, effective
December 1, 2007. Incorporated herein by reference to Exhibit 10.1 to Allstate
Life Insurance Company's Current Report on Form 8-K filed May 23, 2008.
</Table>
136
<Page>
<Table>
10.3 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, 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.
10.4 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.
10.5 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.
10.6 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.
10.7 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.
10.8 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.
10.9 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.
10.10 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.
10.11 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.
10.12 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.
10.13 Form of Investment Management Agreement among Allstate Investments, LLC,
Allstate Insurance Company, The Allstate Corporation and certain affiliates
effective January 1, 2007. Incorporated herein by reference to Exhibit 10.12
to Allstate Life Insurance Company's Annual Report on Form 10-K for 2003.
</Table>
137
<Page>
<Table>
10.14 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.
10.15 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.
10.16 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.
10.17 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.
10.18 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.
10.19 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.
10.20 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. Incorporated herein by
reference to Exhibit 10.19 to Allstate Life Insurance Company's Annual Report
on Form 10-K for 2007.
10.21 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.
Incorporated herein by reference to Exhibit 10.20 to Allstate Life Insurance
Company's Annual Report on Form 10-K for 2007.
10.22 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. Incorporated herein be reference to
Exhibit 10.21 to Allstate Life Insurance Company's Annual Report on Form 10-K
for 2007.
10.23 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.
Incorporated herein by reference to Exhibit 10.22 to Allstate Life Insurance
Company's Annual Report on Form 10-K for 2007.
10.24 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.
</Table>
138
<Page>
<Table>
10.25 Form of Tax Sharing Agreement among The Allstate Corporation and certain
affiliates dated as of November 12, 1996. Incorporated herein by reference to
Exhibit 10.24 to Allstate Life Insurance Company's Annual Report on Form 10-K
for 2007.
10.26 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.
10.27 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.
10.28 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.
10.29 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.
10.30 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.
10.31 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.
10.32 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.
10.33 Credit Agreement dated May 8, 2007, among The Allstate Corporation, Allstate
Insurance Company and Allstate Life Insurance Company, as Borrowers; the
Lenders party thereto, Wells Fargo Bank, National Association, as Syndication
Agent; Bank of America, N.A. and Citibank, N.A., as Documentation Agents;
Barclays Bank, PLC, 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)
10.34 Amendment No. 1 to Credit Agreement dated as of May 22, 2008. Incorporated
herein by reference to Exhibit 10.1 to Allstate Life Insurance Company's
Current Report on Form 8-K filed May 27, 2008.
10.35 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.
</Table>
139
<Page>
<Table>
10.36 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.
10.37 Amendment to Reinsurance Agreement effective December 1, 2007, between
American Heritage Life Insurance Company and Allstate Life Insurance Company.
Incorporated herein by reference to Exhibit 10.1 to Allstate Life Insurance
Company's Current Report on Form 8-K filed January 30, 2008.
10.38 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.
10.39 Amended and Restated Intercompany Liquidity Agreement between Allstate
Insurance Company, Allstate Life Insurance Company and The Allstate
Corporation effective as of May 8, 2008. Incorporated herein by reference to
Exhibit 10.2 to Allstate Life Insurance Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 2008.
10.40 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.
10.41 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. Incorporated herein by reference to
Exhibit 10.39 to Allstate Life Insurance Company's Annual Report on Form 10-K
for 2007.
10.42 Limited Servicing Agreement between Allstate Life Insurance Company, Allstate
Distributors, L.L.C. and Allstate Financial Services, LLC effective October 1,
2002. Incorporated herein by reference to Exhibit 10.40 to Allstate Life
Insurance Company's Annual Report on Form 10-K for 2007.
10.43 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. Incorporated herein by
reference to Exhibit 10.41 to Allstate Life Insurance Company's Annual Report
on Form 10-K for 2007.
10.44 Investment Sub-Advisory Agreement between Allstate Institutional Advisors, LLC
and Allstate Investment Management Company effective as of March 30, 2008.
Incorporated herein by reference to Exhibit 10.1 to Allstate Life Insurance
Company's Current Report on Form 8-K filed April 24, 2008.
10.45 Sale Agreement between Allstate Insurance Company and Allstate Life Insurance
Company effective September 10, 2008 for those securities listed on attached
Exhibit A. Incorporated herein by reference to Exhibit 10.1 to Allstate Life
Insurance Company's Current Report on Form 8-K filed September 16, 2008.
10.46 Sale Agreement between Allstate Insurance Company and Allstate Life Insurance
Company effective September 10, 2008 for those mortgages listed on attached
Exhibit A. Incorporated herein by reference to Exhibit 10.2 to Allstate Life
Insurance Company's Current Report on Form 8-K filed September 16, 2008.
</Table>
140
<Page>
<Table>
10.47 Reinsurance Agreement effective October 1, 2008 between American Heritage Life
Insurance Company and Allstate Life Insurance Company. Incorporated herein by
reference to Exhibit 10.1 to Allstate Life Insurance Company's Current Report
on Form 8-K filed October 28, 2008.
10.48 Surplus Note between Allstate Life Insurance Company and Allstate Insurance
Company dated November 17, 2008. Incorporated herein by reference to Exhibit
10.1 to Allstate Life Insurance Company's Current Report on Form 8-K filed
November 18, 2008.
10.49 Investment Management Agreement between Allstate Investments, LLC and ALIC
Reinsurance Company effective as of March 31, 2008. Incorporated herein by
reference to Exhibit 10.1 to Allstate Life Insurance Company's Current Report
on Form 8-K filed December 23, 2008.
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 Registered
Public Accountant's Services effective February 23, 2009.
</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.
141
<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 18, 2009 /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/ GEORGE E. RUEBENSON President, Chief Executive Officer March 18, 2009
- ------------------------------- and a Director (Principal Executive Officer)
George E. Ruebenson
/s/ JOHN C. PINTOZZI Senior Vice President, Chief Financial March 18, 2009
- ------------------------------- Officer and a Director (Principal Financial Officer)
John C. Pintozzi
Chairman of the Board and a Director March 18, 2009
- -------------------------------
Thomas J. Wilson
/s/ FREDERICK F. CRIPE Executive Vice President and a Director March 18, 2009
- -------------------------------
Frederick F. Cripe
/s/ DAVID A. BIRD Director March 18, 2009
- -------------------------------
David A. Bird
/s/ MICHAEL B. BOYLE Director March 18, 2009
- -------------------------------
Michael B. Boyle
/s/ DON CIVGIN Director March 18, 2009
- -------------------------------
Don Civgin
/s/ JUDITH P. GREFFIN Director March 18, 2009
- -------------------------------
Judith P. Greffin
/s/ SUSAN L. LEES Director March 18, 2009
- -------------------------------
Susan L. Lees
/s/ JOHN C. LOUNDS Director March 18, 2009
- -------------------------------
John C. Lounds
/s/ KEVIN R. SLAWIN Director March 18, 2009
- -------------------------------
Kevin R. Slawin
/s/ DOUGLAS B. WELCH Director March 18, 2009
- -------------------------------
Douglas B. Welch
</Table>
142
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE I--SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2008
<Table>
<Caption>
AMOUNT AT
WHICH
COST/ SHOWN IN THE
AMORTIZED BALANCE
($ IN MILLIONS) COST FAIR VALUE SHEET
---------------- --------------- ---------------
TYPE OF INVESTMENT
Fixed Maturities:
Bonds:
United States government, government agencies and authorities $ 2,792 $ 3,687 $ 3,687
States, municipalities and political subdivisions 3,976 3,308 3,308
Foreign governments 1,652 2,100 2,100
Public utilities 5,070 4,784 4,784
Convertibles and bonds with warrants attached 957 973 973
All other corporate bonds 21,390 18,513 18,513
Asset-backed securities 4,649 2,623 2,623
Mortgage-backed securities 2,923 2,719 2,719
Commercial mortgage-backed securities 5,712 3,730 3,730
Redeemable preferred stocks 15 9 9
---------------- --------------- --------------
Total fixed maturities 49,136 $ 42,446 42,446
---------------- =============== --------------
Equity Securities:
Common Stocks:
Public utilities 1 $ 1 1
Banks, trusts and insurance companies 36 19 19
Industrial, miscellaneous and all other 24 22 22
Non-redeemable preferred stocks 45 40 40
---------------- --------------- --------------
Total equity securities 106 $ 82 82
---------------- =============== --------------
Mortgage loans on real estate 10,012 $ 8,700 10,012
===============
Policy loans 813 813
Derivative instruments 134 $ 138 138
===============
Limited partnership interests 1,187 1,187
Short-term investments 3,855 $ 3,858 3,858
===============
Other long-term investments 1,236 1,236
---------------- --------------
Total investments $ 66,479 $ 59,772
================ ==============
</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, 2008
Life insurance in force $ 505,372 $ 249,644 $ 22,853 $ 278,581 8.2%
Premiums and contract charges:
Life and annuities $ 2,096 $ 733 $ 48 $ 1,411 3.4%
Accident and health 179 141 47 85 55.3%
----------- ----------- ----------- -----------
Total premiums and contract charges $ 2,275 $ 874 $ 95 $ 1,496 6.4%
=========== =========== =========== ===========
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%
=========== =========== =========== ===========
</Table>
(1) No reinsurance or coinsurance income was netted against premium ceded in
2008, 2007 or 2006.
S-2
<Page>
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE V--VALUATION ALLOWANCES AND QUALIFYING ACCOUNTS
<Table>
<Caption>
ADDITIONS
-----------------------
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
($ IN MILLIONS) OF PERIOD EXPENSES ADDITIONS DEDUCTIONS PERIOD
--------- -------- --------- ---------- ------
YEAR ENDED DECEMBER 31, 2008
Allowance for deferred tax assets $-- $-- $ 9 $-- $ 9
Allowance for estimated losses on mortgage loans -- 3 -- -- 3
YEAR ENDED DECEMBER 31, 2007
Allowance for deferred tax assets $-- $-- $-- $-- $--
Allowance for estimated losses on mortgage loans -- -- -- -- --
YEAR ENDED DECEMBER 31, 2006
Allowance for deferred tax assets $-- $-- $-- $-- $--
Allowance for estimated losses on mortgage loans -- -- -- -- --
</Table>
S-3