10-Q 1 a10-17601_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, 2010

 

OR

 

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

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number 1-11840

 

THE ALLSTATE CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

36-3871531

(State or other jurisdiction of incorporation or organization)

 

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

 

2775 Sanders Road, Northbrook, Illinois

60062

(Address of principal executive offices)

(Zip Code)

 

(847) 402-5000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes   X                     No ___

 

Indicate by check mark whether the registrant has submitted electronically 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   X                     No ___

 

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

___

 

 

 

 

Non-accelerated filer

___  (Do not check if a smaller reporting company)

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 ___                   No   X  

 

As of October 22, 2010, the registrant had 538,183,935 common shares, $.01 par value, outstanding.

 



 

THE ALLSTATE CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

September 30, 2010

 

PART I

FINANCIAL INFORMATION

PAGE

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Three-Month and Nine-Month Periods Ended September 30, 2010 and 2009 (unaudited)

1

 

 

 

 

Condensed Consolidated Statements of Financial Position as of September 30, 2010 (unaudited) and December 31, 2009

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2010 and 2009 (unaudited)

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

4

 

 

 

 

Report of Independent Registered Public Accounting Firm

48

 

 

 

Item 2.

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

 

 

 

 

 

Highlights

49

 

Consolidated Net Income

50

 

Property-Liability Highlights

51

 

Allstate Protection Segment

55

 

Discontinued Lines and Coverages Segment

66

 

Property-Liability Investment Results

67

 

Allstate Financial Highlights

68

 

Allstate Financial Segment

68

 

Investments Highlights

75

 

Investments

75

 

Capital Resources and Liquidity Highlights

104

 

Capital Resources and Liquidity

104

 

 

 

Item 4.

Controls and Procedures

108

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

109

 

 

 

Item 1A.

Risk Factors

109

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

109

 

 

 

Item 6.

Exhibits

110

 



 

PART I. FINANCIAL INFORMATION

 

ITEM 1.   FINANCIAL STATEMENTS

 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

($ in millions, except per share data)

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2010

 

2009

 

2010

 

2009

 

 

(unaudited)

 

(unaudited)

Revenues

 

 

 

 

 

 

 

 

Property-liability insurance premiums

$

6,499

$

6,535

$

19,515

$

19,677

Life and annuity premiums and contract charges

 

548

 

482

 

1,637

 

1,460

Net investment income

 

1,005

 

1,084

 

3,104

 

3,368

Realized capital gains and losses:

 

 

 

 

 

 

 

 

Total other-than-temporary impairment losses

 

(99)

 

(539)

 

(637)

 

(1,735)

Portion of loss recognized in other comprehensive income

 

(68)

 

147

 

(91)

 

301

Net other-than-temporary impairment losses recognized in earnings

 

(167)

 

(392)

 

(728)

 

(1,434)

Sales and other realized capital gains and losses

 

23

 

(127)

 

(215)

 

884

Total realized capital gains and losses

 

(144)

 

(519)

 

(943)

 

(550)

 

 

 

 

 

 

 

 

 

 

 

7,908

 

7,582

 

23,313

 

23,955

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

Property-liability insurance claims and claims expense

 

4,603

 

4,573

 

14,109

 

14,295

Life and annuity contract benefits

 

445

 

382

 

1,372

 

1,176

Interest credited to contractholder funds

 

445

 

496

 

1,358

 

1,636

Amortization of deferred policy acquisition costs

 

1,006

 

1,023

 

2,969

 

3,649

Operating costs and expenses

 

828

 

744

 

2,446

 

2,247

Restructuring and related charges

 

9

 

35

 

33

 

112

Interest expense

 

91

 

106

 

275

 

291

 

 

7,427

 

7,359

 

22,562

 

23,406

Gain on disposition of operations

 

9

 

2

 

12

 

6

 

 

 

 

 

 

 

 

 

Income from operations before income tax expense

 

490

 

225

 

763

 

555

 

 

 

 

 

 

 

 

 

Income tax expense

 

123

 

4

 

131

 

219

 

 

 

 

 

 

 

 

 

Net income

367

221

632

336

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share - Basic

0.68

0.41

1.17

0.62

 

 

 

 

 

 

 

 

 

Weighted average shares - Basic

 

540.9

 

539.9

 

540.6

 

539.5

 

 

 

 

 

 

 

 

 

Net income per share - Diluted

0.68

0.41

1.16

0.62

 

 

 

 

 

 

 

 

 

Weighted average shares - Diluted

 

543.0

 

541.5

 

542.7

 

540.5

 

 

 

 

 

 

 

 

 

Cash dividends declared per share

0.20

0.20

0.60

0.60

 

See notes to condensed consolidated financial statements.

 

1



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

 

($ in millions, except par value data)

 

September 30,

 

December 31,

 

 

2010

 

2009

Assets

 

(unaudited)

 

 

Investments:

 

 

 

 

Fixed income securities, at fair value (amortized cost $80,786 and $81,243)

83,193

78,766

Equity securities, at fair value (cost $3,447 and $4,845)

 

3,707

 

5,024

Mortgage loans

 

6,961

 

7,935

Limited partnership interests

 

3,454

 

2,744

Short-term, at fair value (amortized cost $2,776 and $3,056)

 

2,776

 

3,056

Other

 

2,123

 

2,308

Total investments

 

102,214

 

99,833

Cash

 

500

 

612

Premium installment receivables, net

 

4,981

 

4,839

Deferred policy acquisition costs

 

4,671

 

5,470

Reinsurance recoverables, net

 

6,597

 

6,355

Accrued investment income

 

847

 

864

Deferred income taxes

 

670

 

1,870

Property and equipment, net

 

922

 

990

Goodwill

 

874

 

875

Other assets

 

1,799

 

1,872

Separate Accounts

 

8,459

 

9,072

Total assets

132,534

132,652

 

 

 

 

 

Liabilities

 

 

 

 

Reserve for property-liability insurance claims and claims expense

19,294

19,167

Reserve for life-contingent contract benefits

 

13,955

 

12,910

Contractholder funds

 

48,936

 

52,582

Unearned premiums

 

10,001

 

9,822

Claim payments outstanding

 

733

 

742

Other liabilities and accrued expenses

 

5,945

 

5,726

Long-term debt

 

5,909

 

5,910

Separate Accounts

 

8,459

 

9,072

Total liabilities

 

113,232

 

115,931

 

 

 

 

 

Commitments and Contingent Liabilities (Note 10)

 

 

 

 

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, 538 million and 537 million shares outstanding

 

9

 

9

Additional capital paid-in

 

3,165

 

3,172

Retained income

 

31,781

 

31,492

Deferred ESOP expense

 

(45)

 

(47)

Treasury stock, at cost (362 million and 363 million shares)

 

(15,755)

 

(15,828)

Accumulated other comprehensive income:

 

 

 

 

Unrealized net capital gains and losses:

 

 

 

 

Unrealized net capital losses on fixed income securities with OTTI

 

(200)

 

(441)

Other unrealized net capital gains and losses

 

1,919

 

(1,072)

Unrealized adjustment to DAC, DSI and insurance reserves

 

(427)

 

643

Total unrealized net capital gains and losses

 

1,292

 

(870)

Unrealized foreign currency translation adjustments

 

54

 

46

Unrecognized pension and other postretirement benefit cost

 

(1,227)

 

(1,282)

Total accumulated other comprehensive income (loss)

 

119

 

(2,106)

Total shareholders’ equity

 

19,274

 

16,692

Noncontrolling interest

 

28

 

29

Total equity

 

19,302

 

16,721

Total liabilities and equity

132,534

132,652

 

See notes to condensed consolidated financial statements.

 

2



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

($ in millions)

 

Nine Months Ended
September 30,

 

 

2010

 

2009

Cash flows from operating activities

 

(unaudited)

Net income

632

336

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

 

 

 

 

Depreciation, amortization and other non-cash items

 

55

 

(87)

Realized capital gains and losses

 

943

 

550

Gain on disposition of operations

 

(12)

 

(6)

Interest credited to contractholder funds

 

1,358

 

1,636

Changes in:

 

 

 

 

Policy benefits and other insurance reserves

 

143

 

(460)

Unearned premiums

 

172

 

6

Deferred policy acquisition costs

 

(138)

 

471

Premium installment receivables, net

 

(137)

 

(108)

Reinsurance recoverables, net

 

(229)

 

(101)

Income taxes

 

178

 

1,175

Other operating assets and liabilities

 

58

 

103

Net cash provided by operating activities

 

3,023

 

3,515

Cash flows from investing activities

 

 

 

 

Proceeds from sales

 

 

 

 

Fixed income securities

 

17,345

 

16,098

Equity securities

 

4,262

 

4,636

Limited partnership interests

 

387

 

293

Mortgage loans

 

121

 

140

Other investments

 

98

 

429

Investment collections

 

 

 

 

Fixed income securities

 

3,672

 

3,947

Mortgage loans

 

784

 

1,093

Other investments

 

96

 

99

Investment purchases

 

 

 

 

Fixed income securities

 

(20,712)

 

(22,694)

Equity securities

 

(2,721)

 

(5,991)

Limited partnership interests

 

(1,040)

 

(674)

Mortgage loans

 

(55)

 

(23)

Other investments

 

(99)

 

(54)

Change in short-term investments, net

 

104

 

5,437

Change in other investments, net

 

(464)

 

(144)

Disposition of operations

 

7

 

12

Purchases of property and equipment, net

 

(114)

 

(143)

Net cash provided by investing activities

 

1,671

 

2,461

Cash flows from financing activities

 

 

 

 

Proceeds from issuance of long-term debt

 

 

1,003

Repayment of long-term debt

 

(1)

 

(1)

Contractholder fund deposits

 

2,297

 

3,252

Contractholder fund withdrawals

 

(6,779)

 

(9,485)

Dividends paid

 

(322)

 

(434)

Treasury stock purchases

 

(5)

 

(3)

Shares reissued under equity incentive plans, net

 

26

 

2

Excess tax benefits on share-based payment arrangements

 

(7)

 

(6)

Other

 

(15)

 

8

Net cash used in financing activities

 

(4,806)

 

(5,664)

Net (decrease) increase in cash

 

(112)

 

312

Cash at beginning of period

 

612

 

415

Cash at end of period

500

727

 

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, 2010, and for the three-month and nine-month periods ended September 30, 2010 and 2009 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, 2009.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

 

Adopted accounting standards

 

Disclosures about Fair Value Measurements

 

In January 2010, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance which expands disclosure requirements relating to fair value measurements.  The guidance adds requirements for disclosing amounts of and reasons for significant transfers into and out of Levels 1 and 2 and requires gross rather than net disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements.  The guidance also provides clarification that fair value measurement disclosures are required for each class of assets and liabilities.  Disclosures about the valuation techniques and inputs used to measure fair value for measurements that fall in either Level 2 or Level 3 are also required.  The Company adopted the provisions of the new guidance as of March 31, 2010, except for disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which are required for fiscal years beginning after December 15, 2010.  Disclosures are not required for earlier periods presented for comparative purposes.  The new guidance affects disclosures only; and therefore, the adoption had no impact on the Company’s results of operations or financial position.

 

Consolidation of Variable Interest Entities

 

In June 2009, the FASB issued new accounting guidance which requires an entity to perform a qualitative analysis to determine whether it holds a controlling financial interest (i.e., is a primary beneficiary) in a variable interest entity (“VIE”).  The analysis identifies the primary beneficiary of a VIE as the entity that has both the power to direct the activities of the VIE that most significantly impact the economic performance of the VIE and the obligation to absorb losses, or the right to receive benefits, that could potentially be significant to the VIE.  The Company adopted the new guidance as of January 1, 2010.  The adoption resulted in the consolidation of four VIEs for which the Company concluded it is the primary beneficiary as of January 1, 2010.

 

Two of the consolidated VIEs hold investments managed by Allstate Investment Management Company (“AIMCO”), a subsidiary of the Company.  Consolidation as of January 1, 2010 resulted in an increase in total assets of $696 million, an increase in total liabilities of $679 million, an increase in retained income of $7 million and an increase in noncontrolling interest of $10 million.  During the first quarter of 2010, the Company sold substantially all its variable interests in these two VIEs.  As a result, the Company deconsolidated the VIEs as of March 26, 2010.  The Condensed Consolidated Statement of Operations for the nine months ended September 30, 2010 reflects the effect of the consolidation for the portion of the period the Company was the primary beneficiary, which was not material.

 

The adoption also resulted in the consolidation of two insurance company affiliates, Allstate Texas Lloyds and Allstate County Mutual Insurance Company, that underwrite homeowners and auto insurance polices, respectively, and reinsure all of their net business to AIC.  Consolidation as of January 1, 2010 resulted in an increase in total assets of $38 million, an increase in total liabilities of $34 million, an increase in retained income of $3 million and an increase in unrealized net capital gains and losses of $1 million.

 

4



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

In the normal course of investing activities, the Company invests in variable interests issued by VIEs.  These variable interests include structured investments such as residential mortgage-backed securities, commercial mortgage-backed securities and asset-backed securities as well as limited partnerships, special purpose entities and trusts.  For these variable interests, the Company concluded it is not the primary beneficiary due to the amount of the Company’s interest in the VIEs and the Company’s lack of power to direct the activities that are most significant to the economic performance of the VIEs.  The Company’s maximum exposure to loss on these interests is limited to the amount of the Company’s investment, including future funding commitments, as applicable.

 

Embedded Credit Derivatives Scope Exception

 

In March 2010, the FASB issued accounting guidance clarifying the scope exception for embedded credit derivative features, including those in certain collateralized debt obligations and synthetic collateralized debt obligations.  Embedded credit derivative features related to the transfer of credit risk that is only in the form of subordination of one financial instrument to another continue to qualify for the scope exception.  Other embedded credit derivative features must be analyzed for potential bifurcation and separate accounting as a derivative, with periodic changes in fair value recorded in net income.  The adoption of the new guidance as of July 1, 2010 resulted in the bifurcation of the credit default swaps embedded in synthetic collateralized debt obligations purchased after January 1, 2007, and the related net unrealized capital losses were reclassified from accumulated other comprehensive income to retained income.  The cumulative effect of adoption, net of related deferred policy acquisition costs (“DAC”), deferred sales inducement costs (“DSI”) and tax adjustments, was a $19 million increase in unrealized net capital gains and losses, a $9 million decrease in total assets and a $28 million decrease in retained income.

 

Pending accounting standards

 

Consolidation Analysis Considering Investments Held through Separate Accounts

 

In April 2010, the FASB issued guidance clarifying that an insurer is not required to combine interests in investments held in a qualifying separate account with its interests in the same investments held in the general account when performing a consolidation evaluation.  The guidance is effective for fiscal years and interim periods beginning after December 15, 2010 with early adoption permitted.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations or financial position.

 

Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses

 

In July 2010, the FASB issued guidance requiring expanded disclosures relating to the credit quality of financing receivables and the related allowances for credit losses.  The new guidance requires a greater level of disaggregated information, as well as additional disclosures about credit quality indicators, past due information and modifications of its financing receivables.  The new guidance is effective for reporting periods ending after December 15, 2010.  The new guidance affects disclosures only; and therefore, the adoption will have no impact on the Company’s results of operations or financial position.

 

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

 

In October 2010, the FASB issued guidance modifying the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts.  The guidance specifies that incremental direct costs of contract acquisition attributable to successful efforts should be included as deferred acquisition costs.  The guidance also specifies that deferred acquisition costs include advertising costs only when the direct-response advertising accounting criteria are met.  The new guidance is effective for reporting periods beginning after December 15, 2011 and should be applied prospectively, with retrospective application permitted.  If application of the guidance would result in the capitalization of acquisition costs that had not previously been capitalized prior to adoption, the entity may elect not to capitalize those additional costs.  The Company is in process of evaluating the impact of adoption on the Company’s results of operations and financial position.

 

2.  Earnings per share

 

Basic earnings per share is computed using the weighted average number of common shares outstanding, including unvested participating restricted stock units.  Diluted earnings per share is computed using the weighted

 

5



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

average number of common and dilutive potential common shares outstanding.  For the Company, dilutive potential common shares consist of outstanding stock options and unvested non-participating restricted stock units.

 

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

 

($ in millions, except per share data)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2010

 

2009

 

2010

 

2009

Numerator:

 

 

 

 

 

 

 

 

Net income

367

221

632

336

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

540.9

 

539.9

 

540.6

 

539.5

Effect of dilutive potential common shares:

 

 

 

 

 

 

 

 

Stock options

 

1.9

 

1.6

 

2.0

 

1.0

Restricted stock units (non-participating)

 

0.2

 

--

 

0.1

 

--

Weighted average common and dilutive potential common shares outstanding

 

543.0

 

541.5

 

542.7

 

540.5

 

 

 

 

 

 

 

 

 

Earnings per share - Basic

0.68

0.41

1.17

0.62

Earnings per share - Diluted

0.68

0.41

1.16

0.62

 

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 27.6 million and 25.0 million Allstate common shares, with exercise prices ranging from $27.36 to $62.84 and $23.13 to $64.53, were outstanding at September 30, 2010 and 2009, respectively, but were not included in the computation of diluted earnings per share for the three-month periods then ended.  Options to purchase 26.6 million and 26.2 million Allstate common shares, with exercise prices ranging from $27.36 to $64.53 and $23.13 to $65.38, were outstanding at September 30, 2010 and 2009, respectively, but were not included in the computation of diluted earnings per share for the nine-month periods then ended.

 

3.  Supplemental Cash Flow Information

 

Non-cash investment exchanges, including modifications of certain mortgage loans, fixed income securities, limited partnerships and other investments, as well as mergers completed with equity securities, totaled $544 million and $342 million for the nine months ended September 30, 2010 and 2009, respectively.

 

6



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Liabilities for collateral received in conjunction with the Company’s securities lending and over-the-counter (“OTC”) derivatives 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:

 

($ in millions)

 

Nine months ended
September 30,

 

 

2010

 

2009

Net change in proceeds managed

 

 

 

 

Net change in short-term investments

187

(190)

Operating cash flow provided (used)

 

187

 

(190)

Net change in cash

 

2

 

--

Net change in proceeds managed

189

(190)

 

 

 

 

 

Net change in liabilities

 

 

 

 

Liabilities for collateral, beginning of year

(658)

(340)

Liabilities for collateral, end of period

 

(469)

 

(530)

Operating cash flow (used) provided

(189)

190

 

4.  Investments

 

Fair values

 

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

 

($ in millions)

 

Amortized

 

Gross unrealized

 

Fair

 

 

cost

 

Gains

 

Losses

 

value

At September 30, 2010

 

 

 

 

 

 

 

 

U.S. government and agencies

10,721

533

(1)

11,253

Municipal

 

16,366

 

803

 

(401)

 

16,768

Corporate

 

34,870

 

2,618

 

(284)

 

37,204

Foreign government

 

2,946

 

482

 

--

 

3,428

Residential mortgage-backed securities (“RMBS”)

 

9,192

 

245

 

(938)

 

8,499

Commercial mortgage-backed securities (“CMBS”)

 

2,375

 

59

 

(441)

 

1,993

Asset-backed securities (“ABS”)

 

4,280

 

105

 

(375)

 

4,010

Redeemable preferred stock

 

36

 

2

 

--

 

38

Total fixed income securities

80,786

4,847

(2,440)

83,193

At December 31, 2009

 

 

 

 

 

 

 

 

U.S. government and agencies

7,333

219

(16)

7,536

Municipal

 

21,683

 

537

 

(940)

 

21,280

Corporate

 

32,770

 

1,192

 

(847)

 

33,115

Foreign government

 

2,906

 

306

 

(15)

 

3,197

RMBS

 

9,487

 

130

 

(1,630)

 

7,987

CMBS

 

3,511

 

30

 

(955)

 

2,586

ABS

 

3,514

 

62

 

(550)

 

3,026

Redeemable preferred stock

 

39

 

1

 

(1)

 

39

Total fixed income securities

81,243

2,477

(4,954)

78,766

 

7



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Scheduled maturities

 

The scheduled maturities for fixed income securities are as follows at September 30, 2010:

 

($ in millions)

 

Amortized

 

Fair

 

 

cost

 

value

Due in one year or less

3,338

3,389

Due after one year through five years

 

25,627

 

26,746

Due after five years through ten years

 

15,835

 

17,386

Due after ten years

 

22,514

 

23,163

 

 

67,314

 

70,684

RMBS and ABS

 

13,472

 

12,509

Total

80,786

83,193

 

Actual maturities may differ from those scheduled as a result of prepayments by the issuers.  Because of the potential for prepayment on RMBS and ABS, they are not categorized by contractual maturity.  CMBS are categorized by contractual maturity because they generally are not subject to prepayment risk.

 

Net investment income

 

Net investment income is as follows:

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2010

 

2009

 

2010

 

2009

Fixed income securities

926

987

2,840

3,022

Equity securities

 

17

 

15

 

63

 

50

Mortgage loans

 

92

 

121

 

295

 

389

Limited partnership interests

 

6

 

4

 

19

 

11

Short-term investments

 

2

 

4

 

6

 

23

Other

 

5

 

(4)

 

12

 

(7)

Investment income, before expense

 

1,048

 

1,127

 

3,235

 

3,488

Investment expense

 

(43)

 

(43)

 

(131)

 

(120)

Net investment income

1,005

1,084

3,104

3,368

 

Realized capital gains and losses

 

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

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2010

 

2009

 

2010

 

2009

Fixed income securities

84

(33)

(240)

89

Equity securities

 

83

 

(21)

 

142

 

(157)

Mortgage loans

 

(1)

 

(66)

 

(54)

 

(114)

Limited partnership interests

 

(20)

 

(20)

 

(15)

 

(443)

Derivatives

 

(286)

 

(364)

 

(779)

 

151

Other

 

(4)

 

(15)

 

3

 

(76)

Realized capital gains and losses

(144)

(519)

(943)

(550)

 

8



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2010

 

2009

 

2010

 

2009

Impairment write-downs

(137)

(381)

(599)

(1,292)

Change in intent write-downs

 

(30)

 

(11)

 

(129)

 

(142)

Net other-than-temporary impairment losses recognized in earnings

 

(167)

 

(392)

 

(728)

 

(1,434)

Sales

 

319

 

201

 

552

 

882

Valuation of derivative instruments

 

(133)

 

(269)

 

(571)

 

201

Settlements of derivative instruments

 

(152)

 

(92)

 

(209)

 

(52)

EMA limited partnership income

 

(11)

 

33

 

13

 

(147)

Realized capital gains and losses

(144)

(519)

(943)

(550)

 

 Gross gains of $387 million and $341 million and gross losses of $173 million and $144 million were realized on sales of fixed income securities during the three months ended September 30, 2010 and 2009, respectively.  Gross gains of $673 million and $1.12 billion and gross losses of $360 million and $303 million were realized on sales of fixed income securities during the nine months ended September 30, 2010 and 2009, respectively.

 

9



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Other-than-temporary impairment losses by asset type are as follows:

 

($ in millions)

 

Three months ended
September 30, 2010

 

Nine months ended
September 30, 2010

 

 

Gross

 

Included
in OCI

 

Net

 

Gross

 

Included
in OCI

 

Net

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

(1

)

--

 

(1

)

(106

)

4

 

(102

)

Corporate

 

(14

)

 

(1

)

 

(15

)

 

(67

)

 

1

 

 

(66

)

RMBS

 

(56

)

 

(41

)

 

(97

)

 

(268

)

 

(43

)

 

(311

)

CMBS

 

(1

)

 

(26

)

 

(27

)

 

(44

)

 

(37

)

 

(81

)

ABS

 

--

 

 

--

 

 

--

 

 

(9

)

 

(16

)

 

(25

)

Total fixed income securities

 

(72

)

 

(68

)

 

(140

)

 

(494

)

 

(91

)

 

(585

)

Equity securities

 

(14

)

 

--

 

 

(14

)

 

(51

)

 

--

 

 

(51

)

Mortgage loans

 

(3

)

 

--

 

 

(3

)

 

(50

)

 

--

 

 

(50

)

Limited partnership interests

 

(10

)

 

--

 

 

(10

)

 

(42

)

 

--

 

 

(42

)

Other-than-temporary impairment losses

(99

)

(68

)

(167

)

(637

)

(91

)

(728

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended
September 30, 2009

 

Nine months ended
September 30, 2009

 

 

Gross

 

Included
in OCI

 

Net

 

Gross

 

Included
in OCI

 

Net

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

(6

)

2

 

(4

)

(92

)

6

 

(86

)

Corporate

 

(112

)

 

(1

)

 

(113

)

 

(204

)

 

(10

)

 

(214

)

Foreign government

 

--

 

 

--

 

 

--

 

 

(17

)

 

--

 

 

(17

)

RMBS

 

(174

)

 

115

 

 

(59

)

 

(433

)

 

266

 

 

(167

)

CMBS

 

(90

)

 

62

 

 

(28

)

 

(142

)

 

61

 

 

(81

)

ABS

 

(10

)

 

(31

)

 

(41

)

 

(185

)

 

(22

)

 

(207

)

Total fixed income securities

 

(392

)

 

147

 

 

(245

)

 

(1,073

)

 

301

 

 

(772

)

Equity securities

 

(61

)

 

--

 

 

(61

)

 

(247

)

 

--

 

 

(247

)

Mortgage loans

 

(31

)

 

--

 

 

(31

)

 

(80

)

 

--

 

 

(80

)

Limited partnership interests

 

(53

)

 

--

 

 

(53

)

 

(296

)

 

--

 

 

(296

)

Other

 

(2

)

 

--

 

 

(2

)

 

(39

)

 

--

 

 

(39

)

Other-than-temporary impairment losses

(539

)

147

 

(392

)

(1,735

)

301

 

(1,434

)

 

The total amount of other-than-temporary impairment losses included in accumulated other comprehensive income for fixed income securities, which were not included in earnings, are presented in the following table.  The amount excludes $330 million and $192 million as of September 30, 2010 and December 31, 2009, respectively, of net unrealized gains related to changes in valuation of the fixed income securities subsequent to the impairment measurement date.

 

($ in millions)

 

September 30,
2010

 

December 31,
2009

Municipal

(8)

(10)

Corporate

 

(48)

 

(51)

RMBS

 

(484)

 

(594)

CMBS

 

(58)

 

(127)

ABS

 

(40)

 

(89)

Total

(638)

(871)

 

10



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

2010

 

2009

 

2010

 

2009

Beginning balance

(1,309)

(1,506)

(1,187)

--

Beginning balance of cumulative credit loss for securities held at April 1, 2009

 

--

 

--

 

--

 

(1,357)

Cumulative effect of change in accounting principle

 

81

 

--

 

81

 

--

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

 

(101)

 

(88)

 

(265)

 

(122)

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

 

(9)

 

(157)

 

(197)

 

(315)

Reduction in credit loss for securities disposed or collected

 

104

 

396

 

330

 

439

Reduction in credit loss for securities other-than-temporarily impaired to fair value

 

42

 

--

 

43

 

--

Change in credit loss due to accretion of increase in cash flows and time value of cash flows for securities previously other-than-temporarily impaired

 

1

 

--

 

4

 

--

Ending balance

(1,191)

(1,355)

(1,191)

(1,355)

 

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

 

11



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Unrealized net capital gains and losses

 

Unrealized net capital gains and losses included in accumulated other comprehensive income are as follows:

 

($ in millions)

 

Fair

 

Gross unrealized

 

Unrealized net

At September 30, 2010

 

value

 

Gains

 

Losses

 

gains (losses)

Fixed income securities (1)

83,193

4,847

(2,440)

 

$       2,407

Equity securities

 

3,707

 

363

 

(103)

 

260

Short-term investments

 

2,776

 

--

 

--

 

--

Derivative instruments (2)

 

(12)

 

2

 

(19)

 

(17)

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

2,650

Amounts recognized for:

 

 

 

 

 

 

 

 

Insurance reserves (3)

 

 

 

 

 

 

 

(608)

DAC and DSI (4)

 

 

 

 

 

 

 

(49)

Amounts recognized

 

 

 

 

 

 

 

(657)

Deferred income taxes

 

 

 

 

 

 

 

(701)

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$       1,292

 


(1)   Unrealized net capital gains and losses for fixed income securities as of September 30, 2010 comprises $(308) million related to unrealized net capital losses on fixed income securities with OTTI and $2,715 million related to other unrealized net capital gains and losses.

(2)   Included in the fair value of derivative instruments are $2 million classified as assets and $14 million classified as liabilities.

(3)   The insurance reserves adjustment represents the amount by which the reserve balance would increase if the net unrealized gains in the applicable product portfolios were realized and reinvested at current lower interest rates, resulting in a premium deficiency.  Although the Company evaluates premium deficiencies on the combined performance of life insurance and immediate annuities with life contingencies, the adjustment primarily relates to structured settlement annuities with life contingencies, in addition to annuity buy-outs and certain payout annuities with life contingencies.

(4)   The DAC and DSI adjustment balance represents the amount by which the amortization of DAC and DSI would increase or decrease if the unrealized gains or losses in the respective product portfolios were realized.

 

 

 

Fair

 

Gross unrealized

 

Unrealized net

At December 31, 2009

 

value

 

Gains

 

Losses

 

gains (losses)

Fixed income securities (1)

78,766

2,477

(4,954)

 

$      (2,477)

Equity securities

 

5,024

 

381

 

(202)

 

179

Short-term investments

 

3,056

 

--

 

--

 

--

Derivative instruments (2)

 

(20)

 

2

 

(25)

 

(23)

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

(2,321)

Amounts recognized for:

 

 

 

 

 

 

 

 

Insurance reserves

 

 

 

 

 

 

 

--

DAC and DSI

 

 

 

 

 

 

 

990

Amounts recognized

 

 

 

 

 

 

 

990

Deferred income taxes

 

 

 

 

 

 

 

461

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$         (870)

 


(1)     Unrealized net capital gains and losses for fixed income securities as of December 31, 2009 comprises $(679) million related to unrealized net capital losses on fixed income securities with OTTI and $(1,798) million related to other unrealized net capital gains and losses.

(2)     Included in the fair value of derivative instruments are $(2) million classified as assets and $18 million classified as liabilities.

 

12



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Change in unrealized net capital gains and losses

 

The change in unrealized net capital gains and losses for the nine months ended September 30, 2010 is as follows:

 

($ in millions)

 

 

Fixed income securities

4,884

Equity securities

 

81

Derivative instruments

 

6

Total

 

4,971

Amounts recognized for:

 

 

Insurance reserves

 

(608)

DAC and DSI

 

(1,039)

Decrease in amounts recognized

 

(1,647)

Deferred income taxes

 

(1,162)

Increase in unrealized net capital gains and losses

2,162

 

Portfolio monitoring

 

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

 

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

 

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

 

For equity securities, the Company considers various factors, including whether it has the intent and ability to hold the equity security for a period of time sufficient to recover its cost basis.  Where the Company lacks the intent and ability to hold to recovery, or believes the recovery period is extended, the equity security’s decline in fair value is considered other than temporary and is recorded in earnings.  For equity securities managed by a third party, the Company has contractually retained its decision making authority as it pertains to selling equity securities that are in an unrealized loss position.

 

The Company’s portfolio monitoring process includes a quarterly review of all securities to identify instances where the fair value of a security compared to its amortized cost (for fixed income securities) or cost (for equity securities) is below established thresholds.  The process also includes the monitoring of other impairment indicators such as ratings, ratings downgrades and payment defaults.  The securities identified, in addition to other securities for which the Company may have a concern, are evaluated for potential other-than-temporary impairment using all reasonably available information relevant to the collectability or recovery of the security.  Inherent in the Company’s evaluation of other-than-temporary impairment for these fixed income and equity securities are assumptions and estimates about the financial condition and future earnings potential of the issue or issuer.  Some of the factors considered in evaluating whether a decline in fair value is other than temporary are: 1) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry specific market conditions and trends, geographic location and implications of rating agency actions and offering prices; 2) the specific reasons that a security is in an unrealized loss position, including overall market conditions which could affect liquidity; and 3) the length of time and extent to which the fair value has been less than amortized cost or cost.

 

13



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

($ in millions)

 

Less than 12 months

 

12 months or more

 

Total

 

 

Number

 

Fair

 

Unrealized

 

Number

 

Fair

 

Unrealized

 

unrealized

 

 

of issues

 

value

 

losses

 

of issues

 

value

 

losses

 

losses

At September 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

6

633

(1)

 

--

--

--

(1)

Municipal

 

84

 

338

 

(4)

 

431

 

3,003

 

(397)

 

(401)

Corporate

 

82

 

1,026

 

(42)

 

189

 

2,512

 

(242)

 

(284)

Foreign government

 

1

 

2

 

--  

 

2

 

11

 

--

 

--

RMBS

 

266

 

358

 

(5)

 

370

 

2,050

 

(933)

 

(938)

CMBS

 

4

 

31

 

(1)

 

144

 

1,015

 

(440)

 

(441)

ABS

 

50

 

534

 

(17)

 

137

 

1,249

 

(358)

 

(375)

Redeemable preferred stock

 

--

 

--

 

--  

 

1

 

--

 

--

 

--

Total fixed income securities (1)

 

493

 

2,922

 

(70)

 

1,274

 

9,840

 

(2,370)

 

(2,440)

Equity securities

 

1,427

 

992

 

(92)

 

11

 

71

 

(11)

 

(103)

Total fixed income and equity securities

 

1,920

3,914

(162)

 

1,285

9,911

(2,381)

(2,543)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

439

2,621

(58)

 

868

7,111

(1,153)

(1,211)

Below investment grade fixed income securities

 

54

 

301

 

(12)

 

406

 

2,729

 

(1,217)

 

(1,229)

Total fixed income securities

 

493

2,922

(70)

 

1,274

9,840

(2,370)

(2,440)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

38

3,523

$

(16)

 

--

--

--

(16)

Municipal

 

761

 

3,646

 

(123)

 

747

 

5,024

 

(817)

 

(940)

Corporate

 

399

 

5,072

 

(178)

 

421

 

5,140

 

(669)

 

(847)

Foreign government

 

50

 

505

 

(15)

 

1

 

1

 

--

 

(15)

RMBS

 

387

 

1,092

 

(23)

 

453

 

2,611

 

(1,607)

 

(1,630)

CMBS

 

25

 

232

 

(4)

 

259

 

1,790

 

(951)

 

(955)

ABS

 

39

 

352

 

(20)

 

173

 

1,519

 

(530)

 

(550)

Redeemable preferred stock

 

1

 

--

 

--  

 

1

 

21

 

(1)

 

(1)

Total fixed income securities (1)

 

1,700

 

14,422

 

(379)

 

2,055

 

16,106

 

(4,575)

 

(4,954)

Equity securities

 

1,665

 

1,349

 

(113)

 

28

 

450

 

(89)

 

(202)

Total fixed income and equity securities

 

3,365

15,771

(492)

 

2,083

16,556

(4,664)

(5,156)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

1,587

13,891

(293)

 

1,561

13,127

(2,848)

(3,141)

Below investment grade fixed income securities

 

113

 

531

 

(86)

 

494

 

2,979

 

(1,727)

 

(1,813)

Total fixed income securities

 

1,700

14,422

(379)

 

2,055

16,106

(4,575)

(4,954)

 


(1)     Gross unrealized losses resulting from factors other than credit on fixed income securities with other-than-temporary impairments for which the Company has recorded a credit loss in earnings total $4 million for the less than 12 month category and $428 million for the 12 months or greater category as of September 30, 2010 and $20 million for the less than 12 month category and $729 million for the 12 months or greater category as of December 31, 2009.

 

As of September 30, 2010, $728 million of unrealized losses are related to securities with an unrealized loss position less than 20% of amortized cost or cost, the degree of which suggests that these securities do not pose a high risk of being other-than-temporarily impaired.  Of the $728 million, $494 million are related to unrealized losses on investment grade fixed income securities.  Investment grade is defined as a security having a rating of Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB from Standard & Poor’s (“S&P”), Fitch, Dominion or Realpoint, a rating of aaa, aa, a or bbb from A.M. Best, or a comparable internal rating if an externally provided rating is not available.  Unrealized losses on investment grade securities are principally related to widening credit spreads or, in some instances, rising interest rates since the time of initial purchase.

 

As of September 30, 2010, the remaining $1.81 billion of unrealized losses are related to securities in unrealized loss positions greater than or equal to 20% of amortized cost or cost.  Investment grade securities comprising $717 million of these unrealized losses were evaluated based on factors such as expected cash flows and the financial condition and near-term and long-term prospects of the issue or issuer and were determined to have adequate

 

14



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

resources to fulfill contractual obligations.  Of the $1.81 billion, $1.06 billion are related to below investment grade fixed income securities and $32 million are related to equity securities.  Of these amounts, $1.03 billion of the below investment grade fixed income securities had been in an unrealized loss position for a period of twelve or more consecutive months as of September 30, 2010.  Unrealized losses on below investment grade securities are principally related to RMBS, CMBS and ABS and were the result of wider credit spreads resulting from larger risk premiums since the time of initial purchase, largely due to macroeconomic conditions and credit market deterioration, including the impact of declining residential and commercial real estate valuations.

 

RMBS, CMBS and ABS securities in an unrealized loss position were evaluated based on actual and projected collateral losses relative to the securities’ positions in the respective securitization trusts, security specific expectations of cash flows, and credit ratings.  This evaluation also takes into consideration credit enhancement, measured in terms of (i) subordination from other classes of securities in the trust that are contractually obligated to absorb losses before the class of security the Company owns, (ii) the expected impact of other structural features embedded in the securitization trust beneficial to the class of securities the Company owns, such as overcollateralization and excess spread, and (iii) for RMBS and ABS in an unrealized loss position, credit enhancements from reliable bond insurers, where applicable.  Municipal bonds in an unrealized loss position were evaluated based on the quality of the underlying securities, taking into consideration credit enhancements from reliable bond insurers, where applicable.  Unrealized losses on equity securities are primarily related to equity market fluctuations.

 

As of September 30, 2010, the Company has not made the decision to sell and it is not more likely than not the Company will be required to sell fixed income securities with unrealized losses before recovery of the amortized cost basis.  As of September 30, 2010, the Company had the intent and ability to hold equity securities with unrealized losses for a period of time sufficient for them to recover.

 

Limited partnership impairment

 

As of September 30, 2010 and December 31, 2009, the carrying value of equity method limited partnership interests totaled $2.19 billion and $1.64 billion, respectively.  The Company recognizes an impairment loss for equity method investments when evidence demonstrates that it is other-than-temporarily impaired.  Evidence of a loss in value that is other than temporary may include the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment.  The Company had no write-downs related to equity method limited partnership interests for the three months ended September 30, 2010 and 2009.  The Company had write-downs related to equity method limited partnership interests of $1 million and $10 million for the nine months ended September 30, 2010 and 2009, respectively.

 

As of September 30, 2010 and December 31, 2009, the carrying value for cost method limited partnership interests was $1.26 billion and $1.10 billion, respectively.  To determine if an other-than-temporary impairment has occurred, the Company evaluates whether an impairment indicator has occurred in the period that may have a significant adverse effect on the carrying value of the investment.  Impairment indicators may include: significantly reduced valuations of the investments held by limited partnerships; actual recent cash flows received being significantly less than expected cash flows; reduced valuations based on financing completed at a lower value; completed sale of a material underlying investment at a price significantly lower than expected; or any other adverse events since the last financial statements received that might affect the fair value of the investee’s capital.  Additionally, the Company’s portfolio monitoring process includes a quarterly review of all cost method limited partnerships to identify instances where the net asset value is below established thresholds for certain periods of time, as well as investments that are performing below expectations, for further impairment consideration.  If a cost method limited partnership is other-than-temporarily impaired, the carrying value is written down to fair value, generally estimated to be equivalent to the reported net asset value of the underlying funds.  The Company had write-downs related to cost method investments of $10 million and $53 million for the three months ended September 30, 2010 and 2009, respectively, and $41 million and $286 million for the nine months ended September 30, 2010 and 2009, respectively.

 

5.  Fair Value of Assets and Liabilities

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The hierarchy for inputs used in

 

15



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

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

 

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

 

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

 

(b)  Quoted prices for identical or similar assets or liabilities in markets that are not active; or

 

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

 

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

 

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

 

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

 

The second situation where the Company classifies securities in Level 3 is where specific inputs significant to the fair value estimation models are not market observable.  This occurs in two primary instances.  The first relates to the Company’s use of broker quotes.  The second relates to auction rate securities (“ARS”) backed by student loans for which a key input, the anticipated date liquidity will return to this market, is not market observable.

 

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, derivatives embedded in fixed income securities are not disclosed in the hierarchy as free-standing derivatives since they are presented with the host contracts in fixed income securities.  As of September 30, 2010, 74.4% of total assets are measured at fair value and 0.7% of total liabilities are measured at fair value.

 

In determining fair value, the Company principally uses the market approach which generally utilizes market transaction data for the same or similar instruments.  To a lesser extent, the Company uses the income approach which involves determining fair values from discounted cash flow methodologies.  For the majority of Level 2 and Level 3 valuations, a combination of the market and income approaches is used.

 

16



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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

 

Level 1 measurements

 

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

 

·                  Equity securities:  Comprise actively traded, exchange-listed U.S. and international equity securities. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

 

·                  Short-term:  Comprise actively traded money market funds that have daily quoted net asset values for identical assets that the Company can access.

 

·                  Separate account assets:  Comprise actively traded mutual funds that have daily quoted net asset values for identical assets that the Company can access.  Net asset values for the actively traded mutual funds in which the separate account assets are invested are obtained daily from the fund managers.

 

Level 2 measurements

 

·                  Fixed income securities:

 

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

 

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

 

Corporate, including privately placed:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.  Also included are privately placed securities valued using a discounted cash flow model that is widely accepted in the financial services industry and uses market observable inputs and inputs derived principally from, or corroborated by, observable market data.  The primary inputs to the discounted cash flow model include an interest rate yield curve, as well as published credit spreads for similar assets in markets that are not active that incorporate the credit quality and industry sector of the issuer.

 

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

 

RMBS - U.S. government sponsored entities (“U.S. Agency”), Prime residential mortgage-backed securities (“Prime”) and Alt-A residential mortgage-backed securities (“Alt-A”); ABS - auto and student loans and other:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.

 

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

 

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

 

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

 

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

 

·                  Other investments:  Free-standing exchange listed derivatives that are not actively traded are valued based on quoted prices for identical instruments in markets that are not active.

 

17



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

OTC derivatives, including interest rate swaps, foreign currency swaps, foreign exchange forward contracts, and certain credit default swaps, are valued using models that rely on inputs such as interest rate yield curves, currency rates, and counterparty credit spreads that are observable for substantially the full term of the contract.  The valuation techniques underlying the models are widely accepted in the financial services industry and do not involve significant judgment.

 

·                  Contractholder funds:  Derivatives embedded in certain annuity contracts are valued based on internal models that rely on inputs such as interest rate yield curves and equity index volatility assumptions that are market observable for substantially the full term of the contract.  The valuation techniques are widely accepted in the financial services industry and do not include significant judgment.

 

Level 3 measurements

 

·                  Fixed income securities:

 

Municipal:  ARS primarily backed by student loans that have become illiquid due to failures in the auction market are valued using a discounted cash flow model that is widely accepted in the financial services industry and uses significant non-market observable inputs, including estimates of future coupon rates if auction failures continue, maturity assumptions and illiquidity premium.  Also included are municipal bonds that are not rated by third party credit rating agencies but are rated by the National Association of Insurance Commissioners (“NAIC”), and other high-yield municipal bonds.  The primary inputs to the valuation of these municipal bonds include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields and credit spreads.

 

Corporate, including privately placed:  Primarily valued based on non-binding broker quotes.  Also included are equity-indexed notes which are valued using a discounted cash flow model that is widely accepted in the financial services industry and uses significant non-market observable inputs, such as volatility.  Other inputs include an interest rate yield curve, as well as published credit spreads for similar assets that incorporate the credit quality and industry sector of the issuer.

 

RMBS - Subprime residential mortgage-backed securities (“Subprime”) and Alt-A:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.  Also included are Subprime and Alt-A securities that are valued based on non-binding broker quotes.  Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in liquidity that has been experienced in the market for these securities, Subprime and certain Alt-A securities are categorized as Level 3.

 

Foreign government:  Valued based on non-binding broker quotes.

 

CMBS:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields, collateral performance and credit spreads.  Also included are CMBS that are valued based on non-binding broker quotes.  Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in liquidity that has been experienced in the market for these securities, certain CMBS are categorized as Level 3.

 

ABS - Collateralized debt obligations (“CDO”):  Valued based on non-binding broker quotes received from brokers who are familiar with the investments.  Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in liquidity that has been experienced in the market for these securities, all CDO are categorized as Level 3.

 

ABS - student loans and other:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.  Also included are ABS that are valued based on non-binding broker quotes.  Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in

 

18



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

liquidity that has been experienced in the market for these securities, certain ABS are categorized as Level 3.

 

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

 

·                  Contractholder funds:  Derivatives embedded in certain annuity contracts are valued internally using models widely accepted in the financial services industry that determine a single best estimate of fair value for the embedded derivatives within a block of contractholder liabilities.  The models use stochastically determined cash flows based on the contractual elements of embedded derivatives and other applicable market data.  These are categorized as Level 3 as a result of the significance of non-market observable inputs.

 

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

 

Mortgage loans written-down to fair value in connection with recognizing impairments are valued based on the fair value of the underlying collateral.  Limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments are valued using net asset values.

 

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of September 30, 2010:

 

($ in millions)

 

Quoted prices
in active
markets for
identical
assets

 

Significant
other
observable
inputs

 

Significant
unobservable
inputs

 

Counterparty
and cash
collateral

 

Balance
as of
September 30,

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

netting

 

2010

Assets

 

 

 

 

 

 

 

 

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

6,912

 

4,341

 

--

 

 

 

 

11,253

 

Municipal

 

--

 

 

14,624

 

 

2,144

 

 

 

 

 

16,768

 

Corporate

 

--

 

 

35,027

 

 

2,177

 

 

 

 

 

37,204

 

Foreign government

 

--

 

 

3,428

 

 

--

 

 

 

 

 

3,428

 

RMBS

 

--

 

 

6,615

 

 

1,884

 

 

 

 

 

8,499

 

CMBS

 

--

 

 

1,127

 

 

866

 

 

 

 

 

1,993

 

ABS

 

--

 

 

1,658

 

 

2,352

 

 

 

 

 

4,010

 

Redeemable preferred stock

 

--

 

 

37

 

 

1

 

 

 

 

 

38

 

Total fixed income securities

 

6,912

 

 

66,857

 

 

9,424

 

 

 

 

 

83,193

 

Equity securities

 

3,463

 

 

179

 

 

65

 

 

 

 

 

3,707

 

Short-term investments

 

253

 

 

2,523

 

 

--

 

 

 

 

 

2,776

 

Other investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

--

 

 

568

 

 

11

 

(263

)

 

316

 

Separate account assets

 

8,459

 

 

--

 

 

--

 

 

--

 

 

8,459

 

Other assets

 

--

 

 

--

 

 

2

 

 

--

 

 

2

 

Total recurring basis assets

 

19,087

 

 

70,127

 

 

9,502

 

 

(263

)

 

98,453

 

Non-recurring basis (1)

 

--

 

 

--

 

 

95

 

 

--

 

 

95

 

Total assets at fair value

19,087

 

70,127

 

9,597

 

(263

)

98,548

 

% of total assets at fair value

 

19.4

 %

 

71.2

 %

 

9.7

 %

 

(0.3

) %

 

100.0

 %

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractholder funds:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives embedded in annuity contracts

--

 

(145

)

(142

)

 

--

 

(287

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

(2

)

 

(652

)

 

(106

)

259

 

 

(501

)

Total liabilities at fair value

(2

)

(797

)

(248

)

259

 

(788

)

% of total liabilities at fair value

 

0.3

 %

 

101.1

 %

 

31.5

 %

 

(32.9

) %

 

100.0

 %

 


(1)         Includes $55 million of mortgage loans, $34 million of limited partnership interests and $6 million of other investments written-down to fair value in connection with recognizing other-than-temporary impairments.

 

19



 

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, 2009:

 

($ in millions)

 

Quoted prices
in active
markets for
identical
assets

 

Significant
other
observable
inputs

 

Significant
unobservable
inputs

 

Counterparty
and cash
collateral

 

Balance
as of
December 31,

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

netting

 

2009

Assets

 

 

 

 

 

 

 

 

 

 

Fixed income securities: