10-Q 1 a09-11024_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 MARCH 31, 2009

 

 

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 Number)

 

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 

Yes  o  No  o

 

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

 

 

Large accelerated filer
x

Accelerated filer
o

Non-accelerated filer
o

Smaller reporting company
o

 

(Do not check if a smaller reporting company)

 

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 April 30, 2009, the registrant had 536,363,853 common shares, $.01 par value, outstanding.

 

 

 



 

THE ALLSTATE CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

March 31, 2009

 

PART I

FINANCIAL INFORMATION

 

PAGE

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Three-Month Periods Ended March 31, 2009 and 2008 (unaudited)

 

1

 

 

 

 

 

Condensed Consolidated Statements of Financial Position as of March 31, 2009 (unaudited) and December 31, 2008

 

2

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2009 and 2008 (unaudited)

 

3

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

4

 

 

 

 

 

Report of Independent Registered Public Accounting Firm

 

32

 

 

 

 

Item 2.

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

 

 

 

 

 

 

 

Highlights

 

33

 

Consolidated Net (Loss) Income

 

34

 

Property-Liability Highlights

 

35

 

Allstate Protection Segment

 

39

 

Discontinued Lines and Coverages Segment

 

54

 

Property-Liability Investment Results

 

55

 

Allstate Financial Highlights

 

56

 

Allstate Financial Segment

 

56

 

Investment Highlights

 

63

 

Investments

 

63

 

Fair Value of Assets and Liabilities

 

89

 

Deferred Taxes

 

95

 

Capital Resources and Liquidity Highlights

 

96

 

Capital Resources and Liquidity

 

96

 

 

 

 

Item 4.

Controls and Procedures

 

102

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

103

 

 

 

 

Item 1A.

Risk Factors

 

103

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

103

 

 

 

 

Item 6.

Exhibits

 

104

 


 

PART I. FINANCIAL INFORMATION

 

ITEM 1.   FINANCIAL STATEMENTS

 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

Three Months Ended
March 31,

 

($ in millions, except per share data)

 

2009

 

2008

 

 

 

(unaudited)

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

Property-liability insurance premiums earned

 

$

6,582

 

$

6,764

 

Life and annuity premiums and contract charges

 

484

 

452

 

Net investment income

 

1,176

 

1,526

 

Realized capital gains and losses

 

(359

)

(655

)

 

 

7,883

 

8,087

 

Costs and expenses

 

 

 

 

 

Property-liability insurance claims and claims expense

 

4,720

 

4,676

 

Life and annuity contract benefits

 

387

 

397

 

Interest credited to contractholder funds

 

579

 

624

 

Amortization of deferred policy acquisition costs

 

1,397

 

1,075

 

Operating costs and expenses

 

801

 

792

 

Restructuring and related charges

 

45

 

(1

)

Interest expense

 

88

 

88

 

 

 

8,017

 

7,651

 

 

 

 

 

 

 

Gain (loss) on disposition of operations

 

3

 

(9

)

 

 

 

 

 

 

(Loss) income from operations before income tax expense

 

(131

)

427

 

 

 

 

 

 

 

Income tax expense

 

143

 

79

 

 

 

 

 

 

 

Net (loss) income

 

$

(274

)

$

348

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income per share - Basic

 

$

(0.51

)

$

0.62

 

 

 

 

 

 

 

Weighted average shares - Basic

 

538.9

 

560.8

 

 

 

 

 

 

 

Net (loss) income per share - Diluted

 

$

(0.51

)

$

0.62

 

 

 

 

 

 

 

Weighted average shares - Diluted

 

538.9

 

562.8

 

 

 

 

 

 

 

Cash dividends declared per share

 

$

0.20

 

$

0.41

 

 

See notes to condensed consolidated financial statements.

 

1



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

 

 

 

March 31,

 

December 31,

 

($ in millions, except par value data)

 

2009

 

2008

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Investments

 

 

 

 

 

Fixed income securities, at fair value (amortized cost $77,322 and $77,104)

 

$

68,438

 

$

68,608

 

Equity securities, at fair value (cost $2,947 and $3,137)

 

2,410

 

2,805

 

Mortgage loans

 

9,710

 

10,229

 

Limited partnership interests

 

2,482

 

2,791

 

Short-term, at fair value (amortized cost $8,124 and $8,903)

 

8,125

 

8,906

 

Other

 

2,708

 

2,659

 

Total investments

 

93,873

 

95,998

 

Cash

 

837

 

415

 

Premium installment receivables, net

 

4,766

 

4,842

 

Deferred policy acquisition costs

 

8,379

 

8,542

 

Reinsurance recoverables, net

 

6,651

 

6,403

 

Accrued investment income

 

906

 

884

 

Deferred income taxes

 

3,486

 

3,794

 

Property and equipment, net

 

1,044

 

1,059

 

Goodwill

 

874

 

874

 

Other assets

 

2,180

 

3,748

 

Separate Accounts

 

7,375

 

8,239

 

Total assets

 

$

130,371

 

$

134,798

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Reserve for property-liability insurance claims and claims expense

 

$

19,124

 

$

19,456

 

Reserve for life-contingent contract benefits

 

12,669

 

12,881

 

Contractholder funds

 

56,621

 

58,413

 

Unearned premiums

 

9,685

 

10,024

 

Claim payments outstanding

 

629

 

790

 

Other liabilities and accrued expenses

 

6,338

 

6,663

 

Long-term debt

 

5,659

 

5,659

 

Separate Accounts

 

7,375

 

8,239

 

Total liabilities

 

118,100

 

122,125

 

 

 

 

 

 

 

Commitments and Contingent Liabilities (Note 9)

 

 

 

 

 

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, 536 million and 536 million shares outstanding

 

9

 

9

 

Additional capital paid-in

 

3,129

 

3,130

 

Retained income

 

29,825

 

30,207

 

Deferred ESOP expense

 

(46

)

(49

)

Treasury stock, at cost (364 million and 364 million shares)

 

(15,836

)

(15,855

)

Accumulated other comprehensive income:

 

 

 

 

 

Unrealized net capital gains and losses

 

(3,767

)

(3,738

)

Unrealized foreign currency translation adjustments

 

(3

)

5

 

Unrecognized pension and other postretirement benefit cost

 

(1,069

)

(1,068

)

Total accumulated other comprehensive loss

 

(4,839

)

(4,801

)

Total shareholders’ equity

 

12,242

 

12,641

 

Noncontrolling interest

 

29

 

32

 

Total equity

 

12,271

 

12,673

 

Total liabilities and equity

 

$

130,371

 

$

134,798

 

 

See notes to condensed consolidated financial statements.

 

2



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

Three Months Ended
March 31,

 

($ in millions)

 

2009

 

2008

 

 

 

(unaudited)

 

Cash flows from operating activities

 

 

 

 

 

Net (loss) income

 

$

(274

)

$

348

 

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

 

 

 

 

 

Depreciation, amortization and other non-cash items

 

(74

)

(59

)

Realized capital gains and losses

 

359

 

655

 

(Gain) loss on disposition of operations

 

(3

)

9

 

Interest credited to contractholder funds

 

579

 

624

 

Changes in:

 

 

 

 

 

Policy benefits and other insurance reserves

 

(244

)

8

 

Unearned premiums

 

(330

)

(281

)

Deferred policy acquisition costs

 

381

 

(36

)

Premium installment receivables, net

 

71

 

19

 

Reinsurance recoverables, net

 

(81

)

(38

)

Income taxes

 

1,443

 

47

 

Other operating assets and liabilities

 

(305

)

(176

)

Net cash provided by operating activities

 

1,522

 

1,120

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from sales

 

 

 

 

 

Fixed income securities

 

4,483

 

8,012

 

Equity securities

 

1,872

 

3,252

 

Limited partnership interests

 

154

 

114

 

Mortgage loans

 

12

 

 

Other investments

 

16

 

96

 

Investment collections

 

 

 

 

 

Fixed income securities

 

1,203

 

1,062

 

Mortgage loans

 

472

 

135

 

Other investments

 

31

 

26

 

Investment purchases

 

 

 

 

 

Fixed income securities

 

(5,425

)

(5,274

)

Equity securities

 

(1,933

)

(2,906

)

Limited partnership interests

 

(144

)

(333

)

Mortgage loans

 

(10

)

(345

)

Other investments

 

 

(21

)

Change in short-term investments, net

 

707

 

(3,430

)

Change in other investments, net

 

(48

)

(226

)

Disposition of operations

 

12

 

 

Purchases of property and equipment, net

 

(53

)

(52

)

Net cash provided by investing activities

 

1,349

 

110

 

Cash flows from financing activities

 

 

 

 

 

Change in short-term debt, net

 

 

2

 

Contractholder fund deposits

 

1,298

 

2,824

 

Contractholder fund withdrawals

 

(3,577

)

(3,503

)

Dividends paid

 

(220

)

(216

)

Treasury stock purchases

 

(3

)

(431

)

Shares reissued under equity incentive plans, net

 

 

4

 

Excess tax benefits on share-based payment arrangements

 

(6

)

1

 

Other

 

59

 

37

 

Net cash used in financing activities

 

(2,449

)

(1,282

)

Net increase (decrease) in cash

 

422

 

(52

)

Cash at beginning of period

 

415

 

422

 

Cash at end of period

 

$

837

 

$

370

 

 

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 March 31, 2009, and for the three-month periods ended March 31, 2009 and 2008 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, 2008.  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 2009 presentation, certain amounts in the prior year condensed consolidated financial statements and notes have been reclassified.

 

Adopted accounting standards

 

Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”)

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, which redefines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America (“GAAP”), and expands disclosures about fair value measurements.  SFAS No. 157 establishes a three-level hierarchy for fair value measurements based upon the nature of the inputs to the valuation of an asset or liability.  SFAS No. 157 applies where other accounting pronouncements require or permit fair value measurements.  In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), which permits the deferral of the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis.  The Company adopted the provisions of SFAS No. 157 for financial assets and financial liabilities recognized or disclosed at fair value on a recurring or non-recurring basis as of January 1, 2008.  Consistent with the provisions of FSP FAS 157-2, the Company adopted SFAS No. 157 for non-financial assets and liabilities measured at fair value on a non-recurring basis on January 1, 2009.  In October 2008, the FASB issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP FAS 157-3”), which clarifies the application of SFAS No. 157 in a market that is not active.  The Company adopted the provisions of FSP FAS 157-3 as of September 30, 2008.  The adoption of SFAS No. 157 and FSP FAS 157-3 did not have a material effect on the Company’s results of operations or financial position (see Note 4).

 

SFAS No. 141(R), Business Combinations (“SFAS No. 141R”)

 

In December 2007, the FASB issued SFAS No. 141R which replaces SFAS No. 141, “Business Combinations” (“SFAS No. 141”).  In April 2009, the FASB issued FSP No. FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (“FSP FAS 141(R)-1”), which clarifies SFAS No. 141R by addressing application issues raised by preparers, auditors and the legal profession.  Among other things, SFAS No. 141R and the related FSP broaden the scope of SFAS No. 141 to include all transactions where an acquirer obtains control of one or more other businesses; retains the guidance to recognize intangible assets separately from goodwill; requires, with limited exceptions, that all assets acquired and liabilities assumed, including certain of those that arise from contingencies, be measured at their acquisition date fair values; requires most acquisition and restructuring-related costs to be expensed as incurred; requires that step acquisitions, once control is acquired, be recorded at the full amounts of the fair values of the identifiable assets, liabilities and the noncontrolling interest in the acquiree; and replaces the reduction of asset values and recognition of negative goodwill with a requirement to recognize a gain in earnings.  The provisions of SFAS No. 141R and FSP FAS 141(R)-1 are effective for fiscal years beginning after December 15, 2008 and are to be applied prospectively only.  Early adoption is

 

4



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

not permitted. The Company will apply the provisions of SFAS No. 141R to any business combinations effective subsequent to January 1, 2009.

 

SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51 (“SFAS No. 160”)

 

In December 2007, the FASB issued SFAS No. 160 which clarifies that a noncontrolling interest in a subsidiary is that portion of the subsidiary’s equity that is attributable to owners of the subsidiary other than its parent or parent’s affiliates.  Noncontrolling interests are required to be reported as equity in the consolidated financial statements and as such net income will include amounts attributable to both the parent and the noncontrolling interest with disclosure of the amounts attributable to each on the face of the consolidated statements of operations if material.  SFAS No. 160 requires that all changes in a parent’s ownership interest in a subsidiary when control of the subsidiary is retained, be accounted for as equity transactions.  In contrast, when control over a subsidiary is relinquished and the subsidiary is deconsolidated, SFAS No. 160 requires a parent to recognize a gain or loss in net income as well as provide certain associated expanded disclosures.  SFAS No. 160 is effective as of the beginning of a reporting entity’s first fiscal year beginning after December 15, 2008.  SFAS No. 160 requires prospective application as of the beginning of the fiscal year in which the standard is initially applied, except for the presentation and disclosure requirements which are to be applied retrospectively for all periods presented.  The adoption of SFAS No. 160 resulted in $32 million of noncontrolling interest being reclassified from total liabilities to total equity on the December 31, 2008 Condensed Consolidated Statement of Financial Position presented.  The adoption did not have a material effect on the Company’s results of operations.

 

SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133 (“SFAS No. 161”)

 

In March 2008, the FASB issued SFAS No. 161, which amends and expands the disclosure requirements for derivatives currently accounted for in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”).  The new disclosures are designed to enhance the understanding of how and why an entity uses derivative instruments and how derivative instruments affect an entity’s financial position, results of operations, and cash flows.  The standard requires, on a quarterly basis, quantitative disclosures about the potential cash outflows associated with the triggering of credit-risk-contingent features, if any; tabular disclosures about the classification and fair value amounts of derivative instruments reported in the statement of financial position; disclosure of the location and amount of gains and losses on derivative instruments reported in the statement of operations; and qualitative information about how and why an entity uses derivative instruments and how derivative instruments and related hedged items affect the entity’s financial statements.  SFAS No. 161 is effective for fiscal periods beginning after November 15, 2008, and is to be applied on a prospective basis only.  SFAS No. 161 affects disclosures and therefore implementation had no impact on the Company’s results of operations or financial position (see Note 5).

 

Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 109, Written Loan Commitments That are Recorded At Fair Value Through Earnings (“SAB 109”)

 

In October 2007, the SEC issued SAB 109, a replacement of SAB 105, “Application of Accounting Principles to Loan Commitments”.  SAB 109 is applicable to both loan commitments accounted for under SFAS No. 133, and other loan commitments for which the issuer elects fair value accounting under SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”.  SAB 109 states that the expected net future cash flows related to the servicing of a loan should be included in the fair value measurement of a loan commitment accounted for at fair value through earnings.  The expected net future cash flows associated with loan servicing should be determined in accordance with the guidance in SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, as amended by SFAS No. 156, “Accounting for Servicing of Financial Assets”.  SAB 109 should be applied on a prospective basis to loan commitments accounted for under SFAS No. 133 that were issued or modified in fiscal quarters beginning after December 15, 2007.  Earlier adoption was not permitted.  The adoption of SAB 109 did not have a material impact on the Company’s results of operations or financial position.

 

SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (“SFAS No. 159”)

 

In February 2007, the FASB issued SFAS No. 159 which provides reporting entities, on an ongoing basis, an option to report selected financial assets, including investment securities, and financial liabilities, including most insurance contracts, at fair value through earnings.  SFAS No. 159 establishes presentation and disclosure requirements

 

5



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

designed to facilitate comparisons between companies that choose different measurement alternatives for similar types of financial assets and liabilities.  The standard also requires additional information to aid financial statement users’ understanding of the impacts of a reporting entity’s decision to use fair value on its earnings and requires entities to display, on the face of the statement of financial position, the fair value of those assets and liabilities for which the reporting entity has chosen to measure at fair value.  SFAS No. 159 was effective as of the beginning of a reporting entity’s first fiscal year beginning after November 15, 2007.  The Company did not apply the fair value option to any existing financial assets or liabilities as of January 1, 2008 and did not elect to apply the option prospectively to any financial assets or liabilities acquired subsequent to the effective date.  Consequently, the adoption of SFAS No. 159 had no impact on the Company’s results of operations or financial position.

 

FSP No. FIN 39-1, Amendment of FASB Interpretation No. 39 (“FSP FIN 39-1”)

 

In April 2007, the FASB issued FSP FIN 39-1, which amends FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts”.  FSP FIN 39-1 replaces the terms “conditional contracts” and “exchange contracts” with the term “derivative instruments” and requires a reporting entity to offset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement that have been offset in the statement of financial position.  FSP FIN 39-1 was effective for fiscal years beginning after November 15, 2007, with early adoption permitted.  The adoption of FSP FIN 39-1 did not have a material impact on the Company’s results of operations or financial position.

 

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 required, as of December 31, 2006 for calendar year-end companies, 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 pension plans and the accumulated postretirement benefit obligation (“APBO”) for other postretirement benefit plans.  This effectively required 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, at the date of adoption.  In addition, SFAS No. 158 required, on a prospective basis, that the actuarial gains and losses and prior service costs and credits that arise during any reporting period, but are not recognized as components of net periodic benefit cost, be recognized as a component of other comprehensive income (“OCI”) 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 OCI.  The Company adopted the funded status provisions of SFAS No. 158 as of December 31, 2006.  The impact on the Consolidated Statements of Financial Position of adopting SFAS No. 158, including the inter-related impact to the minimum pension liability, was a decrease in shareholders’ equity of $1.11 billion.

 

In addition to the impacts of reporting the funded status of pension and other postretirement benefit plans and the related additional disclosures, SFAS No. 158 required reporting entities to conform plan measurement dates with the fiscal year-end reporting date.  The effective date of the guidance relating to the measurement date of the plans is for years ending after December 15, 2008.  The Company remeasured its plans as of January 1, 2008 to transition to a December 31 measurement date in 2008.  As a result, the Company recorded a decrease of $13 million, net of tax, to beginning retained income in 2008 representing the net periodic benefit cost for the period between October 31, 2007 and December 31, 2007 and a decrease of $80 million, net of tax, to beginning accumulated other comprehensive income in 2008 to reflect changes in the fair value of plan assets and the benefit obligations between October 31, 2007 and January 1, 2008, and for amortization of actuarial gains and losses and prior service cost between October 31, 2007 and December 31, 2007.

 

FSP No. FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161 (“FSP FAS 133-1 and FIN 45-4”)

 

In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, which amends SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), and FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), to both enhance and synchronize the disclosure requirements of the two statements with respect to the potential for adverse

 

6



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

effects of changes in credit risk on the financial statements of the sellers of credit derivatives and certain guarantees.  SFAS No. 133 was amended to require disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument.  FIN 45 was amended to require an additional disclosure about the current status of the payment/performance risk of a guarantee.  The FSP clarifies the FASB’s intent that the disclosures required by SFAS No. 161 should be provided for any reporting period (annual or quarterly interim) beginning after November 15, 2008.  The provisions of this FASB staff position that amend SFAS No. 133 and FIN 45 are effective for reporting periods ending after November 15, 2008, and the provisions that clarify the effective date of SFAS No. 161 are effective upon the adoption of that statement; therefore, the disclosure requirements, which have no impact to the Company’s results of operations or financial position, were adopted at December 31, 2008.

 

FSP No. FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities (“FSP FAS 140-4 and FIN 46(R)-8”)

 

In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, which amends SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS No. 140”), to require additional disclosures about transfers of financial assets and FIN 46, “Consolidation of Variable Interest Entities” (“FIN 46”), to require additional disclosures about variable interest entities for both public enterprises and sponsors that have a variable interest in a variable interest entity.  The disclosures required are intended to provide greater transparency to financial statement users about a transferor’s continuing involvement with transferred financial assets and an enterprise’s involvement with variable interest entities and qualifying special purpose entities.  The provisions of this FASB staff position are effective for reporting periods ending after November 15, 2008; therefore, the disclosure requirements, which did not impact the Company’s results of operations or financial position, were adopted at December 31, 2008.

 

FSP No. EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20 (“FSP EITF 99-20-1”)

 

In January 2009, the FASB issued FSP EITF 99-20-1, which amends FASB Emerging Issues Task Force (“EITF”) No. 99-20 “Recognition of Interest Income and Impairment on Purchased Beneficial Interest and Beneficial Interests That Continue to Be Held by a Transferor or in Securitized Financial Assets,” (“EITF 99-20”), to align the impairment guidance in EITF No. 99-20 with the impairment guidance and related implementation guidance in SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities”.  The provisions of this FASB staff position are effective for reporting periods ending after December 15, 2008.  The adoption of FSP EITF 99-20-1 did not have a material effect on the results of operations or financial position of the Company.

 

FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”)

 

In June 2008, the FASB issued FSP EITF 03-6-1, clarifying that non-forfeitable instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128, “Earnings Per Share”.  The two-class method is an earnings allocation formula that treats participating securities as having the same rights to earnings as available to common shareholders.  The provisions of this FASB staff position are effective for reporting periods ending after December 15, 2008.  The adoption of FSP EITF 03-6-1 impacted previously reported basic and diluted earnings per share amounts as follows: changed from $(1.71) to $(1.70) for the three months ended September 30, 2008, changed from $(2.11) to $(2.10) for the three months ended December 31, 2008, and changed from $(3.07) to $(3.06) for the year ended December 31, 2008.  The basic and diluted earnings per share amounts for other 2008 periods were unchanged.

 

Pending accounting standards

 

FSP No. FAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets (“FSP FAS 132(R)-1”)

 

In January 2009, the FASB issued FSP FAS 132(R)-1 which amends SFAS No. 132(R) “Employers’ Disclosures about Pensions and Other Postretirement Benefits” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan.  Since plan assets measured at fair value are reported net of benefit obligations in an employer’s statements of financial position, the disclosures are intended to increase transparency surrounding the types of assets and associated risks in the benefit plans.  FSP FAS 132(R)-1 requires companies to disclose information about how investment allocation decisions are made in the plans, the fair value of each major category of plan assets at each annual reporting date for each plan separately, information that would enable

 

7



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

users to assess the assumptions and valuation techniques used in the development of the fair value measurements at the reporting date, and information that provides an understanding of significant concentrations of risk in plan assets.  FSP FAS 132(R)-1 is effective for fiscal years ending after December 15, 2009.  The disclosures are not required for earlier periods that are presented for comparative purposes and earlier application is permitted.  FSP FAS 132(R)-1 affects disclosures and therefore implementation will not impact the Company’s results of operations or financial position.

 

FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS 115-2 and FAS 124-2”)

 

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2 which amends SFAS No. 115 and SFAS No. 124 “Accounting for Certain Investments Held by Not-for-Profit Organizations”, to provide recognition guidance for debt securities classified as available-for-sale and held-to-maturity and subject to other-than-temporary impairment (“OTTI”) guidance.  If the fair value of a debt security is less than its amortized cost basis at the reporting date, an entity shall assess whether the impairment is an OTTI.  FSP FAS 115-2 and FAS 124-2 defines the situations under which an OTTI should be considered to have occurred.  When an entity intends to sell the security or more likely than not it will be required to sell the security before recovery of its amortized cost basis, an OTTI is recognized in earnings.  When the entity does not expect to recover the entire amortized cost basis of the security even if it does not intend to sell the security, the entity must consider a number of factors and use its best estimate of the present value of cash flows expected to be collected from the debt security in order to determine whether a credit loss exists, and the period over which the debt security is expected to recover.  The amount of total OTTI related to the credit loss shall be recognized in earnings while the amount of the total OTTI related to other factors shall be recognized in other comprehensive income.  Both the statement of operations and the statement of accumulated other comprehensive income are required to display the OTTI related to credit losses and the OTTI related to other factors on the face of each statement.

 

FSP FAS 115-2 and FAS 124-2 expands the disclosure requirements of SFAS No. 115 (for both debt and equity securities) and requires a more detailed, risk-oriented breakdown of security types and related information, and requires the annual disclosures to be made for interim periods.  In addition, new disclosures are required to help users of financial statements understand the significant inputs used in determining a credit loss as well as a rollforward of that amount each period.  FSP FAS 115-2 and FAS 124-2 is effective for interim periods ending after June 15, 2009 with early adoption permitted in conjunction with the early adoption of FSP No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”).  The disclosures are not required for earlier periods presented for comparative purposes.  FSP FAS 115-2 and FSP 124-2 shall be applied to existing and new investments held by an entity as of the beginning of the interim period in which it is adopted.  A cumulative effect adjustment to the opening balance of retained earnings will be recognized for debt securities with an existing OTTI at the beginning of the interim period in which the FSP is adopted.  The Company will adopt the provisions of FSP FAS 115-2 and FAS 124-2 as of April 1, 2009.  The specific requirements of the FSP applicable to the Company’s portfolio are being interpreted, studied and assessed.  The potential cumulative effect to retained income as of April 1, 2009 is not yet reliably estimable since the Company is still assessing the requirements; however, the Company expects that it will result in an increase to retained income, offset by a decrease to accumulated other comprehensive income by the same amount.

 

FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (FSP FAS 157-4)

 

In April 2009, the FASB issued FSP FAS 157-4, which amends SFAS No. 157, to provide additional guidance for estimating fair value when the volume and level of activity for an asset or liability have significantly decreased. Guidance on identifying circumstances that indicate a transaction is not orderly is also provided.  If it is concluded that there has been a significant decrease in the volume and level of market activity for an asset or liability in relation to normal market activity for an asset or liability, transactions or quoted prices may not be determinative of fair value, and further analysis of the transactions or quoted prices may be needed.  A significant adjustment to the transactions or quoted prices may be necessary to estimate fair value which may be determined based on the point within a range of fair value estimates that is most representative of fair value under the current market conditions.  Determination of whether the transaction is orderly is based on the weight of the evidence.  The disclosure requirements of SFAS No. 157 are increased since disclosures of the inputs and valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques and related inputs during the reporting period are required.

 

8



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

FSP FAS 157-4 defines the disclosures required for major categories by SFAS No. 157 to be the major security types as defined in FASB Statement No. 115.  FSP FAS 157-4 does not require disclosures for earlier periods presented for comparative purposes at initial adoption.  FSP FAS 157-4 is effective for interim periods ending after June 15, 2009 with early adoption permitted but only in conjunction with the early adoption of FSP FAS 115-2 and FAS 124-2.  Revisions resulting from a change in valuation technique or its application shall be accounted for as a change in accounting estimate and disclosed, along with a quantification of the total effect of the change in valuation technique and related inputs, if practicable, by major category.  The Company will adopt the provisions of FSP FAS 157-4 as of April 1, 2009.  Quantification of the estimated effects of the application of the FSP FAS 157-4 requirements will be based on the market conditions and portfolio holdings at the time of adoption and are therefore not yet reliably estimable; however, the Company does not expect a material impact to its results of operations or financial position upon adoption.

 

FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS 107-1 and APB 28-1”)

 

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1 which amends FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments”, to require disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements; and amends Accounting Principles Board Opinion No. 28, “Interim Financial Reporting”, to require those disclosures in summarized financial information at interim reporting periods.  FSP FAS 107-1 and APB 28-1 is effective for interim periods ending after June 15, 2009.  The disclosures are not required for earlier periods presented for comparative purposes and earlier adoption is permitted in conjunction with the early adoption of FSP FAS 115-2 and FAS 124-2 and FSP FAS 157-4.  The Company will adopt the provisions of FSP FAS 107-1 and APB 28-1 for second quarter 2009.  FSP FAS 107-1 and APB 28-1 affects disclosures and therefore implementation will not impact the Company’s results of operations or financial position.

 

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 the 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
March 31,

 

($ in millions, except per share data)

 

2009

 

2008

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

Net (loss) income

 

$

(274

)

$

348

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average common shares outstanding

 

538.9

 

560.8

 

Effect of dilutive potential common shares:

 

 

 

 

 

Stock options

 

 

2.0

 

Weighted average common and dilutive potential common shares outstanding

 

538.9

 

562.8

 

 

 

 

 

 

 

Earnings per share - Basic:

 

$

(0.51

)

$

0.62

 

Earnings per share - Diluted:

 

$

(0.51

)

$

0.62

 

 

As a result of the net loss for the first quarter ended March 31, 2009, weighted average dilutive potential common shares outstanding resulting from 0.6 million stock options were not included in the computation of diluted earnings per share for the three-month period ended March 31, 2009 since inclusion of these securities would have an anti-dilutive effect.  In the absence of the net loss, weighted average common and dilutive potential common shares outstanding would have totaled 539.5 million for the three-month period ended March 31, 2009.

 

9



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The effect of dilutive potential common shares does not include the effect of options with an anti-dilutive effect on earnings per share because their exercise prices exceed the average market price of Allstate common shares during the period or for which the unrecognized compensation cost would have an anti-dilutive effect.  Options to purchase 27.3 million and 17.7 million Allstate common shares, with exercise prices ranging from $23.72 to $65.38 and $48.01 to $65.38, were outstanding at March 31, 2009 and 2008, respectively, but were not included in the computation of diluted earnings per share for the three-month periods.

 

3.  Supplemental Cash Flow Information

 

Non-cash investment exchanges and modifications, which primarily reflect refinancings of fixed income securities and mergers completed with equity securities and limited partnerships, totaled $75 million for the three-month period ended March 31, 2009.

 

Liabilities for collateral received in conjunction with the Company’s securities lending and over-the-counter (“OTC”) derivatives and for funds received from the Company’s security repurchase business activities are reported in other liabilities and accrued expenses or other investments in the Condensed Consolidated Statements of Financial Position.  The accompanying cash flows are included in cash flows from operating activities in the Condensed Consolidated Statements of Cash Flows along with the activities resulting from management of the proceeds, which are as follows:

 

 

 

Three months ended
March 31,

 

($ in millions)

 

2009

 

2008

 

 

 

 

 

 

 

Net change in proceeds managed

 

 

 

 

 

Net change in fixed income securities

 

$

 

$

226

 

Net change in short-term investments

 

67

 

(59

)

Operating cash flow provided

 

$

67

 

$

167

 

 

 

 

 

 

 

Net change in liabilities

 

 

 

 

 

Liabilities for collateral and security repurchase, beginning of year

 

$

(340

)

$

(3,461

)

Liabilities for collateral and security repurchase, end of period

 

(273

)

(3,294

)

Operating cash flow used

 

$

(67

)

$

(167

)

 

4.  Fair Value of Assets and Liabilities

 

The Company adopted the provisions of SFAS No. 157 as of January 1, 2008 for its financial assets and liabilities that are measured at fair value and as of January 1, 2009 for its non-financial assets and liabilities measured at fair value on a non-recurring basis.  SFAS No. 157 established a hierarchy for inputs used in determining fair value that maximize the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available.

 

Assets and liabilities recorded on the Condensed Consolidated Statements of Financial Position at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:

 

Level 1:     Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company can access.

 

Level 2:     Assets and liabilities whose values are based on the following:

 

(a)  Quoted prices for similar assets or liabilities in active markets;

(b)  Quoted prices for identical or similar assets or liabilities in non-active markets; or

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

 

Level 3:     Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.  These inputs reflect the Company’s estimates of the assumptions that market participants would use in valuing the assets and liabilities.

 

10



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The availability of observable inputs varies by instrument.  In situations where fair value is based on internally developed pricing models or inputs that are unobservable in the market, the determination of fair value requires more judgment.  The degree of judgment exercised by the Company in determining fair value is typically greatest for instruments categorized in Level 3.  In many instances, valuation inputs used to measure fair value fall into different levels of the fair value hierarchy.  The category level in the fair value hierarchy is determined based on the lowest level input that is significant to the fair value measurement in its entirety.  The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption.  In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments.  This condition could cause an instrument to be reclassified from Level 1 to Level 2, or from Level 2 to Level 3.

 

Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans, limited partnership interests, bank loans and policy loans.  Accordingly, such investments are only included in the fair value hierarchy disclosure when the investment is subject to remeasurement at fair value after initial recognition and the resulting remeasurement is reflected in the condensed consolidated financial statements.  In addition, equity options embedded in fixed income securities are not disclosed in the hierarchy with free-standing derivatives as the embedded derivatives are presented with the host contract in fixed income securities.  As of March 31, 2009, 66.9% of total assets are measured at fair value and 0.9% of total liabilities are measured at fair value.

 

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of March 31, 2009:

 

 

 

Quoted
prices in
active
markets for
identical
assets

 

Significant
other
observable
inputs

 

Significant
unobservable
inputs

 

Counterparty
and cash
collateral

 

Balance as of
March 31,

 

($ in millions)

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

netting (1)

 

2009

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

$

1,032

 

$

50,531

 

$

16,875

 

 

 

$

68,438

 

Equity securities

 

2,143

 

194

 

73

 

 

 

2,410

 

Short-term investments

 

407

 

7,718

 

 

 

 

8,125

 

Other investments:

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

 

737

 

69

 

$

(376

)

430

 

Separate account assets

 

7,375

 

 

 

 

 

7,375

 

Other assets

 

2

 

 

3

 

 

 

5

 

Total recurring basis assets

 

10,959

 

59,180

 

17,020

 

(376

)

86,783

 

Non-recurring basis (2)

 

 

 

438

 

 

 

438

 

Total assets at fair value

 

$

10,959

 

$

59,180

 

$

17,458

 

$

(376

)

$

87,221

 

% of total assets at fair value

 

12.6

%

67.8

%

20.0

%

(0.4

)%

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Contractholder funds:

 

 

 

 

 

 

 

 

 

 

 

Derivatives embedded in annuity contracts

 

$

 

$

(51

)

$

(291

)

 

 

$

(342

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

(1

)

(963

)

(172

)

$

364

 

(772

)

Total liabilities at fair value

 

$

(1

)

$

(1,014

)

$

(463

)

$

364

 

$

(1,114

)

% of total liabilities at fair value

 

0.1

%

91.0

%

41.6

%

(32.7

)%

100.0

%

 


(1)    In accordance with FSP FIN 39-1, the Company nets all fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral executed with the same counterparty under a master netting agreement.  At March 31, 2009, the right to reclaim cash collateral was offset by securities held, and the obligation to return collateral was $12 million.

 

(2)    Includes $182 million of mortgage loans, $245 million of limited partnership interests and $11 million of other investments written-down to fair value in connection with recognizing other-than-temporary impairments.

 

11



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2008:

 

 

 

Quoted
prices in
active
markets for
identical
assets

 

Significant
other
observable
inputs

 

Significant
unobservable
inputs

 

Counterparty
and cash
collateral

 

Balance as of
December 31,

 

($ in millions)

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

netting (1)

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

$

662

 

$

50,127

 

$

17,819

 

 

 

$

68,608

 

Equity securities

 

2,477

 

254

 

74

 

 

 

2,805

 

Short-term investments

 

563

 

8,343

 

 

 

 

8,906

 

Other investments:

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

 

812

 

13

 

$

(525

)

300

 

Separate account assets

 

8,239

 

 

 

 

 

8,239

 

Other assets

 

 

 

1

 

 

 

1

 

Total recurring basis assets

 

11,941

 

59,536

 

17,907

 

(525

)

88,859

 

Non-recurring basis (2)

 

 

 

301

 

 

 

301

 

Total assets at fair value

 

$

11,941

 

$

59,536

 

$

18,208

 

$

(525

)

$

89,160

 

% of total assets at fair value

 

13.4

%

66.8

%

20.4

%

(0.6

)%

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Contractholder funds:

 

 

 

 

 

 

 

 

 

 

 

Derivatives embedded in annuity contracts

 

$

 

$

(37

)

$

(265

)

 

 

$

(302

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

 

(1,177

)

(114

)

$

505

 

(786

)

Total liabilities at fair value

 

$

 

$

(1,214

)

$

(379

)

$

505

 

$

(1,088

)

% of total liabilities at fair value

 

%

111.6

%

34.8

%

(46.4

)%

100.0

%

 


(1)    In accordance with FSP FIN 39-1, the Company nets all fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral executed with the same counterparty under a master netting agreement.  At December 31, 2008, the right to reclaim cash collateral was offset by securities held, and the obligation to return collateral was $20 million.

 

(2)    Includes $165 million of mortgage loans, $121 million of limited partnership interests and $15 million of other investments written-down to fair value in connection with recognizing other-than-temporary impairments.

 

As required by SFAS No. 157, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety.  Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3).

 

12



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table provides a summary of changes in fair value during the three months ended March 31, 2009 of Level 3 assets and liabilities held at fair value on a recurring basis.  Net transfers in and/or out of Level 3 are reported as having occurred at the beginning of the quarter the transfer occurred; therefore, for all transfers into Level 3, all realized and changes in unrealized gains and losses in the quarter of transfer are reflected in the table below.

 

 

 

 

 

Total realized and
unrealized gains (losses)
included in:

 

Purchases,
sales,

 

 

 

 

 

Total
gains (losses)
included in
Net income
for financial

 

($ in millions)

 

Balance as of
December 31,
2008

 

Net
income (1)

 

OCI on
Statement of
Financial
Position

 

issuances
and
settlements,
net

 

Net
transfers in
and/or (out)
of Level 3

 

Balance as of
March 31, 2009

 

instruments
still held at
March 31,
2009 (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

$

17,819

 

$

(227

)

$

(369

)

$

(601

)

$

253

 

$

16,875

 

$

(217

)

Equity securities

 

74

 

 

(4

)

3

 

 

73

 

 

Other investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives, net

 

(101

)

6

 

 

(8

)

 

(103

) (2)

8

 

Other assets

 

1

 

2

 

 

 

 

3

 

2

 

Total recurring Level 3 assets

 

$

17,793

 

$

(219

)

$

(373

)

$

(606

)

$

253

 

$

16,848

 

$

(207

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractholder funds:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives embedded in annuity contracts

 

$

(265

)

$

(25

)

$

 

$

(1

)

$

 

$

(291

)

$

(25

)

Total recurring Level 3 liabilities

 

$

(265

)

$

(25

)

$

 

$

(1

)

$

 

$

(291

)

$

(25

)

 


(1)   The effect to net income totals $(244) million and is reported in the Condensed Consolidated Statements of Operations as follows: $(268) million in realized capital gains and losses, $50 million in net investment income, $(1) million in interest credited to contractholder funds, and $(25) million in life and annuity contract benefits.

 

(2)   Comprises $69 million of assets and $(172) million of liabilities.

 

(3)   The amounts represent gains and losses included in net income for the period of time that the asset or liability was determined to be in Level 3.  These gains and losses total $(232) million and are reported in the Condensed Consolidated Statements of Operations as follows: $(257) million in realized capital gains and losses, $50 million in net investment income, and $(25) million in life and annuity contract benefits.

 

13



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table provides a summary of changes in fair value during the three months ended March 31, 2008 of Level 3 assets and liabilities held at fair value on a recurring basis.  Net transfers in and/or out of Level 3 are reported as having occurred at the beginning of the quarter the transfer occurred; therefore, for all transfers into Level 3, all realized and changes in unrealized gains and losses in the quarter of transfer are reflected in the table below.

 

 

 

 

 

Total realized and
unrealized gains (losses)
included in:

 

Purchases,
sales,

 

 

 

 

 

Total
gains (losses)
included in
Net income
for financial

 

($ in millions)

 

Balance as of
January 1,
2008

 

Net
income (1)

 

OCI on
Statement of
Financial
Position

 

issuances
and
settlements,
net

 

Net
transfers in
and/or (out)
of Level 3

 

Balance as of
March 31,
2008

 

instruments
still held at
March 31,
2008 (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

$

24,372

 

$

(333

)

$

(977

)

$

(676

)

$

180

 

$

22,566

 

$

(333

)

Equity securities

 

129

 

(1

)

(6

)

13

 

(7

)

128

 

(1

)

Other investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives, net

 

10

 

(52

)

 

3

 

 

(39

) (2)

(38

)

Other assets

 

2

 

 

 

 

 

2

 

 

Total recurring Level 3 assets

 

$

24,513

 

$

(386

)

$

(983

)

$

(660

)

$

173

 

$

22,657

 

$

(372

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractholder funds:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives embedded in annuity contracts

 

$

4

 

$

(14

)

$

 

$

 

$

 

$

(10

)

$

(14

)

Total recurring Level 3 liabilities

 

$

4

 

$

(14

)

$

 

$

 

$

 

$

(10

)

$

(14

)

 


(1)   The effect to net income totals $(400) million and is reported in the Condensed Consolidated Statements of Operations as follows: $(395) million in realized capital gains and losses, $13 million in net investment income, $(9) million in interest credited to contractholder funds, and $(9) million in life and annuity contract benefits.

 

(2)   Comprises $46 million of assets and $(85) million of liabilities.

 

(3)   The amounts represent gains and losses included in net income for the period of time that the asset or liability was determined to be in Level 3.  These gains and losses total $(386) million and are reported in the Condensed Consolidated Statements of Operations as follows: $(384) million in realized capital gains and losses, $13 million in net investment income, $(6) million in interest credited to contractholder funds, and $(9) million in life and annuity contract benefits.

 

5.  Derivative Financial Instruments

 

The Company primarily uses derivatives for risk reduction and asset replication.  In addition, the Company has derivatives embedded in non-derivative “host” contracts, which are required to be separated from the host contract and accounted for at fair value as derivative instruments.  With the exception of non-hedge derivatives used for asset replication and non-hedge embedded derivatives, all of the Company’s derivatives are evaluated for their ongoing effectiveness as either accounting hedge or non-hedge derivative financial instruments on at least a quarterly basis.  The Company does not use derivatives for trading purposes.  Non-hedge accounting is used for “portfolio” level hedging strategies where the terms of the individual hedged items do not meet the strict homogeneity requirements prescribed in SFAS No. 133 to permit the application of SFAS No. 133’s hedge accounting model.

 

The Company uses derivatives to partially mitigate potential adverse impacts from future increases in risk-free interest rates, negative equity market valuations and increases in credit spreads.  Property-Liability uses interest rate swaption contracts and exchange traded options on Treasury futures to offset potential declining fixed income market values resulting from potential rising interest rates.  Property-Liability also uses interest rate swaps to mitigate municipal bond interest rate risk within the municipal bond portfolio.  Exchange traded equity put options are utilized by Property-Liability for overall equity portfolio protection from significant declines in equity market values below a targeted level.  Equity index futures are used by Property-Liability to lock-in equity gains during periods of declining equity market values.  Credit default swaps are used to mitigate the credit risk within the Property-Liability and Allstate Financial fixed income portfolios.

 

Portfolio duration management is a risk management strategy that is principally employed by Property-Liability wherein, depending on the current portfolio duration relative to a designated target and the expectations of future interest rate movements, the Company uses financial futures and interest rate swaps to change the duration of the portfolio in order to mitigate the economic effect that interest rates would otherwise have on the fair value of its fixed income securities.

 

14



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Property-Liability also uses futures to hedge the market risk related to deferred compensation liability contracts and forward contracts to hedge foreign currency risk.  Allstate Financial uses foreign currency swaps primarily to reduce the foreign currency risk associated with issuing foreign currency denominated funding agreements and holding foreign currency denominated investments.

 

Asset-liability management is a risk management strategy that is principally employed by Allstate Financial to balance the respective interest-rate sensitivities of its assets and liabilities.  Depending upon the attributes of the assets acquired and liabilities issued, derivative instruments such as interest rate swaps, caps, floors and futures are acquired to change the interest rate characteristics of existing assets and liabilities to ensure the relationship is maintained within specified ranges and to reduce exposure to rising or falling interest rates.  Allstate Financial uses financial futures and interest rate swaps to hedge anticipated asset purchases and liability issuances and financial futures and options for hedging the Company’s equity exposure contained in equity indexed annuity product contracts that offer equity returns to contractholders.  In addition, Allstate Financial uses interest rate swaps to hedge interest rate risk inherent in funding agreements.

 

When derivatives meet specific criteria, they may be designated as accounting hedges and accounted for as fair value, cash flow, foreign currency fair value or foreign currency cash flow hedges.  Allstate Financial designates certain of its interest rate and foreign currency swap contracts and certain investment risk transfer reinsurance agreements as fair value hedges when the hedging instrument is highly effective in offsetting the risk of changes in the fair value of the hedged item.  Allstate Financial designates certain of its foreign currency swap contracts as cash flow hedges when the hedging instrument is highly effective in offsetting the exposure of variations in cash flows for the hedged risk that could affect net income.  Amounts are reclassified to net investment income as the hedged item affects net income.

 

Asset replication refers to the “synthetic” creation of assets through the use of derivatives and primarily investment grade host bonds to replicate securities that are either unavailable in the cash markets or more economical to acquire in synthetic form.  The Company replicates fixed income securities using a combination of a credit default swap and one or more highly rated fixed income securities to synthetically replicate the economic characteristics of one or more cash market securities.  The Company also creates “synthetic” exposure to equity markets through the use of exchange traded equity index future contracts and an investment grade host bond.

 

The Company’s primary embedded derivatives are conversion options in fixed income securities, which provide the Company with the right to convert the instrument into a predetermined number of shares of common stock; equity options in Allstate Financial annuity product contracts, which provide equity returns to contractholders; and equity-indexed notes containing equity call options, which provide a coupon payout that is determined using one or more equity-based indices.

 

The notional amounts specified in the contracts are used to calculate the exchange of contractual payments under the agreements and are generally not representative of the potential for gain or loss on these agreements.  However, the notional amounts specified in selling protection credit default swaps represent the maximum amount of potential loss, assuming no recoveries.

 

Fair value, which is equal to the carrying value, is the estimated amount that the Company would receive (pay) to terminate the derivative contracts at the reporting date.  The carrying value amounts for OTC free-standing derivatives have been further adjusted for the effects, if any, of legally enforceable master netting agreements and are presented on a net basis in the Condensed Consolidated Statements of Financial Position in accordance with FASB Interpretation No. 39.  For certain exchange traded derivatives, the exchange requires margin deposits as well as daily cash settlements of margin accounts.  As of March 31, 2009, the Company pledged $45 million of securities in the form of margin deposits.

 

The net impact to pre-tax income for derivatives includes valuation and settlements of derivatives which are reported in net income.  For those derivatives which qualify for fair value hedge accounting, net income includes the changes in the fair value of the hedged risk, and therefore reflects any hedging ineffectiveness.  For cash flow hedges, gains and losses amortized from accumulated other comprehensive income are reported in net income.  For embedded derivatives in convertible fixed income securities and equity-indexed notes, accretion income related to the host instrument is reported in net income.

 

15


 


 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table provides a summary of the volume and fair value positions of derivative instruments as well as their reporting location in the Condensed Consolidated Statements of Financial Position at March 31, 2009.

 

($ in millions, except number of contracts)

 

 

 

Asset derivatives

 

 

 

 

 

Volume (1)

 

 

 

 

 

 

 

 

 

Balance sheet location

 

Notional
amount

 

Number
of
contracts

 

Fair
value,
net

 

Gross
asset

 

Gross
liability

 

Derivatives designated as accounting hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Other investments

 

$

 128

 

n/a

 

$

 (11

)

$

 —

 

$

 (11

)

Foreign currency contracts

 

Other investments

 

72

 

n/a

 

6

 

6

 

 

Total

 

 

 

$

 200

 

n/a

 

$

 (5

)

$

 6

 

$

 (11

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as accounting hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Other investments

 

$

 16,939

 

40,000

 

$

 91

 

$

 96

 

$

 (5

)

Interest rate contracts

 

Other assets

 

n/a

 

222

 

 

 

 

Equity and index contracts

 

Other investments

 

98

 

136,130

 

313

 

313

 

 

Equity and index contracts

 

Other assets

 

n/a

 

2,343

 

2

 

2

 

 

Foreign currency contracts

 

Other investments

 

158

 

n/a

 

7

 

8

 

(1

)

Embedded derivative financial instruments

 

Fixed income securities

 

1,744

 

n/a

 

303

 

310

 

(7

)

Embedded derivative financial instruments

 

Other investments

 

1,000

 

n/a

 

2

 

2

 

 

Credit default contracts

 

Other investments

 

1,501

 

n/a

 

32

 

65

 

(33

)

Other contracts

 

Other investments

 

75

 

n/a

 

 

 

 

Other contracts

 

Other assets

 

5

 

n/a

 

3

 

3

 

 

Total

 

 

 

$

21,520

 

178,695

 

$

 753

 

$

 799

 

$

 (46

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total derivative assets

 

 

 

$

21,720

 

178,695

 

$

 748

 

$

 805

 

$

 (57

)

 

 

 

Liability derivatives

 

 

 

 

 

Volume (1)

 

 

 

 

 

 

 

 

 

Balance sheet location

 

Notional
amount

 

Number
of
contracts

 

Fair
value,
net

 

Gross
asset

 

Gross
liability

 

Derivatives designated as accounting hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Other liabilities & accrued expenses

 

$

 3,295

 

n/a

 

$

 (428

)

$

 —

 

$

 (428

)

Foreign currency contracts

 

Other liabilities & accrued expenses

 

196

 

n/a

 

14

 

21

 

(7

)

Foreign currency and interest rate contracts

 

Other liabilities & accrued expenses

 

870

 

n/a

 

165

 

165

 

 

Foreign currency and interest rate contracts

 

Contractholder funds

 

n/a

 

n/a

 

13

 

13

 

 

Total

 

 

 

$

 4,361

 

n/a

 

$

 (236

)

$

 199

 

$

 (435

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as accounting hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Other liabilities & accrued expenses

 

11,579

 

n/a

 

$

 (367

)

$

 59

 

$

 (426

)

Interest rate contracts

 

Other liabilities & accrued expenses

 

n/a

 

4,551

 

 

 

 

Equity and index contracts

 

Other liabilities & accrued expenses

 

n/a

 

23,223

 

(64

)

 

(64

)

Foreign currency contracts

 

Other liabilities & accrued expenses

 

114

 

n/a

 

(12

)

 

(12

)

Embedded derivative financial instruments

 

Contractholder funds

 

5,832

 

n/a

 

(341

)

 

(341

)

Credit default contracts

 

Other liabilities & accrued expenses

 

1,425

 

n/a

 

(89

)

60

 

(149

)

Total

 

 

 

$

 18,950

 

27,774

 

$

 (873

)

$

 119

 

$

 (992

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total derivative liabilities

 

 

 

$

 23,311

 

27,774

 

$

 (1,109

)

$

 318

 

$

 (1,427

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total derivatives

 

 

 

$

 45,031

 

206,469

 

$

 (361

)

 

 

 

 

 


(1)   Volume for OTC derivative contracts is represented by their notional amounts.  Volume for exchange traded derivatives is represented by the number of contracts which is the basis on which they are traded.  (n/a = not applicable)

 

16



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table provides a summary of the impacts of the Company’s foreign currency contracts in cash flow hedging relationships in the Condensed Consolidated Statements of Operations and the Condensed Consolidated Statements of Financial Position for the three month period ended March 31, 2009.  Amortization of net gains from accumulated other comprehensive income related to cash flow hedges is expected to be $3 million during the next twelve months.

 

($ in millions)

 

Location of gain reclassified from accumulated OCI into income (effective portion)

 

Net investment income

 

 

 

 

 

Amount of gain recognized in OCI on derivatives during the period (effective portion)

 

$

 4

 

 

 

 

 

Amount of gain recognized in OCI on derivatives during the term of the hedging relationship (effective portion)

 

$

 20

 

 

 

 

 

Amount of gain reclassified from accumulated OCI into income (effective portion)

 

$

 1

 

 

 

 

 

Location of gain recognized in income on derivative (ineffective portion and amount excluded from effectiveness testing)

 

Realized capital gains
and losses

 

 

 

 

 

Amount of gain recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)

 

$

 —

 

 

The following table presents gains and losses from valuation, settlements and hedge ineffectiveness reported on derivatives used in fair value hedging relationships and derivatives not designated as accounting hedging instruments in the Condensed Consolidated Statements of Operations for the three month period ended March 31, 2009.

 

($ in millions)

 

Net
investment
income

 

Realized
capital gains
and losses

 

Life and
annuity
contract
benefits

 

Interest
credited to
contractholder
funds

 

Operating
costs and
expenses

 

Total gain (loss)
recognized in
net income on
derivatives

 

Derivatives in fair value accounting hedging relationships

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

$

 7

 

$

 4

 

$

 

$

 (12

)

$

 —

 

$

 (1

)

Foreign currency and interest rate contracts

 

 

(1

)

 

(30

)

 

(31

)

Subtotal

 

$

 7

 

$

 3

 

$

 

$

 (42

)

$

 —

 

$

 (32

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as accounting hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

$

 —

 

$

 39

 

$

 

$

 —

 

$

 —

 

$

 39

 

Equity and index contracts

 

 

47

 

 

(23

)

(13

)

11

 

Embedded derivative financial instruments

 

 

(23

)

(23

)

(14

)

 

(60

)

Foreign currency contracts

 

 

1

 

 

 

 

1

 

Credit default contracts

 

 

28

 

 

 

 

28

 

Subtotal

 

$

 —

 

$

 92

 

$

(23

)

$

(37

)

$

(13

)

$

19

 

Total

 

$

 7

 

$

 95

 

$

(23

)

$

(79

)

$

(13

)

$

(13

)

 

The following table provides a summary of the changes in fair value of the Company’s fair value hedging relationships in the Condensed Consolidated Statements of Operations for the three month period ended March 31, 2009.

 

($ in millions)

 

 

 

Gain (loss) on derivatives

 

Gain (loss) on hedged risk

 

Location of gain or (loss) recognized
in net income on derivatives

 

Interest
rate
contracts

 

Foreign
currency &
interest rate
contracts

 

Contractholder
funds

 

Investments

 

Interest credited to contractholder funds

 

$

 (26

)

$

 (35

)

$

 61

 

$

 —

 

Net investment income

 

40

 

 

 

(40

)

Realized capital gains and losses

 

4

 

(1

)

 

 

Total

 

$

 18

 

$

 (36

)

$

 61

 

$

 (40

)

 

The Company manages its exposure to credit risk by utilizing highly rated counterparties, establishing risk control limits, executing legally enforceable master netting agreements (“MNAs”) and obtaining collateral where appropriate.  The Company uses master netting agreements for OTC derivative transactions, including interest rate swap, foreign currency swap, interest rate cap, interest rate floor, credit default swap, forward and certain option agreements (including swaptions).  These agreements permit either party to net payments due for transactions covered by the agreements.  Under the provisions of the agreements, collateral is either pledged or obtained when certain

 

17



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

predetermined exposure limits are exceeded.  As of March 31, 2009, counterparties pledged $12 million in cash to the Company, and the Company pledged $12 million in cash and $576 million in securities to counterparties which includes $433 million of collateral posted under MNAs for contracts containing credit-risk-contingent provisions that are in a liability position and $155 million of collateral posted under MNAs for contracts without credit-risk-contingent liabilities.  The Company has not incurred any losses on derivative financial instruments due to counterparty nonperformance.  Other derivatives including futures and certain option contracts are traded on organized exchanges, which require margin deposits and guarantee the execution of trades, thereby mitigating any potential credit risk associated with transactions executed on organized exchanges.

 

Counterparty credit exposure represents the Company’s potential loss if all of the counterparties concurrently fail to perform under the contractual terms of the contracts and all collateral, if any, becomes worthless.  This exposure is measured by the fair value of OTC free-standing derivative contracts with a positive fair value at the reporting date reduced by the effect, if any, of legally enforceable master netting agreements.

 

The following table summarizes the counterparty credit exposure by counterparty credit rating as it relates to interest rate swap, foreign currency swap, interest rate cap, interest rate floor, credit default swap, forward and certain option agreements (including swaptions).

 

($ in millions)

 

 

 

March 31, 2009

 

December 31, 2008

 

Rating (1)

 

Number
of
counterparties

 

Notional
amount (2)

 

Credit
exposure (2)

 

Exposure,
net of
collateral (2)

 

Number
of
counterparties

 

Notional
amount (2)

 

Credit
exposure (2)

 

Exposure,
net of
collateral (2)

 

AA-

 

2

 

$

6,787

 

$

50

 

$

47

 

3

 

$

4,749

 

$

21

 

$

21

 

A+

 

6

 

10,297

 

41

 

37

 

5

 

6,951

 

15

 

15

 

A

 

3

 

2,645

 

14

 

9

 

3

 

3,730

 

58

 

38

 

A-

 

1

 

166

 

23

 

23

 

1

 

216

 

25

 

25

 

Total

 

12

 

$

19,895

 

$

128

 

$

116

 

12

 

$

15,646

 

$

119

 

$

99

 

 


(1)   Rating is the lower of Standard & Poor’s (“S&P”) or Moody’s ratings.

 

(2)   Only OTC derivatives with a net positive fair value are included for each counterparty.

 

Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices.  Market risk exists for all of the derivative financial instruments the Company currently holds, as these instruments may become less valuable due to adverse changes in market conditions.  To limit this risk, the Company’s senior management has established risk control limits.  In addition, changes in fair value of the derivative financial instruments that the Company uses for risk management purposes are generally offset by the change in the fair value or cash flows of the hedged risk component of the related assets, liabilities or forecasted transactions.

 

Certain of the Company’s derivative instruments contain credit-risk-contingent termination events, cross-default provisions and credit support annex agreements.  Credit-risk-contingent termination events allow the counterparties to terminate the derivative on certain dates if AIC’s, ALIC’s or Allstate Life Insurance Company of New York’s (“ALNY”) financial strength credit ratings by Moody’s or S&P fall below a certain level or in the event AIC, ALIC or ALNY are no longer rated by both Moody’s and S&P.  Credit-risk-contingent cross-default provisions allow the counterparties to terminate the derivative instruments if the Company defaults by pre-determined threshold amounts on certain debt instruments.  Credit-risk-contingent credit support annex agreements specify the amount of collateral the Company must post to counterparties based on AIC’s, ALIC’s or ALNY’s financial strength credit ratings by Moody’s or S&P, or in the event AIC, ALIC or ALNY are no longer rated by both Moody’s and S&P.

 

The following summarizes the fair value of derivative instruments with termination, cross-default or collateral credit-risk-contingent features that are in a liability position as of March 31, 2009, as well as the fair value of assets and collateral that are netted against the liability in accordance with provisions within legally enforceable MNAs.

 

($ in millions)

 

Gross liability fair value of contracts containing credit-risk-contingent features

 

$

889

 

Gross asset fair value of contracts containing credit-risk-contingent features and subject to MNAs

 

(343

)

Collateral posted under MNAs for contracts containing credit-risk-contingent features

 

(433

)

Maximum amount of additional exposure for contracts with credit-risk-contingent features if all features were triggered concurrently

 

$

113

 

 

18



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Credit derivatives — selling protection

 

Credit default swaps (“CDS”) are utilized for selling credit protection against a specified credit event.  A credit default swap is a derivative instrument, representing an agreement between two parties to exchange the credit risk of a specified entity (or a group of entities), or an index based on the credit risk of a group of entities (all commonly referred to as the “reference entity” or a portfolio of “reference entities”), for a periodic premium.  In selling protection, CDS are used to replicate fixed income securities and to complement the cash market when credit exposure to certain issuers is not available or when the derivative alternative is less expensive than the cash market alternative.  Credit risk includes both default risk and market value exposure due to spread widening.  CDS typically have a five-year term.  The following table shows the CDS notional amounts by credit rating and fair value of protection sold as of March 31, 2009:

 

 

 

Notional amount
credit rating underlying notional

 

 

 

($ in millions)

 

AAA

 

AA

 

A

 

BBB

 

BB and lower

 

Total

 

Fair
value

 

Single name

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade corporate debt

 

$

 

$

16

 

$

100

 

$

135

 

$

5

 

$

256

 

$

(29

)

Municipal

 

25

 

110

 

 

 

 

135

 

(20

)

Sovereign

 

 

 

 

20

 

5

 

25

 

(1

)

Subtotal

 

25

 

126

 

100

 

155

 

10

 

416

 

(50

)

First-to-default

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade corporate debt

 

 

 

45

 

45

 

 

90

 

(7

)

Municipal

 

 

120

 

35

 

 

 

155

 

(46

)

Subtotal

 

 

120

 

80

 

45

 

 

245

 

(53

)

Index

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade corporate debt

 

4

 

6

 

77

 

145

 

102

 

334

 

(67

)

Subtotal

 

4

 

6

 

77

 

145

 

102

 

334

 

(67

)

Total

 

$

29

 

$

252

 

$

257

 

$

345

 

$

112

 

$

995

 

$

(170

)

 

In selling protection with CDS, the Company sells credit protection on an identified single name, a basket of names in a first-to-default (“FTD”) structure or credit derivative index (“CDX”) that is generally investment grade, and in return receives periodic premiums through expiration or termination of the agreement.  With single name CDS, this premium or credit spread generally corresponds to the difference between the yield on the referenced entity’s public fixed maturity cash instruments and swap rates, at the time the agreement is executed.  With FTD baskets, because of the additional credit risk inherent in a basket of named credits, the premium generally corresponds to a high proportion of the sum of the credit spreads of the names in the basket and the correlation between the names.  CDX index is utilized to take a position on multiple (generally 125) reference entities.  Credit events are typically defined as bankruptcy, failure to pay, or restructuring, depending on the nature of the reference credit.  If a credit event occurs, the Company settles with the counterparty, either through physical settlement or cash settlement.  In a physical settlement, a reference asset is delivered by the buyer of protection to the Company, in exchange for cash payment at par, while in a cash settlement, the Company pays the difference between par and the prescribed value of the reference asset.  When a credit event occurs in a single name or FTD basket (for FTD, the first credit event occurring for any one name in the basket), the contract terminates at time of settlement.  For CDX index, the reference entity’s name incurring the credit event is removed from the index while the contract continues until expiration.  The maximum payout on a CDS is the contract notional amount.  A physical settlement may afford the Company with recovery rights as the new owner of the asset.

 

The Company monitors risk associated with credit derivatives through individual name credit limits at both a credit derivative and a combined cash instrument/credit derivative level.  The ratings of individual names for which protection has been sold are also monitored.

 

19



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

The Company establishes reserves for claims and claims expense (“loss”) 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, 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