10-Q 1 a18-39458_110q.htm 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

The registrant meets the conditions set forth in General Instructions H (1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format.

 

[X]          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2018

 

OR

 

[  ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to                 

 

Commission file number 0-31248

 

ALLSTATE LIFE INSURANCE COMPANY

(Exact name of registrant as specified in its charter)

 

 

Illinois

36-2554642

 

 

(State or other jurisdiction of

(I.R.S. Employer

 

 

incorporation or organization)

Identification No.)

 

 

3075 Sanders Road, Northbrook, Illinois 60062

(Address of principal executive offices)      (Zip Code)

 

(847) 402-5000

(Registrant’s telephone number, including area code)

 

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 whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

 

Yes   X             No ___

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ____

 

Accelerated filer                 ____  

 

 

Non-accelerated filer    X    

Smaller reporting company ____

 

 

 

Emerging growth company  ____

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ____

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ___           No   X  

 

As of November 5, 2018, the registrant had 23,800 common shares, $227 par value, outstanding, all of which are held by Allstate Insurance Company.

 


 

ALLSTATE LIFE INSURANCE COMPANY

INDEX TO QUARTERLY REPORT ON FORM 10-Q

September 30, 2018

 

PART I

FINANCIAL INFORMATION

PAGE

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income for the Three Month and Nine Month Periods Ended September 30, 2018 and 2017 (unaudited)

1

 

 

 

 

Condensed Consolidated Statements of Financial Position as of September 30, 2018 (unaudited) and December 31, 2017

2

 

 

 

 

Condensed Consolidated Statements of Shareholder’s Equity for the Nine Month Periods Ended September 30, 2018 and 2017 (unaudited)

3

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Month Periods Ended September 30, 2018 and 2017 (unaudited)

4

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

5

 

 

 

 

Report of Independent Registered Public Accounting Firm

35

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

 

Highlights

36

 

Operations

37

 

Investments

42

 

Capital Resources and Liquidity

49

 

Forward-Looking Statements

51

 

 

 

Item 4.

Controls and Procedures

52

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

53

 

 

 

Item 1A.

Risk Factors

53

 

 

 

Item 6.

Exhibits

53

 


 

PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2018

 

2017

 

2018

 

2017

 

 

(unaudited)

 

(unaudited)

Revenues

 

 

 

 

 

 

 

 

Premiums

 

$

174

 

$

172

 

$

526

 

$

511

Contract charges

 

170

 

174

 

519

 

530

Other revenue

 

10

 

9

 

26

 

30

Net investment income

 

385

 

439

 

1,211

 

1,316

Realized capital gains and losses:

 

 

 

 

 

 

 

 

Total other-than-temporary impairment (“OTTI”) losses

 

(3)

 

(4)

 

(5)

 

(45)

OTTI losses reclassified from other comprehensive income (“OCI”)

 

(1)

 

(2)

 

(2)

 

2

Net OTTI losses recognized in earnings

 

(4)

 

(6)

 

(7)

 

(43)

Sales and valuation changes on equity investments and derivatives

 

52

 

25

 

31

 

57

Total realized capital gains and losses

 

48

 

19

 

24

 

14

 

 

787

 

813

 

2,306

 

2,401

Costs and expenses

 

 

 

 

 

 

 

 

Contract benefits

 

362

 

331

 

1,089

 

1,049

Interest credited to contractholder funds

 

150

 

161

 

450

 

483

Amortization of deferred policy acquisition costs

 

39

 

32

 

117

 

116

Operating costs and expenses

 

63

 

78

 

199

 

236

Restructuring and related charges

 

 

1

 

2

 

1

Interest expense

 

1

 

1

 

3

 

4

 

 

615

 

604

 

1,860

 

1,889

 

 

 

 

 

 

 

 

 

Gain on disposition of operations

 

1

 

1

 

4

 

5

 

 

 

 

 

 

 

 

 

Income from operations before income tax expense

 

173

 

210

 

450

 

517

 

 

 

 

 

 

 

 

 

Income tax (benefit) expense

 

(20)

 

70

 

33

 

171

 

 

 

 

 

 

 

 

 

Net income

 

193

 

140

 

417

 

346

 

 

 

 

 

 

 

 

 

Other comprehensive (loss) income, after-tax

 

 

 

 

 

 

 

 

Change in unrealized net capital gains and losses

 

(44)

 

45

 

(280)

 

228

Change in unrealized foreign currency translation adjustments

 

(9)

 

8

 

 

5

Other comprehensive (loss) income, after-tax

 

(53)

 

53

 

(280)

 

233

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

140

 

$

193

 

$

137

 

$

579

 

See notes to condensed consolidated financial statements.

 

1


 

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

 

($ in millions, except par value data)

 

September 30,
2018

 

December 31,
2017

Assets

 

(unaudited)

 

 

Investments

 

 

 

 

Fixed income securities, at fair value (amortized cost $21,291 and $22,004)

 

$

21,752

 

$

23,261

Mortgage loans

 

3,923

 

3,876

Equity securities, at fair value (cost $1,193 and $1,306)

 

1,483

 

1,614

Limited partnership interests

 

3,394

 

3,147

Short-term, at fair value (amortized cost $926 and $725)

 

926

 

725

Policy loans

 

564

 

561

Other

 

1,343

 

1,254

Total investments

 

33,385

 

34,438

Cash

 

71

 

145

Deferred policy acquisition costs

 

1,220

 

1,156

Reinsurance recoverables from non-affiliates

 

2,165

 

2,243

Reinsurance recoverables from affiliates

 

424

 

437

Accrued investment income

 

263

 

263

Other assets

 

476

 

501

Separate Accounts

 

3,282

 

3,422

Total assets

 

$

41,286

 

$

42,605

Liabilities

 

 

 

 

Contractholder funds

 

$

17,759

 

$

18,592

Reserve for life-contingent contract benefits

 

11,255

 

11,625

Unearned premiums

 

4

 

4

Payable to affiliates, net

 

35

 

55

Other liabilities and accrued expenses

 

1,088

 

1,076

Deferred income taxes

 

755

 

836

Notes due to related parties

 

140

 

140

Separate Accounts

 

3,282

 

3,422

Total liabilities

 

34,318

 

35,750

Commitments and Contingent Liabilities (Note 7)

 

 

 

 

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

 

2,024

 

2,024

Retained income

 

4,612

 

3,981

Accumulated other comprehensive income:

 

 

 

 

Unrealized net capital gains and losses:

 

 

 

 

Unrealized net capital gains and losses on fixed income securities with OTTI

 

50

 

47

Other unrealized net capital gains and losses

 

315

 

1,186

Unrealized adjustment to DAC, DSI and insurance reserves

 

(48)

 

(398)

Total unrealized net capital gains and losses

 

317

 

835

Unrealized foreign currency translation adjustments

 

10

 

10

Total accumulated other comprehensive income (“AOCI”)

 

327

 

845

Total shareholder’s equity

 

6,968

 

6,855

Total liabilities and shareholder’s equity

 

$

41,286

 

$

42,605

 

See notes to condensed consolidated financial statements.

 

2


 

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDER’S EQUITY

 

($ in millions)

 

Nine months ended
September 30,

 

 

2018

 

2017

 

 

(unaudited)

Common stock

 

$

5

 

$

5

 

 

 

 

 

Additional capital paid-in

 

 

 

 

Balance, beginning of period

 

2,024

 

1,990

Gain on reinsurance with an affiliate

 

 

34

Balance, end of period

 

2,024

 

2,024

 

 

 

 

 

Retained income

 

 

 

 

Balance, beginning of period

 

3,981

 

3,736

Cumulative effect of change in accounting principle

 

314

 

Net income

 

417

 

346

Dividends

 

(100)

 

(500)

Balance, end of period

 

4,612

 

3,582

 

 

 

 

 

Accumulated other comprehensive income

 

 

 

 

Balance, beginning of period

 

845

 

678

Cumulative effect of change in accounting principle

 

(238)

 

Change in unrealized net capital gains and losses

 

(280)

 

228

Change in unrealized foreign currency translation adjustments

 

 

5

Balance, end of period

 

327

 

911

 

 

 

 

 

Total shareholder’s equity

 

$

6,968

 

$

6,522

 

See notes to condensed consolidated financial statements.

 

3


 

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

($ in millions)

 

Nine months ended
September 30,

 

 

2018

 

2017

Cash flows from operating activities

 

 

(unaudited)

Net income

 

$

417

 

$

346

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

Amortization and other non-cash items

 

(44)

 

(49)

Realized capital gains and losses

 

(24)

 

(14)

Gain on disposition of operations

 

(4)

 

(5)

Interest credited to contractholder funds

 

450

 

483

Changes in:

 

 

 

 

Policy benefits and other insurance reserves

 

(472)

 

(425)

Deferred policy acquisition costs

 

55

 

27

Reinsurance recoverables, net

 

51

 

45

Income taxes

 

(51)

 

156

Other operating assets and liabilities

 

69

 

(185)

Net cash provided by operating activities

 

447

 

379

Cash flows from investing activities

 

 

 

 

Proceeds from sales

 

 

 

 

Fixed income securities

 

4,057

 

3,319

Equity securities

 

1,114

 

1,062

Limited partnership interests

 

223

 

347

Other investments

 

16

 

7

Investment collections

 

 

 

 

Fixed income securities

 

1,077

 

1,226

Mortgage loans

 

349

 

450

Other investments

 

137

 

140

Investment purchases

 

 

 

 

Fixed income securities

 

(4,470)

 

(3,529)

Equity securities

 

(919)

 

(1,028)

Limited partnership interests

 

(426)

 

(479)

Mortgage loans

 

(395)

 

(246)

Other investments

 

(201)

 

(162)

Change in short-term investments, net

 

(124)

 

(79)

Change in policy loans and other investments, net

 

(46)

 

(32)

Net cash provided by investing activities

 

392

 

996

Cash flows from financing activities

 

 

 

 

 

Contractholder fund deposits

 

577

 

605

Contractholder fund withdrawals

 

(1,418)

 

(1,362)

Dividends paid

 

(100)

 

(500)

Other

 

28

 

(14)

Net cash used in financing activities

 

(913)

 

(1,271)

Net (decrease) increase in cash

 

(74)

 

104

Cash at beginning of period

 

145

 

138

Cash at end of period

 

$

71

 

$

242

 

See notes to condensed consolidated financial statements.

 

4


 

ALLSTATE LIFE INSURANCE COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.  General

 

Basis of presentation

 

The accompanying condensed 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 condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).

 

The condensed consolidated financial statements and notes as of September 30, 2018 and for the three month and nine month periods ended September 30, 2018 and 2017 are unaudited.  The condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring accruals) which are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods.  These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2017.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.  All significant intercompany accounts and transactions have been eliminated.

 

Reinsurance transaction

 

Effective January 1, 2017, ALIC entered into a coinsurance reinsurance agreement with Allstate Assurance Company to assume certain term life insurance policies.  The agreement covered policies issued from January 1, 2015 through December 31, 2017.  In connection with the agreement, the Company recorded cash of $20 million, deferred policy acquisition costs (“DAC”) of $45 million, other assets of $11 million, reserve for life-contingent contract benefits of $24 million and deferred tax liabilities of $18 million.  The $34 million gain on the transaction was recorded as an increase to additional capital paid-in since the transaction was between entities under common control.

 

Dividends

 

The Company paid cash dividends of $100 million to AIC in third quarter 2018.

 

Premiums and contract charges

 

The following table summarizes premiums and contract charges by product.

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2018

 

2017

 

2018

 

2017

Premiums

 

 

 

 

 

 

 

 

Traditional life insurance

 

$

143

 

$

143

 

$

435

 

$

429

Accident and health insurance

 

31

 

29

 

91

 

82

Total premiums

 

174

 

172

 

526

 

511

 

 

 

 

 

 

 

 

 

Contract charges

 

 

 

 

 

 

 

 

Interest-sensitive life insurance

 

165

 

170

 

508

 

520

Fixed annuities

 

5

 

4

 

11

 

10

Total contract charges

 

170

 

174

 

519

 

530

Total premiums and contract charges

 

$

344

 

$

346

 

$

1,045

 

$

1,041

 

Adopted accounting standard

 

Recognition and Measurement of Financial Assets and Financial Liabilities

 

Effective January 1, 2018, the Company adopted new Financial Accounting Standards Board (“FASB”) guidance requiring equity investments, including equity securities and limited partnership interests not accounted for under the equity method of accounting or that do not result in consolidation to be measured at fair value with changes in fair value recognized in net income.  The guidance clarifies that an entity should evaluate the realizability of deferred tax assets related to available-for-sale fixed income securities in combination with the entity’s other deferred tax assets.  The Company’s adoption of the new FASB guidance included adoption of the relevant elements of Technical Corrections and Improvements to Financial Instruments, issued in February 2018.

 

Upon adoption of the new guidance on January 1, 2018, $308 million of pre-tax unrealized net capital gains for equity securities were reclassified from AOCI to retained income. The after-tax change in accounting for equity securities did not affect the

 

5


 

Company’s total shareholder’s equity and the unrealized net capital gains of $238 million reclassified to retained income will never be recognized in net income.

 

Upon adoption of the new guidance on January 1, 2018, the carrying value of cost method limited partnership interests increased $95 million, pre-tax, to fair value.  The after-tax cumulative-effect increase in retained income of $76 million increased the Company’s shareholder’s equity but will never be recognized in net income.

 

Changes to significant accounting policies

 

Investments

 

Changes were made to the Company’s Significant Accounting Policies upon adoption of new FASB guidance related to the recognition and measurement of financial assets.  Equity securities primarily include common stocks, exchange traded and mutual funds, non-redeemable preferred stocks and real estate investment trust equity investments.  Equity securities are carried at fair value.  The periodic change in fair value of equity securities is recognized within realized capital gains and losses on the Condensed Consolidated Statements of Operations and Comprehensive Income effective January 1, 2018.

 

Investments in limited partnership interests include interests in private equity funds, real estate funds and other funds.  Where the Company’s interest is so minor that it exercises virtually no influence over operating and financial policies, investments in limited partnership interests purchased prior to January 1, 2018 are accounted for at fair value primarily utilizing the net asset value (“NAV”) as a practical expedient to determine fair value.  All other investments in limited partnership interests, including those purchased subsequent to January 1, 2018, are accounted for in accordance with the equity method of accounting (“EMA”).

 

Investment income from limited partnership interests carried at fair value is recognized based upon the changes in fair value of the investee’s equity primarily determined using NAV.  Income from EMA limited partnership interests is recognized based on the Company’s share of the partnerships’ earnings.  Income from EMA limited partnership interests is generally recognized on a three month delay due to the availability of the related financial statements from investees.

 

Tax Reform

 

On December 22, 2017, Public Law 115-97, known as the Tax Cuts and Jobs Act of 2017 (“Tax Legislation”) became effective, permanently reducing the U.S. corporate income tax rate from 35% to 21% beginning January 1, 2018.  As a result, the corporate tax rate is not comparable between periods.

 

During 2017, the Company revalued its deferred tax assets and liabilities and recorded liabilities related to the transition to the modified territorial system for international taxation.  The impact of the Tax Legislation was adjusted from the Company’s preliminary estimate due to, among other things, changes in interpretations and assumptions the Company previously made, guidance that was issued and actions the Company took as a result of the Tax Legislation.  During the third quarter of 2018, the Company recorded a reduction of $53 million to income tax expense related to these provisional amounts.  The Company may make adjustments to these provisional amounts as additional information becomes available and future guidance is issued by the Internal Revenue Service.

 

Pending accounting standards

 

Measurement of Credit Losses on Financial Instruments

 

In June 2016, the FASB issued guidance which revises the credit loss recognition criteria for certain financial assets measured at amortized cost, including reinsurance recoverables.  The new guidance replaces the existing incurred loss recognition model with an expected loss recognition model.  The objective of the expected credit loss model is for the reporting entity to recognize its estimate of expected credit losses for affected financial assets in a valuation allowance deducted from the amortized cost basis of the related financial assets that results in presenting the net carrying value of the financial assets at the amount expected to be collected.  The reporting entity must consider all relevant information available when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts over the life of an asset.  Financial assets may be evaluated individually or on a pooled basis when they share similar risk characteristics.  The measurement of credit losses for available-for-sale debt securities measured at fair value is not affected except that credit losses recognized are limited to the amount by which fair value is below amortized cost and the carrying value adjustment is recognized through a valuation allowance and not as a direct write-down.  The guidance is effective for reporting periods beginning after December 15, 2019, and for most affected instruments must be adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to beginning retained income.  The Company is in the process of evaluating the impact of adoption.

 

Accounting for Hedging Activities

 

In August 2017, the FASB issued amendments intended to better align hedge accounting with an organization’s risk management activities.  The amendments expand hedge accounting for nonfinancial and financial risk components and revise the measurement methodologies to better align with an organization’s risk management activities.  Separate presentation of hedge ineffectiveness is eliminated to provide greater transparency of the full impact of hedging by requiring presentation of the results

 

6


 

of the hedged item and hedging instrument in a single financial statement line item.  In addition, the amendments are designed to reduce complexity by simplifying the manner in which assessments of hedge effectiveness may be performed.  The guidance is effective for reporting periods beginning after December 15, 2018.  The presentation and disclosure guidance is effective on a prospective basis.  The impact of adoption is not expected to be material to the Company’s results of operations or financial position.

 

Accounting for Long-Duration Insurance Contracts

 

In August 2018, the FASB issued guidance revising the accounting for certain long-duration insurance contracts.  The new guidance changes the measurement of the Company’s reserves for traditional life, life-contingent immediate annuities and certain voluntary accident and health insurance products.  Under the new guidance, measurement assumptions, including those for mortality, morbidity and policy terminations, will be required to be reviewed and updated at least annually.  The effect of updating measurement assumptions other than the discount rate are required to be determined on a retrospective basis and reported in net income.  In addition, cash flows under the new guidance are required to be discounted using an upper-medium grade fixed income instrument yield that is updated through OCI at each reporting date.  These changes will replace current GAAP, which utilizes assumptions set at policy issuance until such time as the assumptions result in reserves that are deficient when compared to reserves computed using current assumptions.  When this occurs under current GAAP, premium deficiency reserves are recognized by unlocking reserve assumptions to eliminate a reserve deficiency.

 

The new guidance requires DAC and other capitalized balances currently amortized in proportion to premiums or gross profits to be amortized on a constant level basis over the expected term for all long-duration insurance contracts.  DAC will not be subject to loss recognition testing but rather will be reduced when actual experience exceeds expected experience (i.e. as a result of unexpected contract terminations).  The new guidance will no longer require adjustments to DAC and deferred sales inducement costs (“DSI”) related to unrealized gains and losses.

 

Market risk benefit product features are required to be measured at fair value with changes in fair value recorded in net income with the exception of changes in the fair value attributable to a change in the instrument’s credit risk, which are required to be recognized in OCI.  Substantially all of the Company’s market risk benefits are reinsured and therefore these impacts are not expected to be material to the Company.

 

The guidance is to be included in the comparable financial statements issued in reporting periods beginning after December 15, 2020, thereby requiring restatement of prior periods presented.  Early adoption is permitted.  The new guidance will be applied to affected contracts and DAC on the basis of existing carrying amounts at the earliest period presented or the new guidance may be applied retrospectively using actual historical experience as of contract inception.  The guidance for market risk benefits is required to be adopted retrospectively.

 

The Company is evaluating the anticipated impacts of applying the new guidance to both retained income and AOCI.  While the requirements of the new guidance represent a material change from existing GAAP, the underlying economics of the business and related cash flows are unchanged.  The Company has not completed an evaluation of the specific impacts of adopting the new guidance, but anticipates the financial statement impact of migrating from existing GAAP to that required by the new guidance to be material, largely attributed to the impact of transitioning from an original investment-based discount rate to one based on an upper-medium grade fixed income investment yield and updates to mortality assumptions that had previously been locked in at issuance.  The Company expects the most significant impacts will occur in the run-off annuity business.  The revised accounting for DAC will be applied prospectively using the new model and any DAC effects existing in AOCI as a result of applying existing GAAP will be reversed.

 

Other revenue presentation

 

The Company revised the presentation of total revenue to include other revenue.  Previously, components of other revenue were presented within operating costs and expenses and primarily represent gross dealer concessions received in connection with Allstate exclusive agencies and exclusive financial specialists sales of non-proprietary products.  Other revenue is recognized when performance obligations are fulfilled.  Prior periods have been reclassified to conform to current separate presentation of other revenue.

 

7


 

2.  Supplemental Cash Flow Information

 

Non-cash investing activities include $38 million and $16 million related to mergers and exchanges completed with equity securities, fixed income securities and limited partnerships, and modifications of certain mortgage loans for the nine months ended September 30, 2018 and 2017, respectively.  Liabilities for collateral received in conjunction with the Company’s securities lending program and over-the-counter (“OTC”) and cleared derivatives are reported in other liabilities and accrued expenses or other investments.  The accompanying cash flows are included in cash flows from operating activities in the Condensed Consolidated Statements of Cash Flows along with the activities resulting from management of the proceeds, which are as follows:

 

($ in millions)

 

Nine months ended
September 30,

 

 

2018

 

2017

Net change in proceeds managed

 

 

 

 

Net change in fixed income securities

 

$

78

 

$

38

Net change in short-term investments

 

(72)

 

(64)

Operating cash flow provided (used)

 

6

 

(26)

Net change in cash

 

 

1

Net change in proceeds managed

 

$

6

 

$

(25)

Net change in liabilities

 

 

 

 

Liabilities for collateral, beginning of period

 

$

(542)

 

$

(550)

Liabilities for collateral, end of period

 

(536)

 

(575)

Operating cash flow (used) provided

 

$

(6)

 

$

25

 

3.  Investments

 

Fair values

 

The amortized cost, gross unrealized gains and losses and fair value for fixed income securities are as follows:

 

($ in millions)

 

Amortized

 

Gross unrealized

 

Fair

 

 

cost

 

Gains

 

Losses

 

value

September 30, 2018

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

592

 

$

24

 

$

(2)

 

$

614

Municipal

 

2,002

 

190

 

(6)

 

2,186

Corporate

 

17,982

 

488

 

(297)

 

18,173

Foreign government

 

169

 

8

 

 

177

Asset-backed securities (“ABS”)

 

324

 

4

 

(3)

 

325

Residential mortgage-backed securities (“RMBS”)

 

166

 

48

 

 

214

Commercial mortgage-backed securities (“CMBS”)

 

43

 

7

 

(1)

 

49

Redeemable preferred stock

 

13

 

1

 

 

14

Total fixed income securities

 

$

21,291

 

$

770

 

$

(309)

 

$

21,752

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

768

 

$

38

 

$

(2)

 

$

804

Municipal

 

2,001

 

275

 

(3)

 

2,273

Corporate

 

18,262

 

960

 

(86)

 

19,136

Foreign government

 

279

 

20

 

 

299

ABS

 

383

 

6

 

(4)

 

385

RMBS

 

205

 

49

 

(1)

 

253

CMBS

 

93

 

6

 

(2)

 

97

Redeemable preferred stock

 

13

 

1

 

 

14

Total fixed income securities

 

$

22,004

 

$

1,355

 

$

(98)

 

$

23,261

 

8


 

Scheduled maturities

 

The scheduled maturities for fixed income securities are as follows as of September 30, 2018:

 

($ in millions)

 

Amortized cost

 

Fair value

Due in one year or less

 

$

1,161

 

$

1,170

Due after one year through five years

 

8,322

 

8,420

Due after five years through ten years

 

7,251

 

7,212

Due after ten years

 

4,024

 

4,362

 

 

20,758

 

21,164

ABS, RMBS and CMBS

 

533

 

588

Total

 

$

21,291

 

$

21,752

 

Actual maturities may differ from those scheduled as a result of calls and make-whole payments by the issuers.  ABS, RMBS and CMBS are shown separately because of the potential for prepayment of principal prior to contractual maturity dates.

 

Net investment income

 

Net investment income is as follows:

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2018

 

2017

 

2018

 

2017

Fixed income securities

 

$

247

 

$

263

 

$

745

 

$

800

Mortgage loans

 

44

 

46

 

141

 

140

Equity securities

 

7

 

9

 

30

 

38

Limited partnership interests (1) (2)

 

74

 

115

 

262

 

315

Short-term investments

 

7

 

3

 

16

 

6

Policy loans

 

8

 

8

 

23

 

23

Other

 

23

 

17

 

68

 

57

Investment income, before expense

 

410

 

461

 

1,285

 

1,379

Investment expense

 

(25)

 

(22)

 

(74)

 

(63)

Net investment income

 

$

385

 

$

439

 

$

1,211

 

$

1,316

_______________

 

(1)          Due to the adoption of the recognition and measurement accounting standard, limited partnerships previously reported using the cost method are now reported at fair value with changes in fair value recognized in net investment income.

 

(2)          Includes net investment income of $39 million and $179 million for EMA limited partnership interests and $35 million and $83 million for limited partnership interests carried at fair value for the three months and nine months ended September 30, 2018, respectively.

 

Realized capital gains and losses

 

Realized capital gains and losses by asset type are as follows:

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2018

 

2017

 

2018

 

2017

Fixed income securities

 

$

(8)

 

$

4

 

$

(26)

 

$

(9)

Mortgage loans

 

 

1

 

2

 

1

Equity securities

 

56

 

7

 

50

 

3

Limited partnership interests

 

(4)

 

11

 

(12)

 

34

Derivatives

 

4

 

(4)

 

11

 

(13)

Other

 

 

 

(1)

 

(2)

Realized capital gains and losses

 

$

48

 

$

19

 

$

24

 

$

14

 

9


 

Realized capital gains and losses by transaction type are as follows:

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2018

 

2017

 

2018

 

2017

Impairment write-downs (1)

 

$

(4)

 

$

(6)

 

$

(7)

 

$

(39)

Change in intent write-downs (1)

 

 

 

 

(4)

Net OTTI losses recognized in earnings

 

(4)

 

(6)

 

(7)

 

(43)

Sales (1)

 

(2)

 

29

 

(14)

 

70

Valuation of equity investments (1)

 

50

 

 

37

 

Valuation and settlements of derivative instruments

 

4

 

(4)

 

8

 

(13)

Realized capital gains and losses

 

$

48

 

$

19

 

$

24

 

$

14

_______________

 

(1)          Due to the adoption of the recognition and measurement accounting standard, equity securities are reported at fair value with changes in fair value recognized in valuation of equity investments and are no longer included in impairment write-downs, change in intent write-downs and sales.

 

Gross gains of $5 million and $22 million and gross losses of $9 million and $8 million were realized on sales of fixed income securities during the three months ended September 30, 2018 and 2017, respectively.  Gross gains of $25 million and $77 million and gross losses of $45 million and $52 million were realized on sales of fixed income and equity securities during the nine months ended September 30, 2018 and 2017, respectively.

 

Valuation changes included in net income for investments still held as of September 30, 2018 are as follows:

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2018

 

2018

Equity securities (1)

 

$

51

 

$

71

Limited partnership interests carried at fair value (1)

 

35

 

84

Total valuation changes

 

$

86

 

$

155

______________

 

(1)          Investments held at the end of a prior quarter that were sold in the current quarter are not included in the year-to-date amounts shown in the table above; therefore, the sum of the quarterly amounts may not equal the year-to-date amount.

 

10


 

OTTI losses by asset type are as follows:

 

($ in millions)

 

Three months ended
September 30, 2018

 

Three months ended
September 30, 2017

 

 

Gross

 

Included
in OCI

 

Net

 

Gross

 

Included
in OCI

 

Net

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

 

$

 

$

 

$

 

$

 

$

 

$

ABS

 

 

(1)

 

(1)

 

(1)

 

 

(1)

RMBS

 

 

 

 

 

 

CMBS

 

(3)

 

 

(3)

 

1

 

(2)

 

(1)

Total fixed income securities

 

(3)

 

(1)

 

(4)

 

 

(2)

 

(2)

Mortgage loans

 

 

 

 

(1)

 

 

(1)

Equity securities (1)

 

 

 

 

(1)

 

 

(1)

Limited partnership interests (1)

 

 

 

 

(2)

 

 

(2)

Other

 

 

 

 

 

 

OTTI losses

 

$

(3)

 

$

(1)

 

$

(4)

 

$

(4)

 

$

(2)

 

$

(6)

 

 

 

Nine months ended
September 30, 2018

 

Nine months ended
September 30, 2017

 

 

Gross

 

Included
in OCI

 

Net

 

Gross

 

Included
in OCI

 

Net

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

 

$

 

$

 

$

 

$

(1)

 

$

 

$

(1)

Corporate

 

 

 

 

(7)

 

3

 

(4)

ABS

 

 

(1)

 

(1)

 

(1)

 

 

(1)

RMBS

 

(1)

 

 

(1)

 

 

(2)

 

(2)

CMBS

 

(3)

 

(1)

 

(4)

 

(8)

 

1

 

(7)

Total fixed income securities

 

(4)

 

(2)

 

(6)

 

(17)

 

2

 

(15)

Mortgage loans

 

 

 

 

(1)

 

 

(1)

Equity securities (1)

 

 

 

 

(16)

 

 

(16)

Limited partnership interests (1)

 

 

 

 

(9)

 

 

(9)

Other

 

(1)

 

 

(1)

 

(2)

 

 

(2)

OTTI losses

 

$

(5)

 

$

(2)

 

$

(7)

 

$

(45)

 

$

2

 

$

(43)

_______________

 

(1)          Due to the adoption of the recognition and measurement accounting standard, equity securities and limited partnerships previously reported using the cost method are now reported at fair value with changes in fair value recognized in net income and are no longer included in the table above.

 

The total amount of OTTI losses included in AOCI at the time of impairment for fixed income securities, which were not included in earnings, are presented in the following table.  The amounts exclude $110 million and $113 million as of September 30, 2018 and December 31, 2017, respectively, of net unrealized gains related to changes in valuation of the fixed income securities subsequent to the impairment measurement date.

 

($ in millions)

 

September 30, 2018

 

December 31, 2017

Municipal

 

$

(4)

 

$

(4)

Corporate

 

 

ABS

 

(6)

 

(8)

RMBS

 

(33)

 

(37)

CMBS

 

(3)

 

(4)

Total

 

$

(46)

 

$

(53)

 

11


 

Rollforwards of the cumulative credit losses recognized in earnings for fixed income securities held as of the end of the period are as follows:

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2018

 

2017

 

2018

 

2017

Beginning balance

 

$

(124)

 

$

(160)

 

$

(138)

 

$

(176)

Additional credit loss for securities previously other-than-temporarily impaired

 

(3)

 

(2)

 

(5)

 

(7)

Additional credit loss for securities not previously other-than-temporarily impaired

 

(1)

 

 

(1)

 

(8)

Reduction in credit loss for securities disposed or collected

 

2

 

13

 

18

 

42

Change in credit loss due to accretion of increase in cash flows

 

1

 

 

1

 

Ending balance

 

$

(125)

 

$

(149)

 

$

(125)

 

$

(149)

 

The Company uses its best estimate of future cash flows expected to be collected from the fixed income security, discounted at the security’s original or current effective rate, as appropriate, to calculate a recovery value and determine whether a credit loss exists.  The determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security.  All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of cash flows expected to be collected.  That information generally includes, but is not limited to, the remaining payment terms of the security, prepayment speeds, foreign exchange rates, the financial condition and future earnings potential of the issue or issuer, expected defaults, expected recoveries, the value of underlying collateral, vintage, geographic concentration of underlying collateral, available reserves or escrows, current subordination levels, third party guarantees and other credit enhancements.  Other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond insurer for insured fixed income securities, and other market data relevant to the realizability of contractual cash flows, may also be considered.  The estimated fair value of collateral will be used to estimate recovery value if the Company determines that the security is dependent on the liquidation of collateral for ultimate settlement.  If the estimated recovery value is less than the amortized cost of the security, a credit loss exists and an OTTI for the difference between the estimated recovery value and amortized cost is recorded in earnings.  The portion of the unrealized loss related to factors other than credit remains classified in AOCI.  If the Company determines that the fixed income security does not have sufficient cash flow or other information to estimate a recovery value for the security, the Company may conclude that the entire decline in fair value is deemed to be credit related and the loss is recorded in earnings.

 

Unrealized net capital gains and losses

 

Unrealized net capital gains and losses included in AOCI are as follows:

 

($ in millions)

 

 

 

Gross unrealized

 

Unrealized net

September 30, 2018

 

Fair value

 

Gains

 

Losses

 

gains (losses)

Fixed income securities

 

$

21,752

 

$

770

 

$

(309)

 

$

461

Short-term investments

 

926

 

 

 

EMA limited partnerships (1)

 

 

 

 

 

 

 

1

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

462

Amounts recognized for:

 

 

 

 

 

 

 

 

Insurance reserves (2)

 

 

 

 

 

 

 

DAC and DSI (3)

 

 

 

 

 

 

 

(61)

Amounts recognized

 

 

 

 

 

 

 

(61)

Deferred income taxes

 

 

 

 

 

 

 

(84)

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$

317

_______________

 

(1)          Unrealized net capital gains and losses for limited partnership interests represent the Company’s share of EMA limited partnerships’ other comprehensive income.  Fair value and gross unrealized gains and losses are not applicable.

 

(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 lower interest rates, resulting in a premium deficiency. This adjustment primarily relates to structured settlement annuities with life contingencies (a type of immediate fixed annuities).

 

(3)          The DAC and DSI adjustment balance 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.

 

12


 

($ in millions)

 

 

 

Gross unrealized

 

Unrealized net

December 31, 2017

 

Fair value

 

Gains

 

Losses

 

gains (losses)

Fixed income securities

 

$

23,261

 

$

1,355

 

$

(98)

 

$

1,257

Equity securities

 

1,614

 

311

 

(3)

 

308

Short-term investments

 

725

 

 

 

Derivative instruments (1)

 

2

 

2

 

 

2

EMA limited partnerships

 

 

 

 

 

 

 

1

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

1,568

Amounts recognized for:

 

 

 

 

 

 

 

 

Insurance reserves

 

 

 

 

 

 

 

(315)

DAC and DSI

 

 

 

 

 

 

 

(189)

Amounts recognized

 

 

 

 

 

 

 

(504)

Deferred income taxes

 

 

 

 

 

 

 

(229)

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$

835

_______________

(1)           Included in the fair value of derivative instruments is $2 million classified as liabilities.

 

Change in unrealized net capital gains and losses

 

The change in unrealized net capital gains and losses for the nine months ended September 30, 2018 is as follows:

 

($ in millions)

 

 

Fixed income securities

 

$

(796)

Equity securities (1)

 

Derivative instruments

 

(2)

Total

 

(798)

Amounts recognized for:

 

 

Insurance reserves

 

315

DAC and DSI

 

128

Amounts recognized

 

443

Deferred income taxes

 

75

Decrease in unrealized net capital gains and losses, after-tax

 

$

(280)

______________

 

(1)  Upon adoption of the recognition and measurement accounting standard on January 1, 2018, $308 million of pre-tax unrealized net capital gains for equity securities were reclassified from AOCI to retained income.  See Note 1 of the condensed consolidated financial statements.

 

Portfolio monitoring

 

The Company has a comprehensive portfolio monitoring process to identify and evaluate each fixed income security whose carrying value may be other-than-temporarily impaired.

 

For each fixed income security in an unrealized loss position, the Company assesses whether management with the appropriate authority has made the decision to sell or whether it is more likely than not the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes.  If a security meets either of these criteria, the security’s decline in fair value is considered other than temporary and is recorded in earnings.

 

If the Company has not made the decision to sell the fixed income security and it is not more likely than not the Company will be required to sell the fixed income security before recovery of its amortized cost basis, the Company evaluates whether it expects to receive cash flows sufficient to recover the entire amortized cost basis of the security.  The Company calculates the estimated recovery value by discounting the best estimate of future cash flows at the security’s original or current effective rate, as appropriate, and compares this to the amortized cost of the security.  If the Company does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the fixed income security, the credit loss component of the impairment is recorded in earnings, with the remaining amount of the unrealized loss related to other factors recognized in other comprehensive income.

 

For fixed income securities managed by third parties, either the Company has contractually retained its decision making authority as it pertains to selling securities that are in an unrealized loss position or it recognizes any unrealized loss at the end of the period through a charge to earnings.

 

The Company’s portfolio monitoring process includes a quarterly review of all securities to identify instances where the fair value of a security compared to its amortized cost is below established thresholds.  The process also includes the monitoring of other impairment indicators such as ratings, ratings downgrades and payment defaults.  The securities identified, in addition to other securities for which the Company may have a concern, are evaluated for potential OTTI using all reasonably available

 

13


 

information relevant to the collectability or recovery of the security.  Inherent in the Company’s evaluation of OTTI for these securities are assumptions and estimates about the financial condition and future earnings potential of the issue or issuer.  Some of the factors that may be considered in evaluating whether a decline in fair value is other than temporary are: 1) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry specific market conditions and trends, geographic location and implications of rating agency actions and offering prices; 2) the specific reasons that a security is in an unrealized loss position, including overall market conditions which could affect liquidity; and 3) the length of time and extent to which the fair value has been less than amortized cost.

 

The following table summarizes the gross unrealized losses and fair value of securities by the length of time that individual securities have been in a continuous unrealized loss position.

 

($ in millions)

 

Less than 12 months

 

12 months or more

 

Total

 

 

Number
of issues

 

Fair
value

 

Unrealized
losses

 

Number
of issues

 

Fair
value

 

Unrealized
losses

 

unrealized
losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

22

 

$

311

 

$

(2)

 

1

 

$

 

$

 

$

(2)

Municipal

 

79

 

148

 

(3)

 

2

 

17

 

(3)

 

(6)

Corporate

 

1,202

 

7,487

 

(179)

 

198

 

1,626

 

(118)

 

(297)

Foreign government

 

 

 

 

 

 

 

 

ABS

 

39

 

161

 

(1)

 

7

 

15

 

(2)

 

(3)

RMBS

 

60

 

4

 

 

39

 

10

 

 

CMBS

 

6

 

18

 

 

2

 

 

(1)

 

(1)

Redeemable preferred stock

 

 

 

 

 

 

 

Total fixed income securities

 

1,408

 

$

8,129

 

$

(185)

 

249

 

$

1,668

 

$

(124)

 

$

(309)

Investment grade fixed income securities

 

1,097

 

$

6,971

 

$

(156)

 

213

 

$

1,552

 

$

(110)

 

$

(266)

Below investment grade fixed income securities

 

311

 

1,158

 

(29)

 

36

 

116

 

(14)

 

(43)

Total fixed income securities

 

1,408

 

$

8,129

 

$

(185)

 

249

 

$

1,668

 

$

(124)

 

$

(309)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

17

 

$

443

 

$

(2)

 

2

 

$

25

 

$

 

$

(2)

Municipal

 

4

 

14

 

 

1

 

11

 

(3)

 

(3)

Corporate

 

456

 

2,899

 

(28)

 

144

 

1,324

 

(58)

 

(86)

ABS

 

33

 

170

 

(1)

 

8

 

24

 

(3)

 

(4)

RMBS

 

70

 

3

 

 

56

 

18

 

(1)

 

(1)

CMBS

 

2

 

1

 

 

6

 

23

 

(2)

 

(2)

Redeemable preferred stock

 

1

 

 

 

 

 

 

Total fixed income securities

 

583

 

3,530

 

(31)

 

217

 

1,425

 

(67)

 

(98)

Equity securities

 

87

 

66

 

(3)

 

1

 

 

 

(3)

Total fixed income and equity securities

 

670

 

$

3,596

 

$

(34)

 

218

 

$

1,425

 

$

(67)

 

$

(101)

Investment grade fixed income securities

 

472

 

$

3,192

 

$

(22)

 

181

 

$

1,320

 

$

(52)

 

$

(74)

Below investment grade fixed income securities

 

111

 

338

 

(9)

 

36

 

105

 

(15)

 

(24)

Total fixed income securities

 

583

 

$

3,530

 

$

(31)

 

217

 

$

1,425

 

$

(67)

 

$

(98)

 

As of September 30, 2018, $294 million of the $309 million unrealized losses are related to securities with an unrealized loss position less than 20% of amortized cost, the degree of which suggests that these securities do not pose a high risk of being other-than-temporarily impaired.  Of the $294 million, $254 million are related to unrealized losses on investment grade fixed income securities.  Of the remaining $40 million, $30 million have been in an unrealized loss position for less than 12 months.  Investment grade is defined as a security having a rating of Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB from S&P Global Ratings (“S&P”), a comparable rating from another nationally recognized rating agency, or a comparable internal rating if an externally provided rating is not available.  Market prices for certain securities may have credit spreads which imply higher or lower credit quality than the current third party rating.  Unrealized losses on investment grade securities are principally related to an increase in market yields which may include increased risk-free interest rates and/or wider credit spreads since the time of initial purchase. The unrealized losses are expected to reverse as the securities approach maturity.

 

As of September 30, 2018, the remaining $15 million of unrealized losses are related to securities in unrealized loss positions greater than or equal to 20% of amortized cost.  Investment grade fixed income securities comprising $12 million of these unrealized losses were evaluated based on factors such as discounted cash flows and the financial condition and near-term and long-term prospects of the issue or issuer and were determined to have adequate resources to fulfill contractual obligations.  Of the $15

 

14


 

million, $3 million are related to below investment grade fixed income securities. Of these amounts, $2 million are related to below investment grade fixed income securities that had been in an unrealized loss position greater than or equal to 20% of amortized cost for a period of twelve or more consecutive months as of September 30, 2018.

 

ABS, RMBS and CMBS in an unrealized loss position were evaluated based on actual and projected collateral losses relative to the securities’ positions in the respective securitization trusts, security specific expectations of cash flows, and credit ratings.  This evaluation also takes into consideration credit enhancement, measured in terms of (i) subordination from other classes of securities in the trust that are contractually obligated to absorb losses before the class of security the Company owns, and (ii) the expected impact of other structural features embedded in the securitization trust beneficial to the class of securities the Company owns, such as overcollateralization and excess spread.  Municipal bonds in an unrealized loss position were evaluated based on the underlying credit quality of the primary obligor, obligation type and quality of the underlying assets.

 

As of September 30, 2018, the Company has not made the decision to sell and it is not more likely than not the Company will be required to sell fixed income securities with unrealized losses before recovery of the amortized cost basis.

 

Limited partnerships

 

Investments in limited partnership interests include interests in private equity funds, real estate funds and other funds.  As of September 30, 2018 and December 31, 2017, the carrying value of EMA limited partnerships totaled $2.63 billion and $2.54 billion, respectively, and limited partnerships carried at fair value as of September 30, 2018, while at cost method as of December 31, 2017, totaled $761 million and $611 million, respectively.

 

Mortgage loans

 

Mortgage loans are evaluated for impairment on a specific loan basis through a quarterly credit monitoring process and review of key credit quality indicators.  Mortgage loans are considered impaired when it is probable that the Company will not collect the contractual principal and interest.  Valuation allowances are established for impaired loans to reduce the carrying value to the fair value of the collateral less costs to sell or the present value of the loan’s expected future repayment cash flows discounted at the loan’s original effective interest rate.  Impaired mortgage loans may not have a valuation allowance when the fair value of the collateral less costs to sell is higher than the carrying value.  Valuation allowances are adjusted for subsequent changes in the fair value of the collateral less costs to sell or present value of the loan’s expected future repayment cash flows.  Mortgage loans are charged off against their corresponding valuation allowances when there is no reasonable expectation of recovery.  The impairment evaluation is non-statistical in respect to the aggregate portfolio but considers facts and circumstances attributable to each loan.  It is not considered probable that additional impairment losses, beyond those identified on a specific loan basis, have been incurred as of September 30, 2018.

 

Accrual of income is suspended for mortgage loans that are in default or when full and timely collection of principal and interest payments is not probable.  Cash receipts on mortgage loans on nonaccrual status are generally recorded as a reduction of carrying value.

 

Debt service coverage ratio is considered a key credit quality indicator when mortgage loans are evaluated for impairment.  Debt service coverage ratio represents the amount of estimated cash flows from the property available to the borrower to meet principal and interest payment obligations.  Debt service coverage ratio estimates are updated annually or more frequently if conditions are warranted based on the Company’s credit monitoring process.

 

The following table reflects the carrying value of non-impaired mortgage loans summarized by debt service coverage ratio distribution.

 

($ in millions)

 

September 30, 2018

 

December 31, 2017

Debt service coverage ratio distribution

 

Fixed rate
mortgage
loans

 

Variable rate
mortgage
loans

 

Total

 

Fixed rate
mortgage
loans

 

Variable rate
mortgage
loans

 

Total

Below 1.0

 

$

2

 

$

15

 

$

17

 

$

3

 

$

 

$

3

1.0 - 1.25

 

190

 

 

190

 

326

 

 

326

1.26 - 1.50

 

1,083

 

 

1,083

 

1,033

 

15

 

1,048

Above 1.50

 

2,587

 

42

 

2,629

 

2,482

 

13

 

2,495

Total non-impaired mortgage loans

 

$

3,862

 

$

57

 

$

3,919

 

$

3,844

 

$

28

 

$

3,872

 

Mortgage loans with a debt service coverage ratio below 1.0 that are not considered impaired primarily relate to instances where the borrower has the financial capacity to fund the revenue shortfalls from the properties for the foreseeable term, the decrease in cash flows from the properties is considered temporary, or there are other risk mitigating circumstances such as additional collateral, escrow balances or borrower guarantees.

 

15


 

The net carrying value of impaired mortgage loans is as follows:

 

($ in millions)

 

September 30,
2018

 

December 31,
2017

Impaired mortgage loans with a valuation allowance

 

$

4

 

$

4

Impaired mortgage loans without a valuation allowance

 

 

Total impaired mortgage loans

 

$

4

 

$

4

Valuation allowance on impaired mortgage loans

 

$

3

 

$

3

 

The valuation allowance on impaired mortgage loans had no activity for the three months and nine months ended September 30, 2018 and 2017. The average balance of impaired loans was $4 million and $8 million for the nine months ended September 30, 2018 and 2017, respectively.

 

Payments on all mortgage loans were current as of September 30, 2018 and December 31, 2017.

 

Short-term investments

 

Short-term investments, including commercial paper, U.S. Treasury bills, money market funds and other short-term investments, are carried at fair value. As of September 30, 2018 and December 31, 2017, the fair value of short-term investments totaled $926 million and $725 million, respectively.

 

Policy loans

 

Policy loans are carried at unpaid principal balances.  As of September 30, 2018 and December 31, 2017, the carrying value of policy loans totaled $564 million and $561 million, respectively.

 

Other investments

 

Other investments primarily consist of agent loans, bank loans, real estate and derivatives.  Agent loans are loans issued to exclusive Allstate agents and are carried at unpaid principal balances, net of valuation allowances and unamortized deferred fees or costs.  Bank loans are primarily senior secured corporate loans and are carried at amortized cost.  Real estate is carried at cost less accumulated depreciation.  Derivatives are carried at fair value.  The following table summarizes other investments.

 

($ in millions)

 

September 30,
2018

 

December 31,
2017

Agent loans

 

$

597

 

$

538

Bank loans

 

422

 

437

Real estate

 

217

 

157

Derivatives and other

 

107

 

122

Total

 

$

1,343

 

$

1,254

 

4.  Fair Value of Assets and Liabilities

 

Fair value is defined 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.  The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available.  Assets and liabilities recorded on the Condensed Consolidated Statements of Financial Position at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:

 

Level 1:  Assets and 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:  Assets and 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 markets that are not active; or

(c)          Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability.

 

Level 3:  Assets and 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.  Unobservable inputs reflect the Company’s estimates of the assumptions that market participants would use in valuing the assets and 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

 

16


 

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.  The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption.  In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments.

 

The Company is responsible for the determination of fair value and the supporting assumptions and methodologies.  The Company gains assurance that assets and liabilities are appropriately valued through the execution of various processes and controls designed to ensure the overall reasonableness and consistent application of valuation methodologies, including inputs and assumptions, and compliance with accounting standards.  For fair values received from third parties or internally estimated, the Company’s processes and controls are designed to ensure that the valuation methodologies are appropriate and consistently applied, the inputs and assumptions are reasonable and consistent with the objective of determining fair value, and the fair values are accurately recorded.  For example, on a continuing basis, the Company assesses the reasonableness of individual fair values that have stale security prices or that exceed certain thresholds as compared to previous fair values received from valuation service providers or brokers or derived from internal models.  The Company performs procedures to understand and assess the methodologies, processes and controls of valuation service providers.  In addition, the Company may validate the reasonableness of fair values by comparing information obtained from valuation service providers or brokers to other third party valuation sources for selected securities.  The Company performs ongoing price validation procedures such as back-testing of actual sales, which corroborate the various inputs used in internal models to market observable data.  When fair value determinations are expected to be more variable, the Company validates them through reviews by members of management who have relevant expertise and who are independent of those charged with executing investment transactions.

 

The Company has two types of situations where investments are classified as Level 3 in the fair value hierarchy.  The first is where specific inputs significant to the fair value estimation models are not market observable.  This primarily occurs in the Company’s use of broker quotes to value certain securities where the inputs have not been corroborated to be market observable, and the use of valuation models that use significant non-market observable inputs.

 

The second situation where the Company classifies securities in Level 3 is where quotes continue to be received from independent third-party valuation service providers and all significant inputs are market observable; however, there has been a significant decrease in the volume and level of activity for the asset when compared to normal market activity such that the degree of market observability has declined to a point where categorization as a Level 3 measurement is considered appropriate.  The indicators considered in determining whether a significant decrease in the volume and level of activity for a specific asset has occurred include the level of new issuances in the primary market, trading volume in the secondary market, the level of credit spreads over historical levels, applicable bid-ask spreads, and price consensus among market participants and other pricing sources.

 

Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans, bank loans, agent 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 condensed consolidated financial statements.

 

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.  For the majority of Level 2 and Level 3 valuations, a combination of the market and income approaches is used.

 

Summary of significant valuation techniques for assets and liabilities measured at fair value on a recurring basis

 

Level 1 measurements

 

·       Fixed income securities:  Comprise certain U.S. Treasury fixed income securities.  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 equity securities.  Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

 

·       Short-term:  Comprise U.S. Treasury bills valued based on unadjusted quoted prices for identical assets in active markets that the Company can access and 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 that are readily determinable 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.

 

17


 

Level 2 measurements

 

·       Fixed income securities:

 

U.S. government and agencies:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

 

Municipal:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

 

Corporate - public:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

 

Corporate - privately placed:  Valued using a discounted cash flow model that is widely accepted in the financial services industry and uses market observable inputs and inputs derived principally from, or corroborated by, observable market data.  The primary inputs to the discounted cash flow model include an interest rate yield curve, as well as published credit spreads for similar assets in markets that are not active that incorporate the credit quality and industry sector of the issuer.

 

Foreign government:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

 

ABS - collateralized debt obligations (“CDO”) and ABS - consumer and other:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.  Certain ABS - CDO and ABS - consumer and other are valued based on non-binding broker quotes whose inputs have been corroborated to be market observable.

 

RMBS:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.

 

CMBS:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, collateral performance and credit spreads.

 

Redeemable preferred stock:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, underlying stock prices and credit spreads.

 

·       Equity securities:  The primary inputs to the valuation include quoted prices or quoted net asset values for identical or similar assets in markets that are not active.

 

·       Short-term:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.  For certain short-term investments, amortized cost is used as the best estimate of fair value.

 

·       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.

 

OTC derivatives, including interest rate swaps, foreign currency swaps, total return swaps, foreign exchange forward contracts, certain options and certain credit default swaps, are valued using models that rely on inputs such as interest rate yield curves, implied volatilities, index price levels, currency rates, and credit spreads 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.

 

Level 3 measurements

 

·       Fixed income securities:

 

Municipal:  Comprise municipal bonds that are not rated by third party credit rating agencies.  The primary inputs to the valuation of these municipal bonds include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields and credit spreads.  Also included are municipal bonds valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable and municipal bonds in default valued based on the present value of expected cash flows.

 

Corporate - public and Corporate - privately placed:  Primarily valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable.  Other inputs include an interest rate yield curve, as well as published credit spreads for similar assets that incorporate the credit quality and industry sector of the issuer.

 

ABS - CDO, ABS - consumer and other:  Valued based on non-binding broker quotes received from brokers who are familiar with the investments and where the inputs have not been corroborated to be market observable.

 

18


 

·       Equity securities:  The primary inputs to the valuation include quoted prices or quoted net asset values for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements.

 

·       Other investments:  Certain OTC derivatives, such as interest rate caps, certain credit default swaps and certain options (including swaptions), are valued using models that are widely accepted in the financial services industry.  These are categorized as Level 3 as a result of the significance of non-market observable inputs such as volatility.  Other primary inputs include interest rate yield curves and credit spreads.

 

·       Contractholder funds:  Derivatives embedded in certain life and 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 primarily use stochastically determined cash flows based on the contractual elements of embedded derivatives, projected option cost and applicable market data, such as interest rate yield curves and equity index volatility assumptions.  These are categorized as Level 3 as a result of the significance of non-market observable inputs.

 

Assets and liabilities measured at fair value on a non-recurring basis

 

Mortgage loans written-down to fair value in connection with recognizing impairments are valued based on the fair value of the underlying collateral less costs to sell.  EMA limited partnership interests written-down to fair value in connection with recognizing OTTI losses are generally valued using net asset values.

 

Investments excluded from the fair value hierarchy

 

Limited partnerships carried at fair value, which do not have readily determinable fair values, use NAV provided by the investees and are excluded from the fair value hierarchy.  These investments are generally not redeemable by the investees and generally cannot be sold without approval of the general partner.  We receive distributions of income and from liquidation of the underlying assets of the investees over the life of these investments, typically 10-12 years.  As of September 30, 2018, the Company has commitments to invest $313 million in these limited partnership interests.

 

19


 

The following table summarizes the Company’s assets and liabilities measured at fair value as of September 30, 2018.

 

($ in millions)

 

Quoted prices
in active
markets for
identical assets
(Level 1)

 

Significant
other
observable
inputs
(Level 2)

 

Significant
unobservable
inputs
(Level 3)

 

Counterparty
and cash
collateral
netting

 

Balance as of
September 30,
2018

Assets

 

 

 

 

 

 

 

 

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

337

 

$

277

 

$

 

 

 

$

614

Municipal

 

 

2,130

 

56

 

 

 

2,186

Corporate - public

 

 

12,382

 

42

 

 

 

12,424

Corporate - privately placed

 

 

5,583

 

166

 

 

 

5,749

Foreign government

 

 

177

 

 

 

 

177

ABS - CDO

 

 

28

 

8

 

 

 

36

ABS - consumer and other

 

 

264

 

25

 

 

 

289

RMBS

 

 

214

 

 

 

 

214

CMBS

 

 

49

 

 

 

 

49

Redeemable preferred stock

 

 

14

 

 

 

 

14

Total fixed income securities

 

337

 

21,118

 

297

 

 

 

21,752

Equity securities

 

1,347

 

15

 

121

 

 

 

1,483

Short-term investments

 

513

 

413

 

 

 

 

926

Other investments: Free-standing derivatives

 

 

105

 

1

 

$

(6)

 

100

Separate account assets

 

3,282

 

 

 

 

 

3,282

Total recurring assets at fair value

 

$

5,479

 

$

21,651

 

$

419

 

$

(6)

 

$

27,543

% of total assets at fair value

 

19.9%

 

78.6%

 

1.5%

 

—%

 

100%

 

 

 

 

 

 

 

 

 

 

 

Investments reported at NAV

 

 

 

 

 

 

 

 

 

761

Total

 

 

 

 

 

 

 

 

 

$

28,304