10-Q 1 a07-25423_110q.htm 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007

 

OR
 

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

THE SECURITIES EXCHANGE ACT OF 1934
 

Commission file number 1-11840

 

THE ALLSTATE CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

36-3871531

(State of Incorporation)

 

(I.R.S. Employer Identification No.)

 

 

 

2775 Sanders Road

 

 

Northbrook, Illinois

 

60062

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:   847/402-5000

 

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 o

 

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

 

Large accelerated filer

 

Accelerated filer

 

Non-accelerated filer

x

 

o

 

o

 

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

 

Yes o

 

No x

 

As of October 26, 2007, the registrant had 570,716,454 common shares, $.01 par value, outstanding.

 

 



 

THE ALLSTATE CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

September 30, 2007

 

 

 

PAGE

PART I

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Three-Month and Nine-Month Periods Ended September 30, 2007 and 2006 (unaudited)

1

 

 

 

 

Condensed Consolidated Statements of Financial Position as of September 30, 2007 (unaudited) and December 31, 2006

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2007 and 2006 (unaudited)

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

4

 

 

 

 

Report of Independent Registered Public Accounting Firm

23

 

 

 

Item 2.

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

 

 

 

 

 

Highlights

24

 

Property-Liability Highlights

25

 

Allstate Protection Segment

29

 

Discontinued Lines and Coverages Segment

42

 

Property-Liability Investment Results

44

 

Allstate Financial Highlights

45

 

Allstate Financial Segment

46

 

Investments

56

 

Capital Resources and Liquidity

62

 

 

 

Item 4.

Controls and Procedures

65

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

66

 

 

 

Item 1A.

Risk Factors

66

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

67

 

 

 

Item 6.

Exhibits

67

 



 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

($ in millions, except per share data)

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

Property-liability insurance premiums earned

 

$

6,819

 

$

6,801

 

$

20,447

 

$

20,537

 

Life and annuity premiums and contract charges

 

449

 

444

 

1,386

 

1,454

 

Net investment income

 

1,603

 

1,554

 

4,808

 

4,613

 

Realized capital gains and losses

 

121

 

(61

)

1,137

 

90

 

 

 

8,992

 

8,738

 

27,778

 

26,694

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Property-liability insurance claims and claims expense

 

4,509

 

4,012

 

12,943

 

11,879

 

Life and annuity contract benefits

 

371

 

388

 

1,185

 

1,135

 

Interest credited to contractholder funds

 

685

 

667

 

2,007

 

1,939

 

Amortization of deferred policy acquisition costs

 

1,170

 

1,160

 

3,539

 

3,522

 

Operating costs and expenses

 

785

 

726

 

2,246

 

2,252

 

Restructuring and related charges

 

2

 

52

 

5

 

171

 

Interest expense

 

90

 

90

 

245

 

261

 

 

 

7,612

 

7,095

 

22,170

 

21,159

 

 

 

 

 

 

 

 

 

 

 

Gain (loss) on disposition of operations

 

6

 

(1

)

8

 

(89

)

 

 

 

 

 

 

 

 

 

 

Income from operations before income tax expense

 

1,386

 

1,642

 

5,616

 

5,446

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

408

 

484

 

1,740

 

1,666

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

978

 

$

1,158

 

$

3,876

 

$

3,780

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share - Basic

 

$

1.70

 

$

1.84

 

$

6.45

 

$

5.95

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares - Basic

 

581.1

 

629.0

 

600.5

 

635.4

 

 

 

 

 

 

 

 

 

 

 

Net income per share - Diluted

 

$

1.70

 

$

1.83

 

$

6.41

 

$

5.91

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares - Diluted

 

585.1

 

633.9

 

605.1

 

639.9

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per share

 

$

0.38

 

$

0.35

 

$

1.14

 

$

1.05

 

 

See notes to condensed consolidated financial statements.

 

1



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

 

 

 

September 30,

 

December 31,

 

($ in millions, except par value data)

 

2007

 

2006

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Investments

 

 

 

 

 

Fixed income securities, at fair value (amortized cost $96,063 and $95,780)

 

$

97,169

 

$

98,320

 

Equity securities, at fair value (cost $6,301 and $6,026)

 

7,811

 

7,777

 

Mortgage loans

 

10,473

 

9,467

 

Short-term

 

3,869

 

2,430

 

Other

 

1,807

 

1,763

 

Total investments

 

121,129

 

119,757

 

 

 

 

 

 

 

Cash

 

307

 

443

 

Premium installment receivables, net

 

4,973

 

4,789

 

Deferred policy acquisition costs

 

5,662

 

5,332

 

Reinsurance recoverables, net

 

5,873

 

5,827

 

Accrued investment income

 

1,184

 

1,062

 

Deferred income taxes

 

528

 

224

 

Property and equipment, net

 

1,060

 

1,010

 

Goodwill

 

825

 

825

 

Other assets

 

1,969

 

2,111

 

Separate Accounts

 

15,863

 

16,174

 

Total assets

 

$

159,373

 

$

157,554

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Reserve for property-liability insurance claims and claims expense

 

$

18,791

 

$

18,866

 

Reserve for life-contingent contract benefits

 

12,899

 

12,786

 

Contractholder funds

 

62,741

 

62,031

 

Unearned premiums

 

10,623

 

10,427

 

Claim payments outstanding

 

805

 

717

 

Other liabilities and accrued expenses

 

10,377

 

10,045

 

Short-term debt

 

 

12

 

Long-term debt

 

5,640

 

4,650

 

Separate Accounts

 

15,863

 

16,174

 

Total liabilities

 

137,739

 

135,708

 

 

 

 

 

 

 

Commitments and Contingent Liabilities (Note 7)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Preferred stock, $1 par value, 25 million shares authorized, none issued

 

 

 

Common stock, $.01 par value, 2.0 billion shares authorized and 900 million issued, 574 million and 622 million shares outstanding

 

9

 

9

 

Additional capital paid-in

 

3,032

 

2,939

 

Retained income

 

32,252

 

29,070

 

Deferred ESOP expense

 

(68

)

(72

)

Treasury stock, at cost (326 million and 278 million shares)

 

(14,001

)

(11,091

)

 

 

 

 

 

 

Accumulated other comprehensive income:

 

 

 

 

 

Unrealized net capital gains and losses

 

1,376

 

2,074

 

Unrealized foreign currency translation adjustments

 

74

 

26

 

Net funded status of pension and other postretirement benefit obligation

 

(1,040

)

(1,109

)

Total accumulated other comprehensive income

 

410

 

991

 

Total shareholders’ equity

 

21,634

 

21,846

 

Total liabilities and shareholders’ equity

 

$

159,373

 

$

157,554

 

 

See notes to condensed consolidated financial statements.

 

2



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

Nine Months Ended

 

 

 

September 30,

 

($ in millions)

 

2007

 

2006

 

 

 

(Unaudited)

 

 

 

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

3,876

 

$

3,780

 

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

 

 

 

 

 

Depreciation, amortization and other non-cash items

 

(189

)

(156

)

Realized capital gains and losses

 

(1,137

)

(90

)

(Gain) loss on disposition of operations

 

(8

)

89

 

Interest credited to contractholder funds

 

2,007

 

1,939

 

Changes in:

 

 

 

 

 

Policy benefits and other insurance reserves

 

(219

)

(3,061

)

Unearned premiums

 

147

 

373

 

Deferred policy acquisition costs

 

(2

)

(251

)

Premium installment receivables, net

 

(159

)

(199

)

Reinsurance recoverables, net

 

(246

)

796

 

Income taxes payable

 

7

 

455

 

Other operating assets and liabilities

 

41

 

(30

)

Net cash provided by operating activities

 

4,118

 

3,645

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from sales

 

 

 

 

 

Fixed income securities

 

18,581

 

18,654

 

Equity securities

 

6,766

 

3,375

 

Investment collections

 

 

 

 

 

Fixed income securities

 

4,334

 

3,598

 

Mortgage loans

 

1,349

 

1,390

 

Investment purchases

 

 

 

 

 

Fixed income securities

 

(21,996

)

(23,868

)

Equity securities

 

(5,973

)

(4,042

)

Mortgage loans

 

(2,332

)

(1,722

)

Change in short-term investments, net

 

(1,547

)

658

 

Change in other investments, net

 

105

 

(90

)

Dispositions of operations

 

6

 

(812

)

Purchases of property and equipment, net

 

(212

)

(108

)

Net cash used in investing activities

 

(919

)

(2,967

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Change in short-term debt, net

 

(12

)

(413

)

Proceeds from issuance of long-term debt

 

987

 

644

 

Repayment of long-term debt

 

(9

)

(19

)

Contractholder fund deposits

 

7,081

 

8,137

 

Contractholder fund withdrawals

 

(7,859

)

(7,402

)

Dividends paid

 

(680

)

(653

)

Treasury stock purchases

 

(3,025

)

(1,259

)

Shares reissued under equity incentive plans, net

 

103

 

150

 

Excess tax benefits from share-based payment arrangements

 

28

 

30

 

Other

 

51

 

121

 

Net cash used in financing activities

 

(3,335

)

(664

)

 

 

 

 

 

 

Net (decrease) increase in cash

 

(136

)

14

 

Cash at beginning of period

 

443

 

313

 

Cash at end of period

 

$

307

 

$

327

 

 

See notes to condensed consolidated financial statements.

 

3



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.  General

 

Basis of presentation

 

The accompanying condensed consolidated financial statements include the accounts of The Allstate Corporation and its wholly owned subsidiaries, primarily Allstate Insurance Company (“AIC”), a property-liability insurance company with various property-liability and life and investment subsidiaries, including Allstate Life Insurance Company (“ALIC”) (collectively referred to as the “Company” or “Allstate”).

 

The condensed consolidated financial statements and notes as of September 30, 2007, and for the three-month and nine-month periods ended September 30, 2007 and 2006 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, 2006. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

 

To conform to the 2007 presentation, certain amounts in the prior year condensed consolidated financial statements and notes have been reclassified.

 

Adopted accounting standards

 

Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (“SOP 05-1”)

 

In October 2005, the American Institute of Certified Public Accountants (“AICPA”) issued SOP 05-1. SOP 05-1 provides accounting guidance for deferred policy acquisition costs associated with internal replacements of insurance and investment contracts other than those set forth in Statement of Financial Accounting Standards (“SFAS”) No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments”. SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by 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. In February 2007, the AICPA issued Technical Practice Aids (“TPAs”) that provide interpretive guidance to be used in applying SOP 05-1. 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 a $9 million after-tax reduction to retained income to reflect the impact on estimated future gross profits 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 deferred policy acquisition costs (“DAC”) and deferred sales inducements (“DSI”) balances of $13 million pre-tax as of January 1, 2007. The ongoing effects of SOP 05-1 are not expected to have a material impact on the Company’s results of operations or financial position.

 

SFAS No. 155, Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140 (“SFAS No. 155”)

 

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, which permits the fair value remeasurement at the date of adoption of any hybrid financial instrument containing an embedded derivative that otherwise would require bifurcation under paragraph 12 or 13 of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133 (“SFAS No. 133”); establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or hybrid financial instruments that contain embedded derivatives requiring bifurcation; and clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. The Company adopted the provisions of SFAS No. 155 on January 1, 2007, which were effective for all financial instruments acquired, issued or subject to a remeasurement event occurring after the beginning of the first fiscal year beginning after September 15, 2006. The Company elected not to remeasure existing hybrid financial instruments that contained embedded derivatives requiring bifurcation at the date of adoption pursuant to paragraph 12 or 13 of SFAS No. 133. The adoption of SFAS No. 155 did not have a material effect on the results of operations or financial position of the Company.

 

4



 

Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”)

 

In July 2006, the FASB issued FIN 48, which 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.

 

The liability for net unrecognized tax benefits at January 1, 2007 was $48 million. The liability balance for unrecognized tax benefits increased to $61 million at September 30, 2007, primarily due to the receipt during the second quarter of a tax refund of $11 million related to prior years’ tax returns. This liability represents an accrual relating to uncertain income tax positions the Company has taken or expects to take on its tax returns. The Company believes it is reasonably possible that the liability balance will be reduced by $61 million within the next 12 months with the resolution of an outstanding issue resulting from the Internal Revenue Service (“IRS”) examination of the 2003 and 2004 tax years.

 

The Company recognizes interest accrued related to unrecognized tax benefits in income tax expense. During the nine months ended September 30, 2007, the balance of interest expense accrued with respect to unrecognized tax benefits increased to $7 million from a receivable balance of $9 million at January 1, 2007, primarily due to the receipt of interest income accrued on the $11 million tax refund received during the second quarter. No amounts have been accrued for penalties.

 

The IRS has completed its examination of the Company’s federal income tax returns for 2003—2004 and the case is under consideration at the IRS Appeals Office. The Company’s tax years prior to 2003 have been examined by the IRS and the statute of limitations has expired on those years.

 

SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) (“SFAS No. 158”)

 

SFAS No. 158 requires recognition in the statements of financial position of the over or underfunded status of defined pension and other postretirement plans, measured as the difference between the fair value of plan assets and the projected benefit obligation (“PBO”) for the pension plans and the accumulated postretirement benefit obligation (“APBO”) for other postretirement benefit plans. This effectively requires the recognition of all previously unrecognized actuarial gains and losses and prior service costs as a component of accumulated other comprehensive income, net of tax. In addition, SFAS No. 158 requires: on a prospective basis, the actuarial gains and losses and the prior service costs and credits that arise during any reporting period, but are not recognized net of tax as components of net periodic benefit cost, be recognized as a component of other comprehensive income; that the measurement date of the plans be the same as the statements of financial position; and that disclosure in the notes to the financial statements include the anticipated impact on the net periodic benefit cost of the actuarial gains and losses and the prior service costs and credits previously deferred and recognized, net of tax, as a component of other comprehensive income. Guidance relating to the measurement date of the plans is effective for the years ending after December 15, 2008. Retrospective application of this standard was not permitted. SFAS No. 158 had no impact on the Company’s results of operations or cash flows. The financial statement impact of adoption, including the inter-related impact on the minimum pension liability, was a decrease in shareholders’ equity of $1.11 billion at December 31, 2006.

 

Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”)

 

In September 2006, the SEC issued SAB 108 to eliminate the diversity of practice in the process by which misstatements are quantified for purposes of assessing their materiality in the financial statements. SAB 108 is intended to eliminate the potential build up of improper amounts on the balance sheet due to limitations of certain methods of materiality assessments utilized in current practice. SAB 108 establishes 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

 

5



 

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, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP FAS 115-1”)

 

FSP FAS 115-1 nullifies the guidance in paragraphs 10-18 of Emerging Issues Task Force Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” and references existing other-than-temporary impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell the security has not been made, and also provides guidance on the subsequent income recognition for impaired debt securities. The Company adopted FSP FAS 115-1 as of January 1, 2006 on a prospective basis. The effects of adoption did not have a material effect on the results of operations or financial position of the Company.

 

SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”)

 

SFAS No. 154 replaces 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.

 

SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”)

 

SFAS No. 123R revises SFAS No. 123 “Accounting for Stock-based Compensation” and supersedes APB Opinion No. 25 “Accounting for Stock Issued to Employees”. SFAS No. 123R requires all share-based payment transactions to be accounted for using a fair value based method to recognize the cost of awards over the period in which the requisite service is rendered. The Company adopted SFAS No. 123R on January 1, 2006 using the modified prospective application method for adoption. The adoption impacts of SFAS No. 123R, which included the recognition of compensation expense related to options with a four year vesting requirement that were granted in 2002  and not fully vested on January 1, 2006, were not material to the results of operations or financial position of the Company. The Company previously adopted the expense provisions of SFAS No. 123 for awards granted or modified subsequent to January 1, 2003, which also did not have a material effect on the results of operations or financial position of the Company.

 

FASB Staff Position No. FAS 123R-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards (“FSP FAS 123R-3”)

 

FSP FAS 123R-3 provided companies an option to elect an alternative calculation method for determining the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123R. SFAS No. 123R requires companies to calculate the pool of excess tax benefits as the net excess tax benefits that would have qualified as such had the Company adopted SFAS No. 123 for recognition purposes when first effective in 1995. FSP FAS 123R-3 provided an alternative calculation based on actual increases to additional paid-in capital related to tax benefits from share-based compensation subsequent to the effective date of SFAS No. 123, less the tax on the cumulative incremental compensation costs the Company included in its pro forma net income disclosures as if the Company had applied the fair-value method to all awards, less the share-based compensation costs included in net income as reported. In conjunction with its adoption of SFAS No. 123R on January 1, 2006, the Company elected the alternative transition method described in FSP FAS 123R-3. The effect of the transition calculation did not have a material effect on the results of operations or financial position of the Company.

 

Pending accounting standards

 

SFAS No. 157, Fair Value Measurements (“SFAS No. 157”)

 

In September 2006, the FASB issued SFAS No. 157 which redefines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. SFAS No. 157 applies where other accounting pronouncements require or permit fair value measurements. Additional disclosures and modifications to current fair value disclosures will be required upon adoption of SFAS No. 157. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effects of adoption of SFAS No. 157 on its results of operations and financial position.

 

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SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”)

 

In February 2007, the FASB issued SFAS No. 159 which provides reporting entities an option to report selected financial assets, including investment securities designated as available for sale, and financial liabilities, including most insurance contracts, at fair value. SFAS No. 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement alternatives for similar types of financial assets and liabilities. The standard also requires additional information to aid financial statement users’ understanding of the impacts of a reporting entity’s decision to use fair value on its earnings and requires entities to display, on the face of the statement of financial position, the fair value of those assets and liabilities for which the reporting entity has chosen to measure at fair value. SFAS No. 159 is effective as of the beginning of a reporting entity’s first fiscal year beginning after November 15, 2007. Because application of the standard is optional, any impacts are limited to those financial assets and liabilities to which SFAS No. 159 would be applied, which have yet to be determined by the Company.

 

SOP 07-1, Clarification of the Scope of the Audit and Accounting Guide, Investment Companies (“the Guide”) and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies (“SOP 07-1”)

 

In June 2007, the AICPA issued SOP 07-1. Upon adoption of the SOP, the Company must also adopt the provisions of FASB Staff Position No. FIN 46(R)-7, “Application of FASB Interpretation No. 46(R) to Investment Companies”, which permanently exempts investment companies from applying the provisions of Interpretation 46(R) to investments carried at fair value. SOP 07-1 provides guidance for determining whether an entity falls within the scope of the Guide and whether investment company accounting should be retained by a parent company upon consolidation of an investment company subsidiary or by an equity method investor in an investment company. In certain circumstances, SOP 07-1 precludes retention of specialized accounting for investment companies (i.e. fair value accounting), when similar direct investments exist in the consolidated group and are measured on a basis inconsistent with that applied to investment companies. Additionally, SOP 07-1 precludes retention of specialized accounting for investment companies if the reporting entity does not distinguish, through documented policies, the nature and type of investments to be held in the investment companies from those made in the consolidated group where other accounting guidance is being applied. SOP 07-1 was to be effective for fiscal years beginning on or after December 15, 2007, however the FASB voted in October 2007 to delay the effective date. A revised effective date for SOP 07-1 is not yet available. The Company is assessing the current and future implications of this standard on its results of operations and 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 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. The effects of applying FSP FIN 39-1 will be recorded as a change in accounting principle through retrospective application. The adoption of FSP FIN 39-1 is not expected to have a material impact on the Company’s results of operations or financial position based on the current level of derivative activity.

 

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2.  Earnings per share

 

Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based on weighted average number of common and dilutive potential common shares outstanding. For Allstate, dilutive potential common shares consist of outstanding stock options and restricted stock units.

 

The computation of basic and diluted earnings per share is presented in the following table.

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

($ in millions, except per share data)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

978

 

$

1,158

 

$

3,876

 

$

3,780

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

581.1

 

629.0

 

600.5

 

635.4

 

Effect of potential dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options

 

2.2

 

3.5

 

2.8

 

3.2

 

Unvested restricted stock units

 

1.8

 

1.4

 

1.8

 

1.3

 

Weighted average common and dilutive potential common shares outstanding

 

585.1

 

633.9

 

605.1

 

639.9

 

 

 

 

 

 

 

 

 

 

 

Earnings per share – Basic:

 

$

1.70

 

$

1.84

 

$

6.45

 

$

5.95

 

Earnings per share – Diluted:

 

$

1.70

 

$

1.83

 

$

6.41

 

$

5.91

 

 

Options with exercise prices exceeding the average market price of Allstate common shares during the period or where the unrecognized compensation cost of the options would have an anti-dilutive effect are excluded from the computation of earnings per share for the period. As a result, options to purchase 4.5 million and 5.1 million Allstate common shares, with exercise prices ranging from $52.23 to $65.38 and $52.23 to $61.90, which were outstanding at September 30, 2007 and 2006, respectively, were not included in the computation of diluted earnings per share for the three-month periods. Options to purchase 4.3 million and 5.9 million Allstate common shares, with exercise prices ranging from $52.23 to $65.38 and $50.79 to $61.90, which were outstanding at September 30, 2007 and 2006, respectively, were not included in the computation of diluted earnings per share for the nine-month periods.

 

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3.  Supplemental Cash Flow Information

 

Non-cash investment exchanges and modifications, which primarily reflect refinancing of fixed income securities and mergers completed with equity securities, totaled $122 million and $81 million for the nine-month periods ended September 30, 2007 and 2006, respectively.

 

Liabilities for collateral received in conjunction with securities lending and other activities and for funds received from security repurchase activities are reported in other liabilities and accrued expenses in the Condensed Consolidated Statements of Financial Position. The associated cash flows are included in cash flows from operating activities in the Condensed Consolidated Statements of Cash Flows along with the related changes in investments, which are as follows:

 

 

 

Nine months ended
September 30,

 

($ in millions)

 

2007

 

2006

 

 

 

 

 

 

 

Net change in fixed income securities

 

$

(621

)

$

(492

)

Net change in short-term investments

 

254

 

(875

)

Operating cash flow used

 

(367

)

(1,367

)

Net change in cash

 

2

 

––

 

Net change in proceeds managed

 

$

(365

)

$

(1,367

)

 

 

 

 

 

 

Liabilities for collateral and security repurchase, beginning of year

 

$

(4,144

)

$

(4,102

)

Liabilities for collateral and security repurchase, end of period

 

(4,509

)

(5,469

)

Operating cash flow provided

 

$

365

 

$

1,367

 

 

4.  Reserve for Property-Liability Insurance Claims and Claims Expense

 

The Company establishes reserves for claims and claims expense on reported and unreported claims of insured losses. The Company’s reserving process takes into account known facts and interpretations of circumstances and factors including the Company’s experience with similar cases, actual claims paid, historical trends involving claim payment patterns and pending levels of unpaid claims, loss management programs, product mix and contractual terms, law changes, court decisions, changes to regulatory requirements and economic conditions. In the normal course of business, the Company may also supplement its claims processes by utilizing third party adjusters, appraisers, engineers, inspectors, and other professionals and information sources to assess and settle catastrophe and non-catastrophe related claims. The effects of inflation are implicitly considered in the reserving process.

 

Because reserves are estimates of unpaid portions of losses that have occurred, including incurred but not reported (“IBNR”) losses, the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process. The ultimate cost of losses may vary materially from recorded amounts, which are based on management’s best estimates. The highest degree of uncertainty is associated with reserves for losses incurred in the current reporting period as it contains the greatest proportion of losses that have not been reported or settled. The Company regularly updates its reserve estimates as new information becomes available and as events unfold that may affect the resolution of unsettled claims. Changes in prior year reserve estimates, which may be material, are reported in property-liability insurance claims and claims expense in the Condensed Consolidated Statements of Operations in the period such changes are determined.

 

Management believes that the reserve for property-liability claims and claims expense, net of reinsurance recoverables, is appropriately established in the aggregate and adequate to cover the ultimate net cost of reported and unreported claims arising from losses which had occurred by the Statement of Financial Position date based on available facts, technology, laws and regulations.

 

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5.  Reinsurance

 

Property-liability insurance premiums earned and life and annuity premiums and contract charges have been reduced by the reinsurance premium ceded amounts shown in the following table.

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

($ in millions)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Property-liability insurance premiums earned

 

$

338

 

$

336

 

$

1,034

 

$

772

 

Life and annuity premiums and contract charges

 

242

 

233

 

719

 

572

 

 

Property-liability insurance claims and claims expense and life and annuity contract benefits and interest credited to contractholder funds have been reduced by the reinsurance recovery amounts shown in the following table.

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

($ in millions)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Property-liability insurance claims and claims expense

 

$

128

 

$

112

 

$

331

 

$

377

 

Life and annuity contract benefits

 

180

 

161

 

498

 

424

 

Interest credited to contractholder funds

 

12

 

18

 

36

 

26

 

 

Life and annuity

 

On June 1, 2006, in accordance with the terms of the definitive Master Transaction Agreement and related agreements (collectively the “Agreement”) the Company and its subsidiaries, Allstate Life Insurance Company (“ALIC”) and Allstate Life Insurance Company of New York (“ALNY”), completed the disposal through reinsurance of substantially all of Allstate Financial’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 Condensed Consolidated Statements of Financial Position, but the related results of operations are fully reinsured and presented net of reinsurance on the Condensed Consolidated Statements of Operations.

 

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 provisions as of the transaction closing date. General account liabilities of $1.31 billion at September 30, 2007 and $1.49 billion as

 

10



 

of December 31, 2006, however, remain on the Condensed Consolidated Statements of Financial Position with a corresponding reinsurance recoverable.

 

For purposes of presentation in the Condensed 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, pretax, and the costs of executing the transaction of $13 million, pretax, were classified as a disposition of operations in the cash flows from investing activities section of the Condensed Consolidated Statements of Cash Flows.

 

Under the Agreement, the Company, ALIC and ALNY 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, the Company, ALIC and ALNY will each 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 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, ALIC and ALNY will continue to issue new variable annuity contracts, accept additional deposits on existing business from existing contractholders on behalf of Prudential and, for a period of twenty-four months or less from the effective date of the transaction, service the reinsured business while Prudential prepares for the migration of the business onto its servicing platform.

 

Pursuant to the Agreement, the final market-adjusted consideration was $628 million. The disposal resulted in a gain of $77 million pretax for ALIC, which was deferred as a result of the disposition being executed through reinsurance. The deferred gain is included as a component of other liabilities and accrued expenses on the Consolidated Statements of Financial Position, and is amortized to gain (loss) on dispositions of operations on the Consolidated Statements of Operations 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 pretax. 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 loss on disposition of operations on the Company’s Consolidated Statements of Operations and amounted to $61 million, after-tax, during 2006. Gain (loss) on disposition of operations on the Consolidated Statements of Operations included amortization of ALIC’s deferred gain, after tax, of $3 million and $1 million for the nine-month periods ended September 30, 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 were $14.67 billion as of September 30, 2007 and $15.07 billion as of December 31, 2006. Separate account balances totaling approximately $1.19 billion at September 30, 2007 and $1.10 billion at December 31, 2006 related primarily to the variable life business that is being retained by ALIC and ALNY, and the variable annuity business in three affiliated companies that were not included in the Agreement. In the first five-months of 2006, prior to this disposition, ALIC’s and ALNY’s variable annuity business generated approximately $127 million in contract charges.

 

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Property-liability

 

The Company entered into the following reinsurance agreements effective June 1, 2007:  a Kentucky agreement that provides coverage for Allstate Protection personal property excess catastrophe losses in the state for earthquake and fires following earthquakes; a North-East agreement for additional hurricane coverage in the states of New York, New Jersey and Connecticut for personal property and auto excess catastrophe losses; and four reinsurance agreements entered into by Allstate Floridian Insurance Company (“AFIC”), a subsidiary of the Company, for personal property excess catastrophe losses in Florida. Effective June 1, 2007, the Company also renewed its aggregate excess of loss agreement that covers storms named or numbered by the National Weather Service, earthquakes, and fires following earthquakes for personal lines auto and property business countrywide except for Florida; New Jersey excess of loss agreement that covers personal property catastrophe losses in excess of the New Jersey multi-year agreement; and South-East agreement that covers personal property excess catastrophe losses for storms named or numbered by the National Weather Service in 11 Atlantic and Gulf states and the District of Columbia. In addition, the Company has a California Fires Following agreement that covers personal property excess catastrophe losses in California effective February 1, 2006 to May 31, 2008, for fires following earthquakes; and multi-year reinsurance treaties effective June 1, 2005 to May 31, 2008, that cover excess catastrophe losses in Connecticut, New Jersey, New York, and Texas.

 

12



 

6.  Company Restructuring

 

The Company undertakes various programs to reduce expenses. These programs generally involve a reduction in staffing levels, and in certain cases, office closures. Restructuring and related charges include employee termination and relocation benefits, and post-exit rent expenses in connection with these programs, and non-cash charges resulting from pension benefit payments made to agents in connection with the 1999 reorganization of Allstate’s multiple agency programs to a single exclusive agency program and the Company’s 2006 voluntary termination offer. The expenses related to these activities are included in the Condensed Consolidated Statements of Operations as restructuring and related charges, and totaled $2 million and $52 million for the three-month periods ended September 30, 2007 and 2006, respectively, and $5 million and $171 million for the nine-month periods ended September 30, 2007 and 2006, respectively.

 

The following table illustrates the changes in the restructuring liability during the nine-month period ended September 30, 2007:

 

($ in millions)

 

Employee
costs

 

Exit
costs

 

Total
liability

 

Balance at the beginning of the year

 

$

20

 

$

2

 

$

22

 

Expense incurred

 

3

 

2

 

5

 

Adjustments to liability

 

(13

)

 

(13

)

Payments applied against liability

 

(4

)

(1

)

(5

)

Balance at the end of the period

 

$

6

 

$

3

 

$

9

 

 

The payments applied against the liability for employee costs primarily reflect severance costs, and the payments for exit costs generally consist of post-exit rent expenses and contract termination penalties.

 

7.  Guarantees and Contingent Liabilities

 

State facility assessments

 

The Company is required to participate in assigned risk plans, reinsurance facilities and joint underwriting associations in various states that provide insurance coverage to individuals or entities that otherwise are unable to purchase such coverage from private insurers. Because of the Company’s participation, it may be exposed to losses that surpass the capitalization of these facilities and/or to assessments from these facilities.

 

Shared markets

 

As a condition of maintaining its licenses to write personal property and casualty insurance in various states, the Company is required to participate in assigned risk plans, reinsurance facilities and joint underwriting associations that provide various types of insurance coverage to individuals or entities that otherwise are unable to purchase such coverage from private insurers. Underwriting results related to these arrangements, which tend to be adverse, have been immaterial to the results of operations.

 

Guarantees

 

The Company provides residual value guarantees on Company leased automobiles. If all outstanding leases were terminated effective September 30, 2007, the Company’s maximum obligation pursuant to these guarantees, assuming the automobiles have no residual value, would be $19 million at September 30, 2007. The remaining term of each residual value guarantee is equal to the term of the underlying lease that range from less than one year to three years. Historically, the Company has not made any material payments pursuant to these 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 $255 million at September 30, 2007. The obligations associated with these fixed income securities expire at various times during the next seven years.

 

In the normal course of business, the Company provides standard indemnifications to counterparties in contracts in connection with numerous transactions, including acquisitions and divestitures. The types of indemnifications typically

 

13



 

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 were 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 September 30, 2007.

 

Regulation

 

The Company is subject to changing social, economic and regulatory conditions. From time to time, regulatory authorities or legislative bodies seek to influence and restrict premium rates, require premium refunds to policyholders, restrict the ability of insurers to cancel or non-renew policies, require insurers to continue to write new policies or limit their ability to write new policies, limit insurers’ ability to change coverage terms or to impose underwriting standards, 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 subsidiaries 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.

 

                  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 or treble 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. When specific monetary demands are made, they are often set just below a state court jurisdictional limit in order to seek the maximum amount available in state court, regardless of the specifics of the case, while still avoiding the risk of removal to federal court. In our experience, monetary demands in pleadings 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.

 

14



 

                  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

 

There is one 19-state certified class action lawsuit pending against Allstate in Washington state court alleging that its failure to pay “inherent diminished value” to insureds under the uninsured motorist property damage liability provisions of auto policies constitutes breach of contract and fraud. Plaintiffs define “inherent diminished value” as the difference between the market value of the insured automobile before an accident and the market value after repair. Plaintiffs allege that they are entitled to the payment of inherent diminished value under the terms of the policy. This lawsuit is similar to others filed against other carriers in the industry. A settlement of the class action for an amount that is not material has been preliminarily approved by the court. Class members in 16 of the 19 states will be invited to participate in the settlement, but the entire case will be dismissed as a result of the settlement.

 

There are a number of state and nationwide class action lawsuits pending in various state courts challenging the legal propriety of Allstate’s medical bill review processes on a number of grounds, including the manner in which Allstate determines reasonableness and necessity. These lawsuits, which to a large degree mirror similar lawsuits filed against other carriers in the industry, allege these processes result in a breach of the insurance policy and, in some cases, the plaintiffs also allege fraud. Plaintiffs seek monetary damages in the form of contractual and extra-contractual damages. The Company denies these allegations. One nationwide class action and one statewide class action have been certified. A settlement of the statewide class action for an amount that is not material has been preliminarily approved by the court. The Company continues to vigorously defend the other cases.

 

There is a nationwide putative class action pending against Allstate that challenges Allstate’s use of a vendor’s automated database in valuing total loss automobiles. To a large degree, this lawsuit mirrors similar lawsuits filed against other carriers in the industry. Plaintiffs allege that flaws in the database result in valuations to the detriment of insureds. The plaintiffs are seeking actual and punitive damages. The lawsuit is in the early stages of discovery and Allstate is vigorously defending it.

 

The Company is defending a number of matters filed in the aftermath of Hurricanes Katrina and Rita, including individual lawsuits, and several statewide putative class action lawsuits pending in Mississippi and Louisiana. These matters are in various stages of development. The lawsuits and developments in litigation arising from the hurricanes include the following:

 

                  The Mississippi Attorney General filed a suit asserting that the flood exclusion found in Allstate’s and other insurance companies’ policies is either ambiguous, unenforceable as unconscionable or contrary to public policy, or inapplicable to the damage suffered in the wake of Hurricane Katrina. Our motion for judgment on the pleadings is pending.

 

                  In an appeal pending in the United States Court of Appeals for the Fifth Circuit, a Mississippi policyholder is challenging the federal trial court’s conclusion that the flood and water damage exclusions in Allstate’s policy apply to “storm surge” damage suffered in the wake of Hurricane Katrina.

 

                  In a putative class action in Mississippi, some members of the Mississippi Windstorm Underwriters Association (“MWUA”) have filed suit against the MWUA board members and the companies they represent, including an Allstate subsidiary, alleging that the Board purchased insufficient reinsurance to protect the MWUA members. Discovery is ongoing.

 

                  In a putative class action in Louisiana, the trial court ruled that Allstate’s and other insurers’ flood, water and negligent construction exclusions do not apply to man-made floods (i.e., floods caused by human negligence), and do not apply to flooding in the New Orleans area to the extent it was caused by human negligence in the design, construction and/or maintenance of the levees. Allstate and other insurers pursued an interlocutory appeal and in June 2007 the United States Court of Appeals for the Fifth Circuit reversed the trial court's ruling. The matter has been remanded to the trial court for further proceedings, which have been consolidated along with other putative class and individual actions brought against the Company and other insurers, challenging the adjustment and settlement of Hurricane Katrina claims.

 

                  In another case, the trial court dismissed a putative class action brought against Allstate and other insurers under Louisiana’s Valued Policy Law (“VPL”), holding that the law did not apply where the cause of the policyholder’s total loss was due in part to a non-covered peril, such as flood. United States Court of Appeals for the Fifth Circuit has affirmed the trial court's dismissal of the case.

 

      The Company has also been sued in a putative class action in the United States District Court for the Western District of Louisiana which challenges the Company's estimating and adjusting of Hurricane Katrina and Rita property damage claims in the State of Louisiana. The Company's motion to strike the class allegations was denied and the parties are proceeding with discovery. Plaintiffs' motion for class certification is pending.

 

15



 

                  The Louisiana Attorney General filed a class action lawsuit in state court against Allstate and other insurers on behalf of Road Home fund recipients alleging that the insurers have failed to pay all damages owed under their policies. The insurers removed the matter to federal court. The plaintiffs' motion to remand the matter to state court is pending before the federal court.

 

                  Private plaintiffs have filed qui tam actions under the Federal False Claims Act against Allstate and certain other insurers in Louisiana and Mississippi federal courts regarding claims that they administered under the National Flood Insurance Program. The action brought in federal court in Louisiana has been dismissed.

 

The various suits described above seek a variety of remedies, including actual and/or punitive damages in unspecified amounts and/or declaratory relief. The Company has been vigorously defending these suits and other matters related to Hurricanes Katrina and Rita.

 

In addition, the Company is responding to subpoenas and requests for information in connection with investigations into the insurance industry’s handling of claims in the aftermath of Hurricanes Katrina and Rita. These investigations are being conducted by federal and state authorities, including a federal grand jury sitting in the Southern District of Mississippi. Other insurers have received similar subpoenas and requests for information.

 

Allstate is defending various lawsuits involving worker classification issues. These lawsuits include several certified class actions challenging the overtime exemption claimed by the Company under the Fair Labor Standards Act or state wage and hour laws. In these cases, plaintiffs seek monetary relief, such as penalties and liquidated damages, and non-monetary relief, such as injunctive relief and an accounting. These class actions mirror similar lawsuits filed against other carriers in the industry and other employers. Allstate is continuing to vigorously defend its worker classification lawsuits.

 

The Company is defending certain matters relating to the Company’s 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 Allstate “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 the Company’s motions for summary judgment.

 

                  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 the Company 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 the Company had reasonable factors other than age to support the rehire policy. The Company’s interlocutory appeal of the trial court’s summary judgment order is now pending in the United States Court of Appeals for the Eighth Circuit.

 

                  The Company is also defending a certified class action filed by former employee agents who terminated their employment prior to the agency program reorganization. These plaintiffs have asserted breach of contract and ERISA claims. The court approved the form of class notice in October 2007 and set a December 2007 deadline for filing dispositive motions.

 

                  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 Allstate’s motion to dismiss the case.

 

16



 

In all of these various matters, plaintiffs seek compensatory and punitive damages, and equitable relief. Allstate has been vigorously defending these lawsuits and other matters related to its agency program reorganization.

 

The Company is vigorously defending its homeowners insurance rates in administrative actions filed by the Texas Department of Insurance. The Department is focusing, as they have with other insurers, on the reasonableness of the Company’s rates for the risks to which they apply.

 

                  In 2004, the Company made a rate filing requesting to reduce its rates by approximately 1.5%. In December 2004, the Commissioner disapproved that filing and began proceedings to disapprove the Company's then current rates. Following an administrative hearing process, in 2006, the Texas Commissioner of Insurance ordered the Company to reduce its then current homeowners rates by 5% and to pay refunds on the difference plus interest back to December 30, 2004, for which the Company has been accruing. The Company implemented a 5% rate decrease occurring in two stages but challenged this 2006 refund order in the Travis County, Texas district court. In March 2007, the district court affirmed in whole the Texas Commissioner's rate refund order. In April 2007, the Company appealed the judgment of the district court to the Third Court of Appeals, Austin, Texas. This appeal remains pending.

 

                  Allstate filed and implemented an 8% rate increase in August 2007 and immediately received an order from the Commissioner disapproving the rate change. In addition, in October 2007 the Commissioner ordered the Company to pay refunds of its homeowners rates amounting to approximately 6.5% for the period between August 20, 2007 and October 5, 2007, and refunds of approximately 18.5% for the period following October 5, 2007, plus interest. The Company was granted a permanent injunction that allows the Company’s August rate change to stay in place while the Company defends the rate change in disputing the refund order. The Company has filed a petition for an administrative hearing with respect to the refund order.

 

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.

 

Asbestos and environmental

 

Allstate’s reserves for asbestos claims were $1.34 billion and $1.38 billion, net of reinsurance recoverables of $804 million and $823 million, at September 30, 2007 and December 31, 2006, respectively. Reserves for environmental claims were $248 million and $194 million, net of reinsurance recoverables of $112 million and $55 million, at September 30, 2007 and December 31, 2006, respectively. Approximately 64% and 67% of the total net asbestos and environmental reserves at September 30, 2007 and December 31, 2006, respectively, were for incurred but not reported estimated losses.

 

Management believes its net loss reserves for environmental, asbestos and other discontinued lines exposures are appropriately established based on available facts, technology, laws and regulations. However, establishing net loss reserves for asbestos, environmental and other discontinued lines claims is subject to uncertainties that are greater than those presented by other types of claims. The ultimate cost of losses may vary materially from recorded amounts, which are based on management’s best estimate. Among the complications are lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure and unresolved legal issues regarding policy coverage; unresolved legal issues regarding the determination, availability and timing of exhaustion of policy limits; plaintiffs’ evolving and expanding theories of liability, availability and collectibility of recoveries from reinsurance, retrospectively determined premiums and other contractual agreements; and estimating the extent and timing of any contractual liability, and other uncertainties. There are also complex legal issues concerning the interpretation of various insurance policy provisions and whether those losses are covered, or were ever intended to be covered, and could be recoverable through retrospectively determined premium, reinsurance or other contractual agreements. Courts have reached different and sometimes inconsistent conclusions as to when losses are deemed to have occurred and which policies provide coverage; what types of losses are

 

17



 

covered; whether there is an insurer obligation to defend; how policy limits are determined; how policy exclusions and conditions are applied and interpreted; and whether clean-up costs represent insured property damage. Management believes these issues are not likely to be resolved in the near future, and the ultimate cost may vary materially from the amounts currently recorded resulting in an increase in loss reserves. In addition, while the Company believes that improved actuarial techniques and databases have assisted in its ability to estimate asbestos, environmental, and other discontinued lines net loss reserves, these refinements may subsequently prove to be inadequate indicators of the extent of probable losses. Due to the uncertainties and factors described above, management believes it is not practicable to develop a meaningful range for any such additional net loss reserves that may be required.

 

8.  Components of Net Periodic Pension and Postretirement Benefit Costs

 

The components of net periodic cost for the Company’s pension and postretirement benefit plans are as follows:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

($ in millions)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Pension benefits

 

 

 

 

 

 

 

 

 

Service cost

 

$

41

 

$

46

 

$

121

 

$

139

 

Interest cost

 

78

 

76

 

233

 

228

 

Expected return on plan assets

 

(89

)

(80

)

(265

)

(241

)

Amortization of:

 

 

 

 

 

 

 

 

 

Prior service costs

 

 

(1

)

(1

)

(2

)

Net loss

 

29

 

36

 

87

 

107

 

Settlement loss (1)

 

3

 

95

 

25

 

108

 

Net periodic pension cost

 

$

62

 

$

172

 

$

200

 

$

339

 

 

 

 

 

 

 

 

 

 

 

Postretirement benefits

 

 

 

 

 

 

 

 

 

Service cost

 

$

6

 

$

6

 

$

18

 

$

19

 

Interest cost

 

16

 

17

 

49

 

51

 

Amortization of:

 

 

 

 

 

 

 

 

 

Prior service costs

 

 

 

(1

)

(1

)

Net loss

 

 

 

 

1

 

Special termination benefit

 

 

 

 

3

 

Net periodic postretirement cost

 

$

22

 

$

23

 

$

66

 

$

73

 

 


(1)  In the three-months ended September 30, 2006, the Company recognized an $89 million pretax non-cash settlement charge as a result of higher lump sum payments to participants of the Company’s pension plans.

 

18



 

9.  Business Segments

 

Summarized revenue data for each of the Company’s business segments are as follows:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

($ in millions)

 

2007

 

2006

 

2007

 

2006

 

Revenues

 

 

 

 

 

 

 

 

 

Property-Liability

 

 

 

 

 

 

 

 

 

Property-liability insurance premiums earned

 

 

 

 

 

 

 

 

 

Standard auto

 

$

4,287

 

$

4,199

 

$

12,791

 

$

12,498

 

Non-standard auto

 

322

 

377

 

1,002

 

1,177

 

Auto

 

4,609

 

4,576

 

13,793

 

13,675

 

Homeowners

 

1,566

 

1,561

 

4,722

 

4,815

 

Other

 

644

 

664

 

1,932

 

2,045

 

Allstate Protection

 

6,819

 

6,801

 

20,447

 

20,535

 

Discontinued Lines and Coverages

 

 

 

 

2

 

Total property-liability insurance premiums earned

 

6,819

 

6,801

 

20,447

 

20,537

 

Net investment income

 

474

 

455

 

1,482

 

1,382

 

Realized capital gains and losses

 

250

 

(34

)

1,131

 

233

 

Total Property-Liability

 

7,543

 

7,222

 

23,060

 

22,152

 

 

 

 

 

 

 

 

 

 

 

Allstate Financial

 

 

 

 

 

 

 

 

 

Life and annuity premiums and contract charges

 

 

 

 

 

 

 

 

 

Traditional life

 

70

 

68

 

210

 

207

 

Immediate annuities with life contingencies

 

32

 

59

 

161

 

177

 

Accident and health and other

 

97

 

84

 

280

 

247

 

Total life and annuity premiums

 

199

 

211

 

651

 

631

 

Interest-sensitive life

 

230

 

215

 

677

 

632

 

Fixed annuities

 

19

 

17

 

56

 

53

 

Variable annuities

 

 

1

 

1

 

138

 

Bank and other

 

1

 

 

1

 

 

Total contract charges

 

250

 

233

 

735

 

823

 

Total life and annuity premiums and contract charges

 

449

 

444

 

1,386

 

1,454

 

Net investment income

 

1,086

 

1,063

 

3,212

 

3,115

 

Realized capital gains and losses

 

(127

)

(30

)

 

(138

)

Total Allstate Financial

 

1,408

 

1,477

 

4,598

 

4,431

 

 

 

 

 

 

 

 

 

 

 

Corporate and Other

 

 

 

 

 

 

 

 

 

Service fees

 

3

 

2

 

8

 

7

 

Net investment income

 

43

 

36

 

114

 

116

 

Realized capital gains and losses

 

(2

)

3

 

6

 

(5

)

Total Corporate and Other before reclassification of service fees

 

44

 

41

 

128

 

118

 

Reclassification of service fees (1)

 

(3

)

(2

)

(8

)

(7

)

Total Corporate and Other

 

41

 

39

 

120

 

111

 

Consolidated Revenues

 

$

8,992

 

$

8,738

 

$

27,778

 

$

26,694

 

 


(1) For presentation in the Condensed Consolidated Statements of Operations, service fees of the Corporate and Other segment are reclassified to operating costs and expenses.

 

19



 

Summarized financial performance data for each of the Company’s reportable segments are as follows:

 

 

 

Three months ended
September 30,

 

Nine months ended

September 30,

 

($ in millions)

 

2007

 

2006

 

2007

 

2006

 

Net income

 

 

 

 

 

 

 

 

 

Property-Liability

 

 

 

 

 

 

 

 

 

Underwriting income

 

 

 

 

 

 

 

 

 

Allstate Protection

 

$

688

 

$

1,196

 

$

2,544

 

$

3,652

 

Discontinued Lines and Coverages

 

(71

)

(118

)

(36

)

(133

)

Total underwriting income

 

617

 

1,078

 

2,508

 

3,519

 

Net investment income

 

474

 

455

 

1,482

 

1,382

 

Income tax expense on operations

 

(319

)

(466

)

(1,209

)

(1,523

)

Realized capital gains and losses, after-tax

 

163

 

(22

)

733

 

153

 

Gain (loss) on disposition of operations, after-tax

 

 

 

 

(1

)

Property-Liability net income

 

935

 

1,045

 

3,514

 

3,530

 

 

 

 

 

 

 

 

 

 

 

Allstate Financial

 

 

 

 

 

 

 

 

 

Life and annuity premiums and contract charges

 

449

 

444

 

1,386

 

1,454

 

Net investment income

 

1,086

 

1,063

 

3,212

 

3,115

 

Periodic settlements and accruals on non-hedge derivative financial instruments

 

12

 

14

 

36

 

44

 

Contract benefits and interest credited to contractholder funds

 

(1,058

)

(1,059

)

(3,191

)

(3,080

)

Operating costs and expenses and amortization of deferred policy acquisition costs

 

(273

)

(244

)

(766

)

(840

)

Restructuring and related charges

 

(1

)

(5

)

 

(24

)

Income tax expense on operations

 

(68

)

(65

)

(220

)

(217

)

Operating income

 

147

 

148

 

457

 

452

 

Realized capital gains and losses, after-tax

 

(82

)

(19

)

 

(89

)

Deferred policy acquisition costs and deferred sales inducements amortization relating to realized capital gains and losses, after-tax

 

11

 

16

 

(4

)

40

 

Reclassification of periodic settlements and accruals on non-hedge financial instruments, after-tax

 

(8

)

(9

)

(23

)

(28

)

Gain (loss) on disposition of operations, after-tax

 

2

 

(1

)

4

 

(59

)

Allstate Financial net income

 

70

 

135

 

434

 

316

 

 

 

 

 

 

 

 

 

 

 

Corporate and Other

 

 

 

 

 

 

 

 

 

Service fees (1)

 

3

 

2

 

8

 

7

 

Net investment income

 

43

 

36

 

114

 

116

 

Operating costs and expenses

 

(98

)

(91

)

(276

)

(266

)

Restructuring and related charges

 

 

 

 

(1

)

Income tax benefit on operations

 

26

 

29

 

78

 

81

 

Operating loss

 

(26

)

(24

)

(76

)

(63

)

Realized capital gains and losses, after-tax

 

(1

)

2

 

4

 

(3

)

Corporate and Other net loss

 

(27

)

(22

)

(72

)

(66

)

Consolidated net income (loss)

 

$

978

 

$

1,158

 

$

3,876

 

$

3,780

 

 


(1) For presentation in the Condensed Consolidated Statements of Operations, service fees of the Corporate and Other segment are reclassified to operating costs and expenses.

 

20



 

10. Other Comprehensive Income

 

The components of other comprehensive income (loss) on a pretax and after-tax basis are as follows:

 

 

 

Three months ended September 30,

 

 

 

2007

 

2006

 

($ in millions)

 

Pretax

 

Tax

 

After-
tax

 

Pretax

 

Tax

 

After-
tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized net holding gains (losses) arising during the period, net of related offsets

 

$

227

 

$

(80

)

$

147

 

$

1,570

 

$

(549

)

$

1,021

 

Less: reclassification adjustment of realized capital gains and losses

 

310

 

(109

)

201

 

235

 

(82

)

153

 

Unrealized net capital (losses) gains

 

(83

)

29

 

(54

)

1,335

 

(467

)

868

 

Unrealized foreign currency translation adjustments

 

36

 

(13

)

23

 

 

 

 

Net funded status of pension and other postretirement benefit obligation

 

22

 

(8

)

14

 

 

 

 

Other comprehensive (loss) income

 

$

(25

)

$

8

 

(17

)

$

1,335

 

$

(467

)

868

 

Net income

 

 

 

 

 

978

 

 

 

 

 

1,158

 

Comprehensive income

 

 

 

 

 

$

961

 

 

 

 

 

$

2,026

 

 

 

 

Nine months ended September 30,

 

 

 

2007

 

2006

 

($ in millions)

 

Pretax

 

Tax

 

After-
tax

 

Pretax

 

Tax

 

After-
tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized net holding (losses) gains arising during the period, net of related offsets

 

$

55

 

$

(19

)

$

36

 

$

(11

)

$

4

 

$

(7

)

Less: reclassification adjustment of realized capital gains and losses

 

1,129

 

(395

)

734

 

188

 

(66

)

122

 

Unrealized net capital (losses) gains

 

(1,074

)

376

 

(698

)

(199

)

70

 

(129

)

Unrealized foreign currency translation adjustments

 

74

 

(26

)

48

 

25

 

(9

)

16

 

Net funded status of pension and other postretirement benefit obligation

 

72

 

(3

)

69

 

 

 

 

Other comprehensive (loss) income

 

$

(928

)

$

347

 

(581

)

$

(174

)

$

61

 

(113

)

Net income

 

 

 

 

 

3,876

 

 

 

 

 

3,780

 

Comprehensive income

 

 

 

 

 

$

3,295

 

 

 

 

 

$

3,667

 

 

21



 

11.  Capital Structure

 

In May 2007, the Company issued $500 million of Series A 6.50% and $500 million of Series B 6.125% Fixed-to-Floating Rate Junior Subordinated Debentures (together the “Debentures”). The scheduled maturity dates for the Debentures are May 15, 2057 and May 15, 2037 for Series A and Series B, respectively, with a final maturity date of May 15, 2067. Any or all of the Debentures may be redeemed (a) on or after May 15, 2037 or May 15, 2017 for Series A and Series B, respectively, at a redemption price equal to 100% of the principal amount of the Debentures being redeemed plus any accrued and unpaid interest and (b) before May 15, 2037 or May 15, 2017 for Series A and Series B, respectively, (i) in whole at any time or in part from time to time or (ii) in whole, but not in part, if certain changes occur relating to the tax treatment of or rating agency equity credit accorded to the Debentures, in each case at a redemption price equal to the greater of 100% of the principal amount of the Debentures being redeemed plus any accrued and unpaid interest and the applicable make-whole amount.

 

Interest on the Debentures is payable semi-annually at the stated fixed annual rate to May 15, 2037 and May 15, 2017 for Series A and Series B, respectively, and then payable quarterly at an annual rate equal to the three-month LIBOR plus 2.12% and 1.935% for Series A and Series B, respectively. The Company may elect at one or more times to defer payment of interest on the Debentures for one or more consecutive interest periods that do not exceed 10 years. Interest compounds during such deferral periods at the rate in effect for each period. The interest deferral feature obligates the Company in certain circumstances to issue common stock or certain other types of securities if it cannot otherwise raise sufficient funds to make the required interest payments. The Company has reserved 75 million shares of its authorized and unissued common stock to satisfy this obligation.

 

In connection with the issuance of the Debentures, the Company entered into replacement capital covenants. These covenants are not intended for the benefit of the holders of the Debentures and may not be enforced by them. Rather, they are for the benefit of holders of one or more other designated series of the Company’s indebtedness, initially the 6.90% Senior Debentures due 2038. Pursuant to these covenants, the Company has agreed that it will not repay, redeem, or purchase the Debentures on or before May 15, 2067 and May 15, 2047 for Series A and Series B, respectively, unless, subject to certain limitations, the Company has received proceeds in specified amounts from the issuance of specified securities. These covenants terminate in 2067 and 2047 for Series A and Series B, respectively, or earlier upon the occurrence of certain events, including an acceleration of the Debentures of the particular series due to the occurrence of an event of default. An event of default, as defined by the supplemental indentures, includes default in the payment of interest or principal and bankruptcy proceedings.

 

In May 2007, the Company entered into a new $1.00 billion unsecured revolving credit facility, which replaced the Company’s primary credit facility covering short-term liquidity requirements. The facility has an initial term of five years expiring in 2012 with two one-year extensions that can be exercised in the first or second year of the facility upon approval of existing or replacement lenders providing more than two-thirds of the commitments to lend. This facility also 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 the Company not to exceed a 37.5% debt to capital resources ratio as defined in the agreement. 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 Company’s senior, unsecured, nonguaranteed long-term debt.

 

22



 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of

The Allstate Corporation

 

We have reviewed the accompanying condensed consolidated statement of financial position of The Allstate Corporation and subsidiaries (the “Company”) as of September 30, 2007, and the related condensed consolidated statements of operations for the three-month and nine-month periods ended September 30, 2007 and 2006, and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2007 and 2006. These interim financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial position of The Allstate Corporation and subsidiaries as of December 31, 2006, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for the year then ended, not presented herein. In our report dated February 21, 2007, which report includes an explanatory paragraph as to changes in the Company’s method of accounting for defined pension and other postretirement plans in 2006, and its method of accounting for certain nontraditional long-duration contracts and separate accounts in 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial position as of December 31, 2006 is fairly stated, in all material respects, in relation to the consolidated statement of financial position from which it has been derived.

 

 

/s/ Deloitte & Touche LLP

 

Chicago, Illinois

October 30, 2007

 

23



 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2007 AND 2006

 

OVERVIEW

 

The following discussion highlights significant factors influencing the consolidated financial position and results of operations of The Allstate Corporation (referred to in this document as “we”, “our”, “us”, the “Company” or “Allstate”). It should be read in conjunction with the condensed consolidated financial statements and notes thereto found under Part I. Item 1. contained herein, and with the discussion, analysis, consolidated financial statements and notes thereto in Part I. Item 1. and Part II. Item 7. and Item 8. of The Allstate Corporation Annual Report on Form 10-K for 2006. Analysis of our insurance segments is provided in the Property-Liability Operations (which includes the Allstate Protection and the Discontinued Lines and Coverages segments) and in the Allstate Financial Segment sections of Management’s Discussion and Analysis (“MD&A”). The segments are consistent with the way in which we use financial information to evaluate business performance and to determine the allocation of resources.

 

Allstate continues to pursue a multifaceted strategy that is focused upon four key activities:  operational excellence, aggressive capital management, customer-centric products and services, and enterprise risk and return initiatives to capture incremental sources of profit.

 

HIGHLIGHTS

 

             Net income decreased 15.5% to $978 million in the third quarter of 2007 from $1.16 billion in the third quarter of 2006, and increased 2.5% to $3.88 billion in the first nine months of 2007 from $3.78 billion in the first nine months of 2006. Net income per diluted share decreased 7.1% to $1.70 in the third quarter of 2007 from $1.83 in the third quarter of 2006, and increased 8.5% to $6.41 in the first nine months of 2007 from $5.91 in the first nine months of 2006.

 

             Total revenues increased 2.9% to $8.99 billion in the third quarter of 2007 from $8.74 billion in the third quarter of 2006, and 4.1% to $27.78 billion in the first nine months of 2007 from $26.69 billion in the first nine months of 2006.

 

             Realized capital gains on a pre-tax basis were $121 million in the third quarter of 2007 compared to realized capital losses of $61 million in the third quarter of 2006, and realized capital gains were $1.14 billion in the first nine months of 2007 compared to $90 million in the first nine months of 2006.

 

             Book value per diluted share increased 6.8% to $37.45 as of September 30, 2007 compared to $35.08 as of September 30, 2006, increased 2.9% compared to $36.39 as of June 30, 2007 and increased 7.5% compared to $34.84 as of December 31, 2006.

 

             For the twelve months ended September 30, 2007, return on the average of beginning and ending period shareholders’ equity of 23.2% was comparable to the twelve months ended September 30, 2006.

 

             Property-Liability premiums earned increased 0.3% to $6.82 billion in the third quarter of 2007 from $6.80 billion in the third quarter of 2006, and decreased 0.4% to $20.45 billion for the first nine months of 2007 from $20.54 billion for the first nine months of 2006.

 

             The Property-Liability combined ratio was 91.0 in the third quarter of 2007 compared to 84.1 in the third quarter of 2006 and 87.7 in the first nine months of 2007 compared to 82.9 in the first nine months of 2006.

 

             Allstate Financial net income decreased $65 million to $70 million in the third quarter of 2007 from $135 million in the third quarter of 2006, and increased $118 million to $434 million in the first nine months of 2007 compared to $316 million in the first nine months of 2006.

 

             Stock repurchases totaled $773 million and $2.97 billion for the three months and nine months ended September 30, 2007, respectively. As of September 30, 2007, our $4.00 billion share repurchase program, which was increased from $3.00 billion in May 2007, had $820 million remaining and is expected to be completed by March 31, 2008. Share repurchases during the second and third quarter of 2007 included an accelerated stock repurchase agreement which commenced on June 27, 2007 and settled on August 14, 2007 totaling $500 million.

 

24



 

CONSOLIDATED NET INCOME

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(in millions)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

Property-liability insurance premiums earned

 

$

6,819

 

$

6,801

 

$

20,447

 

$

20,537

 

Life and annuity premiums and contract charges

 

449

 

444

 

1,386

 

1,454

 

Net investment income

 

1,603

 

1,554

 

4,808

 

4,613

 

Realized capital gains and losses

 

121

 

(61

)

1,137

 

90

 

Total revenues

 

8,992

 

8,738

 

27,778

 

26,694

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Property-liability insurance claims and claims expense

 

(4,509

)

(4,012

)

(12,943

)

(11,879

)

Life and annuity contract benefits

 

(371

)

(388

)

(1,185

)

(1,135

)

Interest credited to contractholder funds

 

(685

)

(667

)

(2,007

)

(1,939

)

Amortization of deferred policy acquisition costs

 

(1,170

)

(1,160

)

(3,539

)

(3,522

)

Operating costs and expenses

 

(785

)

(726

)

(2,246

)

(2,252

)

Restructuring and related charges

 

(2

)

(52

)

(5

)

(171

)

Interest expense

 

(90

)

(90

)

(245

)

(261

)

Total costs and expenses

 

(7,612

)

(7,095

)

(22,170

)

(21,159

)

 

 

 

 

 

 

 

 

 

 

Gain (loss) on disposition of operations

 

6

 

(1

)

8

 

(89

)

Income tax expense

 

(408

)

(484

)

(1,740

)

(1,666

)

Net income

 

$

978

 

$

1,158

 

$

3,876

 

$

3,780

 

 

 

 

 

 

 

 

 

 

 

Property-Liability

 

$

935

 

$

1,045

 

$

3,514

 

$

3,530

 

Allstate Financial

 

70

 

135

 

434

 

316

 

Corporate and Other

 

(27

)

(22

)

(72

)

(66

)

Net income

 

$

978

 

$

1,158

 

$

3,876

 

$

3,780

 

 

PROPERTY-LIABILITY HIGHLIGHTS

 

                  Premiums written decreased 0.7% to $7.08 billion in the third quarter of 2007 from $7.12 billion in the third quarter of 2006, and 1.4% to $20.62 billion in the first nine months of 2007 from $20.92 billion in the first nine months of 2006. Allstate brand standard auto premiums written increased 2.3% to $4.08 billion in the third quarter of 2007 from $3.99 billion in the third quarter of 2006, and 2.3% to $12.09 billion in the first nine months of 2007 from $11.81 billion in the first nine months of 2006. Allstate brand homeowners premiums written decreased 2.8% to $1.59 billion in the third quarter of 2007 from $1.64 billion in the third quarter of 2006, and 4.3% to $4.35 billion in the first nine months of 2007 from $4.54 billion in the first nine months of 2006. Premiums written is an operating measure that is defined and reconciled to premiums earned on page 29.

 

                  The impact of the cost of the catastrophe reinsurance program on premiums written totaled $227 million in the third quarter of 2007 compared to $211 million in the third quarter of 2006 and $674 million in the first nine months of 2007 compared to $398 million in the first nine months of 2006. Excluding this cost, premiums written decreased 0.4% and 0.1% in the third quarter and first nine months of 2007, respectively, when compared to the same periods of 2006.

 

                  Premium operating measures and statistics contributing to the overall Allstate brand standard auto premiums written growth were the following:

 

25



 

                  1.3% increase in policies in force (“PIF”) as of the third quarter of 2007 when compared to the third quarter of 2006

 

                  4.8% and 0.8% decrease in new issued applications in the third quarter and first nine months of 2007, respectively, when compared to the same periods of 2006

 

                  0.7 point decline in the renewal ratio to 89.4% in the third quarter of 2007 compared to the third quarter of 2006, and 0.4 point decline in the renewal ratio to 89.7% in the first nine months of 2007 compared to the first nine months of 2006

 

                  1.0% increase in the six month average premium to $423 in the third quarter of 2007, and 0.5% increase in the six month average premium in the first nine months of 2007 to $421

 

                  Premium operating measures and statistics contributing to the overall Allstate brand homeowners premiums written decline were the following:

 

                  2.7% decrease in PIF as of the third quarter of 2007 when compared to the third quarter of 2006

 

                  22.7% and 17.2% decrease in new issued applications in the third quarter and first nine months of 2007, respectively, when compared to the same periods of 2006

 

                  1.1 point decline in the renewal ratio to 86.3% in the third quarter of 2007 compared to the third quarter of 2006, and 0.5 point decline in the renewal ratio to 86.7% in the first nine months of 2007 compared to the first nine months of 2006

 

                  1.6% increase in the twelve month average premium to $846 in the third quarter of 2007, and 2.0% increase in the twelve month average premium in the first nine months of 2007 to $848

 

                  Standard auto property damage gross claim frequency (rate of claim occurrence) increased 4.8% and 4.0% in the third quarter and first nine months of 2007, respectively, from the same periods of 2006, and bodily injury gross claim frequency increased 0.1% and decreased 1.1% in the third quarter and first nine months of 2007, respectively, from the same periods of 2006. Auto property damage and bodily injury paid severities (average cost per claim) increased 2.8% and 7.3%, respectively, in the third quarter of 2007, and 1.7% and 4.9%, respectively, in the first nine months of 2007 from the same periods of 2006. The Allstate brand standard auto loss ratio increased 5.9 points to 65.8 in the third quarter of 2007 from 59.9 in the third quarter of 2006, and 4.0 points to 64.3 in the first nine months of 2007 from 60.3 in the first nine months of 2006.

 

                  Homeowner gross claim frequency excluding catastrophes increased 5.4% and 10.6% in the third quarter and first nine months of 2007, respectively, from the same periods of 2006. Homeowners paid severity, excluding catastrophes, increased 11.8% and 9.9% in the third quarter and first nine months of 2007, respectively, from the same periods of 2006. The Allstate brand homeowners loss ratio, which includes catastrophes, increased 18.6 points to 68.4 in the third quarter of 2007 from 49.8 in the third quarter of 2006, and 14.1 points to 63.7 in the first nine months of 2007 from 49.6 in the first nine months of 2006.

 

                  Prior year unfavorable reserve reestimates in the third quarter of 2007 totaled $52 million compared to favorable prior year reserve reestimates of $221 million in the third quarter of 2006. Prior year favorable reserve reestimates in the first nine months of 2007 totaled $220 million compared to $787 million in the first nine months of 2006.

 

                  Catastrophe losses in the third quarter of 2007 totaled $343 million compared to $169 million in the third quarter of 2006 and $937 million in the first nine months of 2007 compared to $531 million in the first nine months of 2006. Impact of prior year reserve reestimates on catastrophe losses was $57 million and $101 million unfavorable in the third quarter and first nine months of 2007, respectively, compared to a favorable impact of $36 million and $223 million in the third quarter and first nine months of 2006, respectively.

 

                  Underwriting income for Property-Liability was $617 million in the third quarter of 2007 compared to $1.08 billion in the third quarter of 2006 and $2.51 billion in the first nine months of 2007 compared to $3.52 billion in the first nine months of 2006. Underwriting income, a measure that is not based on generally accepted accounting principles (“GAAP”), is defined below.

 

                  Investments as of September 30, 2007 decreased 1.5% from September 30, 2006 and net investment income increased 4.2% and 7.2% in the third quarter and first nine months of 2007 when compared to the same periods of 2006.

 

26



 

PROPERTY-LIABILITY OPERATIONS

 

Our Property-Liability operations consist of two business segments: Allstate Protection and Discontinued Lines and Coverages. Allstate Protection is comprised of two brands, the Allstate brand and Encompass brand. Allstate Protection is principally engaged in the sale of personal property and casualty insurance, primarily private passenger auto and homeowners insurance, to individuals in the United States and Canada. Discontinued Lines and Coverages includes results from insurance coverage that we no longer write and results for certain commercial and other businesses in run-off. These segments are consistent with the groupings of financial information that management uses to evaluate performance and to determine the allocation of resources.

 

Underwriting income (loss), a measure that is not based on GAAP and is reconciled to net income on page 28, is calculated as premiums earned, less claims and claims expense (“losses”), amortization of deferred policy acquisition costs (“DAC”), operating costs and expenses and restructuring and related charges, as determined using GAAP. We use this measure in our evaluation of results of operations to analyze the profitability of the Property-Liability insurance operations separately from investment results. It is also an integral component of incentive compensation. It is useful for investors to evaluate the components of income separately and in the aggregate when reviewing performance. Net income is the GAAP measure most directly comparable to underwriting income (loss). Underwriting income (loss) should not be considered as a substitute for net income and does not reflect the overall profitability of the business.

 

The table below includes GAAP operating ratios we use to measure our profitability. We believe that they enhance an investor’s understanding of our profitability. They are calculated as follows:

 

                  Claims and claims expense (“loss”) ratio - the ratio of claims and claims expense to premiums earned. Loss ratios include the impact of catastrophe losses.

 

                  Expense ratio – the ratio of amortization of DAC, operating costs and expenses, and restructuring and related charges to premiums earned.

 

                  Combined ratio – the ratio of claims and claims expense, amortization of DAC, operating costs and expenses, and restructuring and related charges to premiums earned. The combined ratio is the sum of the loss ratio and the expense ratio. The difference between 100% and the combined ratio represents underwriting income as a percentage of premiums earned.

 

We have also calculated the following impacts of specific items on the GAAP operating ratios because of the volatility of these items between fiscal periods.

 

                  Effect of catastrophe losses on combined ratio – the percentage of catastrophe losses included in claims and claims expense to premiums earned. This ratio includes prior year reserve reestimates of catastrophe losses.

 

                  Effect of prior year reserve reestimates on combined ratio – the percentage of prior year reserve reestimates included in claims and claims expense to premiums earned. This ratio includes prior year reserve reestimates of catastrophe losses.

 

                  Effect of restructuring and related charges on combined ratio – the percentage of restructuring and related charges to premiums earned.

 

                  Effect of Discontinued Lines and Coverages on combined ratio – the ratio of claims and claims expense and other costs and expenses in the Discontinued Lines and Coverages segment to Property-Liability premiums earned. The sum of the effect of Discontinued Lines and Coverages on the combined ratio and the Allstate Protection combined ratio is equal to the Property-Liability combined ratio.

 

27



 

Summarized financial data, a reconciliation of underwriting income to net income and GAAP operating ratios for our Property-Liability operations are presented in the following table.

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(in millions, except ratios)

 

2007

 

2006

 

2007

 

2006

 

Premiums written

 

$

7,075

 

$

7,123

 

$

20,623

 

$

20,922

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

Premiums earned

 

$

6,819

 

$

6,801

 

$

20,447

 

$

20,537

 

Net investment income

 

474

 

455

 

1,482

 

1,382

 

Realized capital gains and losses

 

250

 

(34

)

1,131

 

233

 

Total revenues

 

7,543

 

7,222

 

23,060

 

22,152

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Claims and claims expense

 

(4,509

)

(4,012

)

(12,943

)

(11,879

)

Amortization of DAC

 

(1,025

)

(1,039

)

(3,081

)

(3,088

)

Operating costs and expenses

 

(667

)

(625

)

(1,910

)

(1,905

)

Restructuring and related charges

 

(1

)

(47

)

(5

)

(146

)

Total costs and expenses

 

(6,202

)

(5,723

)

(17,939

)

(17,018

)

 

 

 

 

 

 

 

 

 

 

Gain (loss) on disposition of operations

 

 

 

 

(1

)

Income tax expense

 

(406

)

(454

)

(1,607

)

(1,603

)

Net income

 

$

935

 

$

1,045

 

$

3,514

 

$

3,530

 

 

 

 

 

 

 

 

 

 

 

Underwriting income

 

$

617

 

$

1,078

 

$

2,508

 

$

3,519

 

Net investment income

 

474

 

455

 

1,482

 

1,382

 

Income tax expense on operations

 

(319

)

(466

)

(1,209

)

(1,523

)

Realized capital gains and losses, after-tax

 

163

 

(22

)

733

 

153

 

Gain (loss) on disposition of operations, after-tax

 

 

 

 

(1

)

Net income

 

$

935

 

$

1,045

 

$

3,514

 

$

3,530

 

 

 

 

 

 

 

 

 

 

 

Catastrophe losses

 

$

343

 

$

169

 

$

937

 

$

531

 

 

 

 

 

 

 

 

 

 

 

GAAP operating ratios

 

 

 

 </