** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

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** **

**FORM 10-Q**

** **

**The Registrantmeets the conditions set forth in General Instruction H (1)(a) and (b) of Form10-Q and is therefore filing this Form with the reduced disclosure format.**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OF 15(d)

**OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

** **

**FOR THE QUARTERLY PERIODENDED SEPTEMBER 30, 2006**

** **

**OR**

** **

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d)

**OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

** **

**Commission file number:000-31248**

** **

**ALLSTATE LIFE INSURANCE COMPANY**

(Exact name of registrantas specified in its charter)
| **Illinois**                                                                 | **36-2554642**                        |
|------------------------------------------------------------------------------|---------------------------------------|
| (State of Incorporation)                                                     | (I.R.S. Employer  Identification No.) |
|                                                                         |                                  |
| **3100  Sanders Road  Northbrook, Illinois**                                 | **60062**                             |
| (Address of  principal executive offices)                                    | (Zip code)                            |
|                                                                         |                                  |
| Registrant’s  telephone number, including area code: **(847) 402-5000** |

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes x   Noo

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

| Large accelerated filer | Accelerated  filer | Non-accelerated  filer |
|-------------------------|--------------------|------------------------|
| o                       | o                  | x                      |

 

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

Yes o   Nox

None of the common equity of the registrant is held bynon-affiliates. Therefore, the aggregate market value of the common equity heldby non-affiliates of the registrant is zero.

AS OF NOVEMBER 7, 2006, THEREGISTRANT HAD 23,800 COMMON SHARES, $227 PAR VALUE, OUTSTANDING, ALL OF WHICHARE HELD BY ALLSTATE INSURANCE COMPANY.

 

 

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**ALLSTATELIFE INSURANCE COMPANYINDEX TO QUARTERLY REPORT ON FORM 10-QSeptember 30, 2006**
|                  | ** ** | ** **                                                                                                                                 | ** ** | **PAGE**   | ** ** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| **PART I**  | ** ** | **FINANCIAL INFORMATION**                                                                                                                  | ** ** | ** ** | ** ** |
|             |       |                                                                                                                                       |       |       |       |
| Item 1.     |       | Financial  Statements                                                                                                                      |       |       |       |
|             |       |                                                                                                                                       |       |       |       |
|             |       | Condensed  Consolidated Statements of Operations for the Three-Month and Nine-Month  Periods Ended September 30, 2006 and 2005 (unaudited) |       | 1          |       |
|             |       |                                                                                                                                       |       |       |       |
|             |       | Condensed  Consolidated Statements of Financial Position as of September 30, 2006  (unaudited) and December 31, 2005                       |       | 2          |       |
|             |       |                                                                                                                                       |       |       |       |
|             |       | Condensed  Consolidated Statements of Cash Flows for the Nine-Month Periods Ended  September 30, 2006 and 2005 (unaudited)                 |       | 3          |       |
|             |       |                                                                                                                                       |       |       |       |
|             |       | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                          |       | 4          |       |
|             |       |                                                                                                                                       |       |       |       |
|             |       | Report  of Independent Registered Public Accounting Firm                                                                                   |       | 13         |       |
|             |       |                                                                                                                                       |       |       |       |
| Item 2.     |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                |       | 14         |       |
|             |       |                                                                                                                                       |       |       |       |
| Item 4.     |       | Controls  and Procedures                                                                                                                   |       | 26         |       |
|             |       |                                                                                                                                       |       |       |       |
| **PART II** | ** ** | **OTHER INFORMATION**                                                                                                                      | ** ** | ** ** | ** ** |
|             |       |                                                                                                                                       |       |       |       |
| Item 1.     |       | Legal  Proceedings                                                                                                                         |       | 27         |       |
|             |       |                                                                                                                                       |       |       |       |
| Item 1A.    |       | Risk  Factors                                                                                                                              |       | 27         |       |
|             |       |                                                                                                                                       |       |       |       |
| Item 6.     |       | Exhibits                                                                                                                                   |       | 27         |       |

 

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** **

**PART I. FINANCIALINFORMATIONITEM 1. FINANCIAL STATEMENTS**

**ALLSTATE LIFEINSURANCE COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**
|                                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **(in millions)**                                | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                            | ** ** | **(Unaudited)**                  | ** ** | **(Unaudited)**                 | ** ** |
| **Revenues**                                          |       |                             |       |                            |       |   |   |   |   |
| Premiums                                              |       | $                                | 129        |                            | $          | 104 |   | $ | 392 |   | $ | 359 |   |
| Contract charges                                      |       | 218                              |       | 275                             |       | 780 |   | 797 |   |
| Net investment income                                 |       | 1,035                            |       | 942                             |       | 3,026 |   | 2,745 |   |
| Realized capital gains  and losses                    |       | (30                              | )          | 26                              |       | (137 | ) | 51 |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
|                                                  |       | 1,352                            |       | 1,347                           |       | 4,061 |   | 3,952 |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| **Costs and expenses**                                |       |                             |       |                            |       |   |   |   |   |
| Contract benefits                                     |       | 336                              |       | 316                             |       | 989 |   | 1,000 |   |
| Interest credited to  contractholder funds            |       | 651                              |       | 589                             |       | 1,889 |   | 1,736 |   |
| Amortization of  deferred policy acquisition costs    |       | 106                              |       | 117                             |       | 387 |   | 450 |   |
| Operating costs and  expenses                         |       | 82                               |       | 99                              |       | 283 |   | 325 |   |
| Restructuring and  related charges                    |       | 5                                |       | —                          |       | 23 |   | — |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
|                                                  |       | 1,180                            |       | 1,121                           |       | 3,571 |   | 3,511 |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| Gain (loss) on  disposition of operations             |       | 3                                |       | 1                               |       | (85 | ) | (7 | ) |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| **Income from operations before  income tax expense** |       | 175                              |       | 227                             |       | 405 |   | 434 |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| Income tax expense                                    |       | 53                               |       | 68                              |       | 131 |   | 120 |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| **Net income**                                        |       | $                                | 122        |                            | $          | 159 |   | $ | 274 |   | $ | 314 |   |

 

See notes tocondensed consolidated financial statements.

1

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**ALLSTATE LIFEINSURANCE COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION**
|                                                                                                                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **($ in millions, except par value data)**                                                        | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                      | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
|                                                                                                                            |       |                   |       |                  |       |
| **Assets**                                                                                                                      |       |                   |       |                  |       |
| Investments                                                                                                                     |       |                   |       |                  |       |
| Fixed income  securities, at fair value (amortized cost $61,332 and $59,717)                                                    |       | $                      | 63,060     |                  | $          | 61,977 |   |
| Mortgage loans                                                                                                                  |       | 8,396                  |       | 8,108                 |       |
| Equity  securities                                                                                                              |       | 471                    |       | 324                   |       |
| Short-term                                                                                                                      |       | 1,511                  |       | 927                   |       |
| Policy loans                                                                                                                    |       | 745                    |       | 729                   |       |
| Other                                                                                                                           |       | 830                    |       | 691                   |       |
|                                                                                                                            |       |                   |       |                  |       |
| Total investments                                                                                                               |       | 75,013                 |       | 72,756                |       |
|                                                                                                                            |       |                   |       |                  |       |
| Cash                                                                                                                            |       | 149                    |       | 154                   |       |
| Deferred policy  acquisition costs                                                                                              |       | 3,485                  |       | 3,948                 |       |
| Reinsurance  recoverables, net                                                                                                  |       | 3,450                  |       | 1,699                 |       |
| Accrued investment  income                                                                                                      |       | 710                    |       | 648                   |       |
| Other assets                                                                                                                    |       | 708                    |       | 582                   |       |
| Separate Accounts                                                                                                               |       | 15,595                 |       | 15,235                |       |
|                                                                                                                            |       |                   |       |                  |       |
| **Total  assets**                                                                                                               |       | $                      | 99,110     |                  | $          | 95,022 |   |
|                                                                                                                            |       |                   |       |                  |       |
| **Liabilities**                                                                                                                 |       |                   |       |                  |       |
| Contractholder funds                                                                                                            |       | $                      | 60,622     |                  | $          | 58,190 |   |
| Reserve for  life-contingent contract benefits                                                                                  |       | 12,102                 |       | 11,881                |       |
| Unearned premiums                                                                                                               |       | 34                     |       | 35                    |       |
| Payable to affiliates,  net                                                                                                     |       | 96                     |       | 98                    |       |
| Other liabilities and  accrued expenses                                                                                         |       | 4,513                  |       | 3,054                 |       |
| Deferred income taxes                                                                                                           |       | 245                    |       | 340                   |       |
| Long-term debt                                                                                                                  |       | 263                    |       | 181                   |       |
| Separate Accounts                                                                                                               |       | 15,595                 |       | 15,235                |       |
|                                                                                                                            |       |                   |       |                  |       |
| **Total  liabilities**                                                                                                          |       | 93,470                 |       | 89,014                |       |
|                                                                                                                            |       |                   |       |                  |       |
| **Commitments and Contingent  Liabilities (Note 5)**                                                                            |       |                   |       |                  |       |
|                                                                                                                            |       |                   |       |                  |       |
| **Shareholder’s Equity**                                                                                                   |       |                   |       |                  |       |
| Redeemable preferred  stock — series A, $100 par value, 1,500,000 shares authorized, 49,230 shares  issued and outstanding |       | 5                      |       | 5                     |       |
| Redeemable preferred  stock — series B, $100 par value, 1,500,000 shares authorized, none issued                           |       | —                 |       | —                |       |
| Common stock, $227 par  value, 23,800 shares authorized and outstanding                                                         |       | 5                      |       | 5                     |       |
| Additional capital  paid-in                                                                                                     |       | 1,108                  |       | 1,108                 |       |
| Retained income                                                                                                                 |       | 4,151                  |       | 4,302                 |       |
| Accumulated other  comprehensive income:                                                                                        |       |                   |       |                  |       |
| Unrealized net  capital gains and losses                                                                                        |       | 371                    |       | 588                   |       |
|                                                                                                                            |       |                   |       |                  |       |
| **Total  accumulated other comprehensive income**                                                                               |       | 371                    |       | 588                   |       |
|                                                                                                                            |       |                   |       |                  |       |
| **Total  shareholder’s equity**                                                                                            |       | 5,640                  |       | 6,008                 |       |
|                                                                                                                            |       |                   |       |                  |       |
| **Total liabilities and  shareholder’s equity**                                                                            |       | $                      | 99,110     |                  | $          | 95,022 |   |

 

See notes tocondensed consolidated financial statements.

2

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**ALLSTATE LIFEINSURANCE COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**
|                                                                                    | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**          | ** ** |
| **(in millions)**                                                             | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                                                                         | ** ** | **(Unaudited)**                 | ** ** |
| **Cash flows from operating  activities**                                          |       |                            |       |   |   |
| Net income                                                                         |       | $                               | 274        |   | $ | 314 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                            |       |   |   |
| Amortization and  other non-cash items                                             |       | (212                            | )          | (125 | ) |
| Realized capital  gains and losses                                                 |       | 137                             |       | (51 | ) |
| Loss on  disposition of operations                                                 |       | 85                              |       | 7 |   |
| Interest  credited to contractholder funds                                         |       | 1,889                           |       | 1,736 |   |
| Changes in:                                                                        |       |                            |       |   |   |
| Contract benefit  and other insurance reserves                                     |       | (180                            | )          | (157 | ) |
| Unearned  premiums                                                                 |       | (1                              | )          | 2 |   |
| Deferred policy  acquisition costs                                                 |       | (204                            | )          | (115 | ) |
| Reinsurance  recoverables, net                                                     |       | (159                            | )          | (136 | ) |
| Income taxes  payable                                                              |       | (115                            | )          | (33 | ) |
| Other operating  assets and liabilities                                            |       | 7                               |       | (100 | ) |
| Net cash  provided by operating activities                                         |       | 1,521                           |       | 1,342 |   |
|                                                                               |       |                            |       |   |   |
| **Cash flows from investing  activities**                                          |       |                            |       |   |   |
| Proceeds from sales                                                                |       |                            |       |   |   |
| Fixed income  securities                                                           |       | 10,096                          |       | 7,695 |   |
| Equity  securities                                                                 |       | 99                              |       | 56 |   |
| Investment collections                                                             |       |                            |       |   |   |
| Fixed income  securities                                                           |       | 2,433                           |       | 3,507 |   |
| Mortgage loans                                                                     |       | 1,367                           |       | 894 |   |
| Investment purchases                                                               |       |                            |       |   |   |
| Fixed income  securities                                                           |       | (13,744                         | )          | (13,823 | ) |
| Equity  securities                                                                 |       | (202                            | )          | (126 | ) |
| Mortgage loans                                                                     |       | (1,620                          | )          | (1,420 | ) |
|                                                                               |       |                            |       |   |   |
| Change in short-term  investments, net                                             |       | 238                             |       | (116 | ) |
| Disposition of  operations                                                         |       | (812                            | )          | (2 | ) |
| Change in other  investments, net                                                  |       | (7                              | )          | (55 | ) |
| Net cash used in  investing activities                                             |       | (2,152                          | )          | (3,390 | ) |
|                                                                               |       |                            |       |   |   |
| **Cash flows from financing activities**                                           |       |                            |       |   |   |
| Redemption of  mandatorily redeemable preferred stock                              |       | (19                             | )          | (19 | ) |
| Contractholder fund  deposits                                                      |       | 7,772                           |       | 8,175 |   |
| Contractholder fund  withdrawals                                                   |       | (6,702                          | )          | (6,042 | ) |
| Dividends paid                                                                     |       | (425                            | )          | (50 | ) |
| Net cash  provided by financing activities                                         |       | 626                             |       | 2,064 |   |
|                                                                               |       |                            |       |   |   |
| **Net (decrease) increase in cash**                                                |       | (5                              | )          | 16 |   |
| **Cash at beginning of the period**                                                |       | 154                             |       | 241 |   |
| **Cash at end of period**                                                          |       | $                               | 149        |   | $ | 257 |   |

 

See notes tocondensed consolidated financial statements.

3

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**ALLSTATE LIFEINSURANCE COMPANY AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

**1. General**

**Basis of Presentation**

The accompanying condensedconsolidated financial statements include the accounts of Allstate LifeInsurance Company (“ALIC”) and its wholly owned subsidiaries (together withALIC, the “Company”). ALIC is wholly owned by Allstate Insurance Company (“AIC”),a wholly owned subsidiary of The Allstate Corporation (the “Corporation”).

The condensedconsolidated financial statements and notes as of September 30, 2006, and forthe three-month and nine-month periods ended September 30, 2006 and 2005 areunaudited. The condensed consolidated financial statements reflect alladjustments (consisting only of normal recurring accruals), which are, in theopinion of management, necessary for the fair presentation of the financialposition, results of operations and cash flows for the interim periods. Thesecondensed consolidated financial statements and notes should be read in conjunctionwith the consolidated financial statements and notes thereto included in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2005. Theresults of operations for the interim periods should not be consideredindicative of results to be expected for the full year.

To conform to the 2006presentation, certain amounts in the prior year condensed consolidatedfinancial statements and notes have been reclassified.

Equity securities include commonstocks, non-redeemable preferred stocks and limited partnership interests.Common stocks and non-redeemable preferred stocks had a carrying value of $71million and $67 million, and cost of $61 million and $62 million at September30, 2006 and December 31, 2005, respectively. Investments in limitedpartnership interests had a carrying value of $400 million and $257 million atSeptember 30, 2006 and December 31, 2005, respectively.

In July 2006, the Companyparticipated in the establishment of an investment management variable interestentity (“VIE”) that holds assets under the management of Allstate InvestmentManagement Company, an unconsolidated affiliate of the Company, on behalf ofunrelated third party investors. The VIE had assets consisting primarily ofinvestment securities and cash totaling $400 million and liabilities, primarilylong-term debt, totaling $410 million at September 30, 2006. The Company doesnot consolidate the VIE because it is not the primary beneficiary. The Company’smaximum loss exposure related to its investment in the VIE is the currentcarrying value of its investment, which was $8 million at September 30, 2006.

**Adopted accounting standards**

*Financial Accounting Standards Board Staff Position No. FAS115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application toCertain Investments” (“FSP FAS 115-1”)*

TheCompany adopted Financial Accounting Standards Board (“FASB”) FSP FAS 115-1 asof January 1, 2006. FSP FAS 115-1 nullifies the guidance in paragraphs 10-18 ofEITF Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments” and references existingother-than-temporary impairment guidance. FSP FAS 115-1 clarifies that aninvestor should recognize an impairment loss no later than when the impairmentis deemed other-than-temporary, even if a decision to sell the security has notbeen made, and also provides guidance on the subsequent accounting for incomerecognition on an impaired debt security. The adoption of FSP FAS 115-1 wasrequired on a prospective basis and did not have a material effect on theresults of operations or financial position of the Company.

*Statement of Financial Accounting Standards No. 154, “AccountingChanges and Error Corrections” (“SFAS No. 154”)*

The Companyadopted SFAS No. 154 on January 1, 2006. SFAS No. 154 replaces AccountingPrinciples Board (“APB”) Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “ReportingAccounting Changes in Interim Financial Statements”. SFAS No. 154 requiresretrospective application to prior periods’ financial statements for changes inaccounting principle, unless determination of either the period specificeffects or the cumulative effect of the change is impracticable or otherwisepromulgated. The Company had no accounting changes or error corrections affectedby the new standard.

4

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## **Pending accounting standards**

*Statementof Position 05-1, “Accounting by Insurance Enterprises for Deferred AcquisitionCosts in Connection with Modifications or Exchanges of Insurance Contracts” (“SOP05-1”)*

In October 2005, the American Institute ofCertified Public Accountants (“AICPA”) issued SOP 05-1. SOP 05-1 providesaccounting guidance for deferred policy acquisition costs associated withinternal replacements of insurance and investment contracts other than thosealready described in SFAS No. 97, “Accounting and Reporting by InsuranceEnterprises for Certain Long-Duration Contracts and for Realized Gains andLosses from the Sale of Investments”. SOP 05-1 defines an internal replacementas a modification in product benefits, features, rights or coverages thatoccurs by the exchange of a contract for a new contract, or by amendment,endorsement or rider to a contract, or by the election of a feature or coveragewithin a contract. The provisions of SOP 05-1 are effective for internalreplacements occurring in fiscal years beginning after December 15, 2006. TheCompany is currently assessing the impact of the SOP on its results ofoperations and financial position. Based on the issued standard, the Companydoes not expect the impact of the adoption to have a material effect on itsresults of operations or financial position; however, the standard is currentlyunder review and clarifications or revisions may be issued by the AICPA and/orthe FASB that could affect the Company’s impact assessment.

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

In February 2006, theFASB issued SFAS No. 155, which permits the fair value remeasurement of anyhybrid financial instrument that contains an embedded derivative that otherwisewould require bifurcation under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities*”*; clarifies which interest-onlystrips and principal-only strips are not subject to the requirements of SFASNo. 133; establishes a requirement to evaluate interests in securitizedfinancial assets to identify interests that are freestanding derivatives orhybrid financial instruments that contain an embedded derivative requiringbifurcation and clarifies that concentration of credit risk in the form ofsubordination are not embedded derivatives. At the date of initial adoption,the Company must decide whether or not to remeasure its then existing hybridfinancial instruments in accordance with SFAS No. 155 or retain its currentaccounting under SFAS No. 133. All securities acquired on or after January 1,2007 must be accounted for in accordance with the new guidance. The Companywill adopt SFAS No. 155 as of January 1, 2007, but has not yet determined if itwill utilize the option to fair value hybrid contracts owned at the date ofadoption and subject to SFAS No. 133.

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

In July 2006, theFASB issued FIN 48, which clarifies the accounting for uncertainty in incometaxes recognized in an entity’s financial statements in accordance with FASBStatement No. 109, “Accounting for Income Taxes”. FIN 48 requires an entity torecognize the tax benefit of uncertain tax positions only when it is morelikely than not, based on the position’s technical merits, that the positionwould be sustained upon examination by the respective taxing authorities. Thetax benefit is measured as the largest benefit that is more than fifty-percentlikely of being realized upon final settlement with the respective taxingauthorities. FIN 48 is effective for fiscal years beginning after December 15,2006. FIN 48 is not expected to have a material effect on the results ofoperations or financial position of the Company.

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

In September 2006,the FASB issued SFAS No. 157 which defines fair value, establishes a frameworkfor measuring fair value in generally accepted accounting principles (“GAAP”),and expands disclosures about fair value measurements. SFAS No. 157 applieswhere other accounting pronouncements require or permit fair valuemeasurements; it does not require any new fair value measurements under GAAP.SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.The effects of adoption will be determined by the types of instruments carriedat fair value in the Company’s financial statements at the time of adoption aswell as the method utilized to determine their fair values prior to adoption.Based on the Company’s current use of fair value measurements, SFAS No. 157 isnot expected to have a material effect on the results of operations orfinancial position of the Company.

5

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*Securities and Exchange Commission (“SEC”) StaffAccounting Bulletin No. 108, “Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements” (“SAB 108”)*

In September 2006,the SEC issued SAB 108 in order to eliminate the diversity of practice in theprocess by which misstatements are quantified for purposes of assessingmateriality on the financial statements. SAB 108 establishes a singlequantification framework wherein the significance measurement is based on theeffects of the misstatements on each of the financial statements as well as therelated financial statement disclosures. If a company’s existing methods forassessing the materiality of misstatements are not in compliance with the provisionsof SAB 108, the initial application of the provisions may be adopted byrestating prior period financial statements under certain circumstances orotherwise by recording the cumulative effect of initially applying theprovisions of SAB 108 as adjustments to the carrying values of assets andliabilities as of January 1, 2006 with an offsetting adjustment recorded to theopening balance of retained earnings. The provisions of SAB 108 must be appliedno later than the annual financial statements issued for the first fiscal yearending after November 15, 2006. The Company’s adoption of SAB 108 in the fourthquarter of 2006 for the fiscal year then ended is not expected to have amaterial effect on its results of operations or financial position.

**2.****              Related PartyTransaction**

**SurplusNote**

In the first nine monthsof 2006, under an existing agreement with Kennett Capital, Inc. (“Kennett”), anunconsolidated affiliate of ALIC, ALIC sold Kennett a $100 million redeemablesurplus note issued by ALIC Reinsurance Company, a wholly owned subsidiary ofALIC. The surplus note is due June 1, 2036 with an initial rate of 6.18% thatwill reset once every ten years to the then current ten year Constant MaturityTreasury yield (“CMT”), plus 1.14%. As payment, Kennett issued a full recoursenote due June 1, 2036 to ALIC for the same amount with an initial interest rateof 5.98% that will reset once every ten years to the then current ten year CMT,plus 0.94%. The note due from Kennett is classified as other investments and therelated surplus note is classified as long-term debt in the CondensedConsolidated Statements of Financial Position.

**3.****              Supplemental Cash Flow Information**

Non-cash investmentexchanges and modifications, which primarily reflect refinancing of fixed incomesecurities and mergers completed with equity securities, totaled $26 millionand $19 million for the nine-month periods ended September 30, 2006 and 2005,respectively.

Liabilities forcollateral received in conjunction with securities lending and other activitiesand for funds received from security repurchase activities are reported inother liabilities and accrued expenses in the Condensed Consolidated Statementsof Financial Position. The accompanying cash flows are included in cash flowsfrom operating activities in the Condensed Consolidated Statements of CashFlows along with the related changes in investments, which are as follows:
|                                                                        | ** ** | **Nine months ended** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                             | ** ** | **September 30,**          | ** ** |
| **(in millions)**                                                 | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                                                             | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net change in  fixed income securities                                 |       | $                               | (531       | ) | $ | (904 | ) |
| Net change in  short-term investments                                  |       | (760                            | )          | 183 |   |
| Operating cash flow used                                               |       | $                               | (1,291     | ) | $ | (721 | ) |
|                                                                   |       |                            |       |   |   |
| Liabilities for  collateral and security repurchase, beginning of year |       | $                               | (2,231     | ) | $ | (2,928 | ) |
| Liabilities for  collateral and security repurchase, end of period     |       | (3,522                          | )          | (3,649 | ) |
| Operating cash  flow provided                                          |       | $                               | 1,291      |   | $ | 721 |   |

 

6

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**4.****Reinsurance**

The effects ofreinsurance on premiums and contract charges are as follows:
|                                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)**                             | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                         |       |                                                 |       |                                                |       |   |   |   |   |
| **Premiums  and contract charges**                 |       |                                                 |       |                                                |       |   |   |   |   |
| Direct                                             |       | $                                                    | 562        |                                                | $          | 516 |   | $ | 1,690 |   | $ | 1,570 |   |
| Assumed                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                                          |       | 4                                                    |       | 5                                                   |       | 12 |   | 13 |   |
| Non-affiliate                                      |       | 6                                                    |       | 7                                                   |       | 21 |   | 20 |   |
| Ceded—non-affiliate                           |       | (225                                                 | )          | (149                                                | )          | (551 | ) | (447 | ) |
|                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums and  contract charges, net of reinsurance |       | $                                                    | 347        |                                                | $          | 379 |   | $ | 1,172 |   | $ | 1,156 |   |

 

The effects of reinsurance on contract benefits are asfollows:
|                                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)**                 | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                             | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Contract  benefits**                 | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Direct                                 |       | $                                                    | 483        |                                                | $          | 427 |   | $ | 1,369 |   | $ | 1,351 |   |
| Assumed                                |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                              |       | 2                                                    |       | 2                                                   |       | 8 |   | 8 |   |
| Non-affiliate                          |       | 6                                                    |       | 6                                                   |       | 17 |   | 17 |   |
| Ceded—non-affiliate               |       | (155                                                 | )          | (119                                                | )          | (405 | ) | (376 | ) |
|                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Contract  benefits, net of reinsurance |       | $                                                    | 336        |                                                | $          | 316 |   | $ | 989 |   | $ | 1,000 |   |

 

On June 1, 2006, ALIC, its subsidiary, Allstate LifeInsurance Company of New York (“ALNY”), and the Corporation completed thedisposal of substantially all of its variable annuity business pursuant to adefinitive agreement (the “Agreement”) with Prudential Financial, Inc. and itssubsidiary, The Prudential Insurance Company of America (collectively “Prudential”),which was entered into on March 8, 2006. The disposal was effected through acombination of coinsurance and modified coinsurance reinsurance agreements (the“Reinsurance Agreements”).

As a result of the modified coinsurance reinsurance,the separate account assets remain on the Company’s Condensed ConsolidatedStatements of Financial Position, but the related results of operations arefully reinsured to Prudential beginning on June 1, 2006 and presented net ofreinsurance on the Condensed Consolidated Statements of Operations. In contrast,$1.36 billion of assets supporting general account liabilities have beentransferred to Prudential, net of consideration, under the coinsurancereinsurance provisions. The general account liabilities of $1.63 billion,however, remain on the Condensed Consolidated Statements of Financial Positionwith a corresponding reinsurance recoverable and the results of operations arepresented net of reinsurance. For purposes of presentation in the CondensedConsolidated Statements of Cash Flows, the Company treated the reinsurance ofsubstantially all the variable annuity business of ALIC and ALNY to Prudentialas a disposition of operations, consistent with the substance of thetransaction which was the disposition of a block of business accomplishedthrough reinsurance. Accordingly, the net consideration transferred toPrudential, $731 million (computed as $1.36 billion of general accountinsurance liabilities transferred to Prudential on the closing date lessconsideration of $628 million), the cost of hedging the ceding commissionreceived from Prudential, $69 million, pre-tax, and the costs of executing thetransaction, $12 million, pre-tax, were classified as a disposition ofoperations in the cash flows from investing activities section of the CondensedConsolidated Statements of Cash Flows. The Reinsurance Agreements do notextinguish the Company’s primary liability under the variable annuitycontracts.

7

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Under the Agreement, ALIC, ALNY and the Corporationhave indemnified Prudential for certain pre-closing contingent liabilities(including extra-contractual liabilities of ALIC and ALNY and liabilitiesspecifically excluded from the transaction) that ALIC and ALNY have agreed toretain. In addition, ALIC, ALNY and the Corporation will each indemnifyPrudential for certain post-closing liabilities that may arise from the acts ofALIC, ALNY and their agents, including in connection with ALIC’s and ALNY’sprovision of transition services.

The terms of the Agreement give Prudential the rightto be the exclusive provider of its variable annuity products through theAllstate proprietary agency force for three years and a non-exclusive preferredprovider for the following two years. During a transition period, ALIC and ALNYwill continue to issue new variable annuity contracts, accept additionaldeposits on existing business from existing contractholders on behalf ofPrudential and, for a period of twenty-four months or less, service thereinsured business while Prudential prepares for the migration of the businessonto its servicing platform.

Pursuant to the Agreement, the final market-adjustedconsideration was $628 million. The disposal resulted in a gain of $88 millionpretax for ALIC, which was deferred as a result of the disposition beingexecuted through reinsurance. The deferred gain decreased to $78 million as ofSeptember 30, 2006, due to closing adjustments and amortization. The deferredgain is included as a component of other liabilities and accrued expenses onthe Condensed Consolidated Statements of Financial Position, and is amortizedto gain (loss) on disposition of operations on the Condensed ConsolidatedStatements of Operations over the life of the reinsured business which isestimated to be approximately 18 years. For ALNY, the transaction resulted in aloss of $6 million pretax, which was recognized in the second quarter. ALNY’sreinsurance loss and other amounts related to the disposal of the business,including the initial costs and final market value settlements of thederivatives acquired by ALIC to economically hedge substantially all of theexposure related to market adjustments between the effective date of theAgreement and the closing of the transaction, transactional expenses incurredand amortization of ALIC’s deferred reinsurance gain, were included as acomponent of gain (loss) on disposition of operations on the CondensedConsolidated Statements of Operations and amounted to $59 million, after-tax,in the nine months ended September 30, 2006. During the third quarter of 2006,gain (loss) on disposition of operations on the Condensed ConsolidatedStatements of Operations included $1 million, after-tax, of amortization ofALIC’s deferred gain. DAC and DSI were reduced by $726 million and $70 million,respectively, as of the effective date of the transaction for balances relatedto the variable annuity business subject to the Reinsurance Agreements.

In the five-months of 2006 prior to the disposition ofsubstantially all of the variable annuity business, ALIC’s and ALNY’s variableannuity business generated approximately $127 million in contract charges. Inthe three-month and nine-month periods ended September 30, 2006, premiums andcontract charges of $72 million and $94 million, contract benefits of $15million and $20 million, interest credited to contractholder funds of $17million and $22 million, and operating costs and expenses of $29 million and$39 million, respectively, were ceded to Prudential pursuant to the ReinsuranceAgreements.

The separate account balances related to the modifiedcoinsurance reinsurance were $14.55 billion as of September 30, 2006. Separateaccount balances totaling approximately $1.05 billion at September 30, 2006related to the variable life business, and three affiliated companies that theCompany plans to sell continue to be retained by ALIC. In 2005, ALIC’s and ALNY’svariable annuity business generated approximately $278 million in contractcharges. The separate account balances were $14.23 billion and general accountbalances were $1.81 billion as of December 31, 2005.

**5.****Guaranteesand Contingent Liabilities**

**Guarantees**

TheCompany owns certain fixed income securities that obligate the Company toexchange credit risk or to forfeit principal due, depending on the nature oroccurrence of specified credit events for the referenced entities. In the eventall such specified credit events were to occur, the Company’s maximum amount atrisk on these fixed income securities, as measured by the amount of theaggregate initial investment, was $223 million at September 30, 2006. Theobligations associated with these fixed income securities expire at varioustimes during the next seven years.

8

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In the normal course of business,the Company provides standard indemnifications to counterparties in contractsin connection with numerous transactions, including acquisitions anddivestitures. The types of indemnifications typically provided includeindemnifications for breaches of representations and warranties, taxes andcertain other liabilities, such as third party lawsuits. The indemnificationclauses are often standard contractual terms and were entered into in thenormal course of business based on an assessment that the risk of loss would beremote. The terms of the indemnifications vary in duration and nature. In manycases, the maximum obligation is not explicitly stated and the contingenciestriggering the obligation to indemnify have not occurred and are not expected tooccur. Consequently, the maximum amount of the obligation under suchindemnifications is not determinable. Historically, the Company has not madeany material payments pursuant to these obligations.

The aggregate liability balancerelated to all guarantees was not material as of September 30, 2006.

**Regulation**

The Company is subject tochanging social, economic and regulatory conditions. From time to time,regulatory authorities or legislative bodies seek to impose additionalregulations regarding agent and broker compensation and otherwise expandoverall regulation of insurance products and the insurance industry. Theultimate changes and eventual effects of these initiatives on the Company’sbusiness, if any, are uncertain.

**Legal and Regulatory Proceedingsand Inquiries**

**Background**

The Company andcertain affiliates are involved in a number of lawsuits, regulatory inquiries,and other legal proceedings arising out of various aspects of its business. Asbackground to the “Proceedings” sub-section below, please note the following:

·             These matters raisedifficult and complicated factual and legal issues and are subject to manyuncertainties and complexities, including but not limited to, the underlyingfacts of each matter; novel legal issues; variations between jurisdictions inwhich matters are being litigated, heard or investigated; differences inapplicable laws and judicial interpretations; the length of time before many ofthese matters might be resolved by settlement, through litigation or otherwiseand, in some cases, the timing of their resolutions relative to other similarmatters involving other companies; the fact that some of the lawsuits areputative class actions in which a class has not been certified and in which thepurported class may not be clearly defined; the fact that some of the lawsuitsinvolve multi-state class actions in which the applicable law(s) for the claimsat issue is in dispute and therefore unclear; and the current challenging legalenvironment faced by large corporations and insurance companies.

·             In the lawsuits,plaintiffs seek a variety of remedies including equitable relief in the form ofinjunctive and other remedies and monetary relief in the form of contractualand extra-contractual damages. In some cases, the monetary damages soughtinclude punitive damages. Often specific information about the relief sought,such as the amount of damages, is not available because plaintiffs have notrequested specific relief in their pleadings. In our experience, when specificmonetary demands are made in pleadings, they bear little relation to theultimate loss, if any, to the Company.

·             In connection withregulatory examinations and proceedings, government authorities may seekvarious forms of relief, including penalties, restitution and changes inbusiness practices. The Company may not be advised of the nature and extent ofrelief sought until the final stages of the examination or proceeding.

9

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·             For the reasonsspecified above, it is often not possible to make meaningful estimates of theamount or range of loss that could result from the matters described below inthe “Proceedings” subsection. The Company reviews these matters on an on-goingbasis and follows the provisions of SFAS No. 5, “Accounting for Contingencies”,when making accrual and disclosure decisions. When assessing reasonablypossible and probable outcomes, the Company bases its decisions on itsassessment of the ultimate outcome following all appeals.

·             Dueto the complexity and scope of the matters disclosed in the “Proceedings”subsection below and the many uncertainties that exist, the ultimate outcome ofthese matters cannot be reasonably predicted. In the event of an unfavorableoutcome in one or more of these matters, the ultimate liability may be inexcess of amounts currently reserved and may be material to the Company’soperating results or cash flows for a particular quarter or annual period.However, based on information currently known to it, management believes thatthe ultimate outcome of all matters described below as they are resolved overtime is not likely to have a material adverse effect on the financial positionof the Company.

**Proceedings**

Legal proceedings involving Allstate agencies and AICmay impact the Company, even when the Company is not directly involved, becausethe Company sells its products through a variety of distribution channelsincluding Allstate agencies. Consequently, information about the moresignificant of these proceedings is provided in the following paragraph.

AIC is defending certain matters relating to itsagency program reorganization announced in 1999. These matters include alawsuit filed in December 2001 by the U.S. Equal Employment OpportunityCommission (“EEOC”) alleging retaliation under federal civil rights laws (the “EEOCI” suit) and a class action filed in August 2001 by former employee agentsalleging retaliation and age discrimination under the Age Discrimination inEmployment Act (“ADEA”), breach of contract and ERISA violations (the “Romero I”suit). In March 2004, in the consolidated EEOC I and Romero I litigation, thetrial court issued a memorandum and order that, among other things, certifiedclasses of agents, including a mandatory class of agents who had signed arelease, for purposes of effecting the court’s declaratory judgment that therelease is voidable at the option of the release signer. The court also orderedthat an agent who voids the release must return to AIC “any and all benefitsreceived by the [agent] in exchange for signing the release.” The court alsostated that, “on the undisputed facts of record, there is no basis for claimsof age discrimination.” The EEOC and plaintiffs have asked the court to clarifyand/or reconsider its memorandum and order. The case otherwise remains pending.The EEOC also filed another lawsuit in October 2004 alleging age discriminationwith respect to a policy limiting the rehire of agents affected by the agencyprogram reorganization (the “EEOC II” suit). In EEOC II, in October 2006, thecourt granted partial summary judgment to the EEOC. Although the court did notdetermine that AIC was liable for age discrimination under the ADEA, itdetermined that the rehire policy resulted in a disparate impact, reserving fortrial the determination on whether AIC had reasonable factors other than age tosupport the rehire policy. AIC is also defending a certified class action filedby former employee agents who terminated their employment prior to the agencyprogram reorganization. These plaintiffs have asserted breach of contract andERISA claims. A putative nationwide class action has also been filed by formeremployee agents alleging various violations of ERISA, including a workerclassification issue. These plaintiffs are challenging certain amendments tothe Agents Pension Plan and are seeking to have exclusive agent independentcontractors treated as employees for benefit purposes. This matter wasdismissed with prejudice by the trial court, was the subject of furtherproceedings on appeal, and was reversed and remanded to the trial court inApril 2005. In all of these various matters, plaintiffs seek compensatory andpunitive damages, and equitable relief. AIC has been vigorously defending theselawsuits and other matters related to its agency program reorganization. Theoutcome of these disputes is currently uncertain.

The Company has resolved through mediation andsettlement all but two of its lawsuits brought by plaintiffs challengingtrading restrictions the Company adopted in an effort to limit market-timingactivity in its variable annuity sub-accounts. In the remaining lawsuits, theplaintiffs seek a variety of remedies including monetary and equitable relief.The Company has been vigorously defending these matters, but their outcome iscurrently uncertain.

10

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The Company is defending a certified nationwide classaction related to certain of universal life policies written prior to 1992. Thebreach of contract claim involves premium increases that the Company chargedrelated to those policies. Other life insurance companies have faced similarsuits. The Company is vigorously defending this lawsuit, and the outcome ofthis dispute is currently uncertain.

The Company is currently undergoing periodic marketconduct examinations by state insurance regulators. Regulators in the state ofNew York are focusing, as they have with other insurers, on the Company’s NewYork subsidiary’s compliance with the state’s replacement sales andrecord-keeping processes with regard to life insurance and annuities amongother issues. They have alleged that the Company’s New York subsidiary failedto meet the requirements of certain applicable regulations. In relation to thisexamination, the Company accrued $17 million of additional contractholderbenefits. The final outcomes of these examinations are still pending; however,the Company’s New York subsidiary has begun certain customer remediation stepsrelated to replacement sales.

**OtherMatters**

The Corporation and some of its subsidiaries,including the Company, have received interrogatories and demands forinformation from regulatory and enforcement authorities relating to variousinsurance products and practices. The areas of inquiry include variable annuitymarket timing, late trading and the issuance of funding agreements backingmedium-term notes. The Corporation and some of its subsidiaries, including theCompany, have also received interrogatories and demands for information fromauthorities seeking information relevant to on-going investigations into thepossible violation of antitrust or insurance laws by unnamed parties and, inparticular, seeking information as to whether any person engaged in activitiesfor the purpose of price fixing, market allocation, or bid rigging. The Companybelieves that these inquiries are similar to those made to many financialservices companies as part of industry-wide investigations by variousauthorities into the practices, policies and procedures relating to insuranceand financial services products. The Corporation and its subsidiaries haveresponded and will continue to respond to these inquiries.

Various other legal and regulatory actions arecurrently pending that involve the Company and specific aspects of its conductof business. Like other members of the insurance industry, the Company is thetarget of a number of class action lawsuits and other types of proceedings,some of which involve claims for substantial or indeterminate amounts. Theseactions are based on a variety of issues and target a range of the Company’spractices. The outcome of these disputes is currently unpredictable.

One or more ofthese matters could have an adverse effect on the Company’s operating resultsor cash flows for a particular quarter or annual period. However, based oninformation currently known to it, management believes that the ultimateoutcome of all matters described in this “Other Matters” subsection in excessof amounts currently reserved, as they are resolved over time is not likely tohave a material effect on the operating results, cash flows or financialposition of the Company.

11

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**6. Other Comprehensive Income**

The components of othercomprehensive income (loss) on a pretax and after-tax basis are as follows:
|                                                                                          | ** ** | **Three months ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| **(in millions)**                                                                   | ** ** | **Pretax**                                               | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pretax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net  holding gains (losses) arising during the period, net of related offsets |       | $                                                        | 664        |   | $ | (233 | ) | $ | 431 |   | $ | (521 | ) | $ | 182 |   | $ | (339 | ) |
| Less:  reclassification adjustment of realized capital gains and losses                  |       | 162                                                      |       | (57 | ) | 105 |   | (64 | ) | 22 |   | (42 | ) |
| Other  comprehensive income (loss)                                                       |       | $                                                        | 502        |   | $ | (176 | ) | 326 |   | $ | (457 | ) | $ | 160 |   | (297 | ) |
|                                                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                               |       |                                                     |       |   |   | 122 |   |   |   |   |   | 159 |   |
| Comprehensive income  (loss)                                                             |       |                                                     |       |   |   | $ | 448 |   |   |   |   |   | $ | (138 | ) |

 
|                                                                                  | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| **(in millions)**                                                           | ** ** | **Pretax**                                              | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pretax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net  holding losses arising during the period, net of related offsets |       | $                                                       | (465       | ) | $ | 162 |   | $ | (303 | ) | $ | (596 | ) | $ | 209 |   | $ | (387 | ) |
| Less: reclassification  adjustment of realized capital gains and losses          |       | (132                                                    | )          | 46 |   | (86 | ) | (45 | ) | 16 |   | (29 | ) |
| Other  comprehensive loss                                                        |       | $                                                       | (333       | ) | $ | 116 |   | (217 | ) | $ | (551 | ) | $ | 193 |   | (358 | ) |
|                                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                       |       |                                                    |       |   |   | 274 |   |   |   |   |   | 314 |   |
| Comprehensive income  (loss)                                                     |       |                                                    |       |   |   | $ | 57 |   |   |   |   |   | $ | (44 | ) |

 

12

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Shareholder ofAllstate Life Insurance Company:

We have reviewed theaccompanying condensed consolidated statement of financial position of AllstateLife Insurance Company and subsidiaries (the “Company”, an affiliate of TheAllstate Corporation) as of September 30, 2006, and the related condensedconsolidated statements of operations for the three-month and nine-monthperiods ended September 30, 2006 and 2005, and the condensed consolidatedstatements of cash flows for the nine-month periods ended September 30, 2006and 2005. These interim financial statements are the responsibility of theCompany’s management.

We conducted our reviewsin accordance with the standards of the Public Company Accounting OversightBoard (United States). A review of interim financial information consistsprincipally of applying analytical procedures and making inquiries of personsresponsible for financial and accounting matters. It is substantially less inscope than an audit conducted in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the objective of which isthe expression of an opinion regarding the financial statements taken as awhole. Accordingly, we do not express such an opinion.

Based on our reviews, weare not aware of any material modifications that should be made to suchcondensed consolidated interim financial statements for them to be inconformity with accounting principles generally accepted in the United Statesof America.

We have previouslyaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated statement of financialposition of Allstate Life Insurance Company and subsidiaries as of December 31,2005, and the related consolidated statements of operations and comprehensiveincome, shareholder’s equity, and cash flows for the year then ended, notpresented herein. In our report dated March 10, 2006, which report includes anexplanatory paragraph relating to a change in method of accounting for certainnontraditional long-duration contracts and for separate accounts in 2004 andchanges in the methods of accounting for embedded derivatives in modifiedcoinsurance agreements and variable interest entities in 2003, we expressed anunqualified opinion on those consolidated financial statements. In our opinion,the information set forth in the accompanying condensed consolidated statementof financial position as of December 31, 2005 is fairly stated, in all materialrespects, in relation to the consolidated statement of financial position fromwhich it has been derived.

/s/ Deloitte & ToucheLLP

Chicago, IllinoisNovember 6, 2006

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**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE-MONTH ANDNINE-MONTH PERIODS ENDED SEPTEMBER 30, 2006 AND 2005**

**OVERVIEW**

The followingdiscussion highlights significant factors influencing the consolidatedfinancial position and results of operations of Allstate Life Insurance Company(referred to in this document as “we”, “our”, “us”, or the “Company”). Itshould be read in conjunction with the condensed consolidated financialstatements and notes thereto found under Part I. Item 1. contained herein, andwith the discussion, analysis, consolidated financial statements and notesthereto in Part I. Item 1. and Part II. Item 7. and Item 8. of the AllstateLife Insurance Company Annual Report on Form 10-K for 2005. We operate as asingle segment entity, based on the manner in which we use financialinformation to evaluate business performance and to determine the allocation ofresources.

**HIGHLIGHTS**

·               Net income declined 23.3% to $122 million inthe third quarter of 2006 and 12.7% to $274 million in the first nine months of2006 compared to the same periods in 2005.

·               Gross margin declined 5.2% in the thirdquarter and increased 9.1% in the first nine months of 2006 compared to thesame periods of 2005. Gross margin, a measure that is not based on generally acceptedaccounting principles (“non-GAAP”), is defined on page 18.

·               Contractholderfund deposits totaled $2.17 billion and $7.74 billion for the third quarter andfirst nine months of 2006, respectively, compared to $1.64 billion and $8.18billion for the third quarter and first nine months of 2005, respectively.

·               Investmentsas of September 30, 2006 increased 2.2% from September 30, 2005 and netinvestment income increased 9.9% and 10.2% in the third quarter and first ninemonths of 2006, respectively, compared to the same periods in the prior year.

·               Dividends of $300 million and $125 million inthe third quarter and second quarter of 2006, respectively, were paid byAllstate Life Insurance Company (“ALIC”) to its parent, Allstate InsuranceCompany (“AIC”). Subject to regulatory approval, ALIC expects to pay additionaldividends of approximately $150 million during the fourth quarter of 2006.

·               On June 1, 2006, we completed the disposal ofsubstantially all of our variable annuity business through reinsurance. Whencomparing the third quarter and first nine months of 2006 to the same period inthe prior year, the following impacts to the Condensed Consolidated Statementsof Operations and gross margin resulted from the disposal of the variableannuity business:
| (in millions)                                                         | ** ** | **Three months ended  September 30, 2006  Compared to the  Same Period in the  Prior Year** | ** ** | **Nine months ended  September 30, 2006  Compared to the  Same Period in the  Prior Year** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Favorable/(unfavorable)**                                                |       |                                                                                                                                          |       |                                                                                                                                         |       |
| Premiums and contract  charges                                             |       | $                                                                                                                                             | (73        | )                                                                                                                                            | $          | (67 | ) |
| Net investment income                                                      |       | (12                                                                                                                                           | )          | (21                                                                                                                                          | )          |
| Periodic settlements  and accruals on non-hedge derivative instruments (1) |       | (1                                                                                                                                            | )          | (2                                                                                                                                           | )          |
| Contract benefits                                                          |       | 12                                                                                                                                            |       | 31                                                                                                                                           |       |
| Interest credited to  contractholder funds                                 |       | 17                                                                                                                                            |       | 19                                                                                                                                           |       |
| Amortization of DAC (2)                                                    |       | 34                                                                                                                                            |       | (46                                                                                                                                          | )          |
| Operating costs and  expenses                                              |       | 20                                                                                                                                            |       | 30                                                                                                                                           |       |
| Loss on disposition of  operations                                         |       | 2                                                                                                                                             |       | (86                                                                                                                                          | )          |
| Income from  operations before income tax expense                          |       | $                                                                                                                                             | (1         | )                                                                                                                                            | $          | (142 | ) |
|                                                                       |       |                                                                                                                                          |       |                                                                                                                                         |       |
| Investment margin                                                          |       | $                                                                                                                                             | 1          |                                                                                                                                         | $          | (2 | ) |
| Benefit margin                                                             |       | 1                                                                                                                                             |       | 29                                                                                                                                           |       |
| Contract charges and  fees                                                 |       | (62                                                                                                                                           | )          | (64                                                                                                                                          | )          |
| Gross margin (3)                                                           |       | $                                                                                                                                             | (60        | )                                                                                                                                            | $          | (37 | ) |

----

(1)             Periodicsettlements and accruals on non-hedge derivative instruments are reflected as acomponent of realized capital gains and losses on the Condensed ConsolidatedStatements of Operations.

(2)             Amortizationdeceleration of $55 million was recognized in the first nine months of 2005 forvariable annuities.

(3)             Grossmargin and its components are measures that are not based on GAAP. Grossmargin, investment margin and benefit margin are defined on pages 18, 20 and21, respectively.

14

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**OPERATIONS**

**Premiums** represent revenues generated fromtraditional life, immediate annuities with life contingencies and otherinsurance products that have significant mortality or morbidity risk.

**Contractcharges** are revenues generated from interest-sensitive life,variable annuities, fixed annuities and institutional products for whichdeposits are classified as contractholder funds or separate accountsliabilities. Contract charges are assessed against the contractholder accountvalues for maintenance, administration, cost of insurance and surrender priorto contractually specified dates. As a result, changes in contractholder fundsare considered in the evaluation of growth and as indicators of future levelsof revenues. Subsequent to the close of our reinsurance transaction withPrudential on June 1, 2006, variable annuity contract charges on the businesssubject to the transaction are fully reinsured to Prudential and presented netof reinsurance on the Condensed Consolidated Statements of Operations (see Note4 to the Condensed Consolidated Financial Statements).

Thefollowing table summarizes premiums and contract charges by product.
|                                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)**                       | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Premiums**                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Traditional life                             |       | $                                                    | 60         |                                                | $          | 60 |   | $ | 186 |   | $ | 181 |   |
| Immediate annuities  with life contingencies |       | 59                                                   |       | 37                                                  |       | 177 |   | 160 |   |
| Other                                        |       | 10                                                   |       | 7                                                   |       | 29 |   | 18 |   |
| **Total premiums**                           |       | 129                                                  |       | 104                                                 |       | 392 |   | 359 |   |
|                                         |       |                                                 |       |                                                |       |   |   |   |   |
| **Contract charges**                         |       |                                                 |       |                                                |       |   |   |   |   |
| Interest-sensitive life                      |       | 200                                                  |       | 184                                                 |       | 589 |   | 542 |   |
| Fixed annuities                              |       | 17                                                   |       | 16                                                  |       | 53 |   | 49 |   |
| Variable annuities                           |       | 1                                                    |       | 75                                                  |       | 138 |   | 206 |   |
| **Total contract charges**                   |       | 218                                                  |       | 275                                                 |       | 780 |   | 797 |   |
| **Total premiums and contract charges**      |       | $                                                    | 347        |                                                | $          | 379 |   | $ | 1,172 |   | $ | 1,156 |   |

 

The followingtable summarizes premiums and contract charges by distribution channel.
|                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)**                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **Premiums**                            |       |                                                 |       |                                                |       |   |   |   |   |
| Allstate agencies                       |       | $                                                    | 65         |                                                | $          | 51 |   | $ | 194 |   | $ | 184 |   |
| Independent agents                      |       | 14                                                   |       | 31                                                  |       | 46 |   | 58 |   |
| Specialized brokers                     |       | 49                                                   |       | 22                                                  |       | 150 |   | 115 |   |
| Other                                   |       | 1                                                    |       | —                                              |       | 2 |   | 2 |   |
| **Total premiums**                      |       | 129                                                  |       | 104                                                 |       | 392 |   | 359 |   |
|                                    | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Contract charges**                    | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Allstate agencies                       |       | 138                                                  |       | 129                                                 |       | 413 |   | 388 |   |
| Financial institutions                  |       | 13                                                   |       | 73                                                  |       | 155 |   | 202 |   |
| Independent agents                      |       | 62                                                   |       | 66                                                  |       | 197 |   | 185 |   |
| Specialized brokers                     |       | 4                                                    |       | 6                                                   |       | 13 |   | 20 |   |
| Other                                   |       | 1                                                    |       | 1                                                   |       | 2 |   | 2 |   |
| **Total contract charges**              |       | 218                                                  |       | 275                                                 |       | 780 |   | 797 |   |
| **Total premiums and contract charges** |       | $                                                    | 347        |                                                | $          | 379 |   | $ | 1,172 |   | $ | 1,156 |   |

 

15

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Total premiums increased24.0% to $129 million in the third quarter of 2006 and 9.2% to $392 million inthe first nine months of 2006 compared to the same periods of 2005. Theincrease in the third quarter and first nine months of 2006 was attributableprimarily to increased premiums on immediate annuities sold with lifecontingencies.

Contract charges declined20.7% to $218 million in the third quarter of 2006 and 2.1% to $780 million inthe first nine months of 2006 compared to the same periods of 2005. Excludingcontract charges on variable annuities, substantially all of which arereinsured to Prudential effective June 1, 2006, contract charges increased 8.5%and 8.6% in the third quarter and first nine months of 2006, respectively,compared to the same periods of 2005. These increases were mostly due to highercontract charges on interest-sensitive life products resulting from growth ofbusiness in force. Contract charges on fixed annuities were slightly higher inthe third quarter and first nine months of 2006 due to increased surrendercharges.

*Contractholderfunds* represent interest-bearing liabilities arising from thesale of individual and institutional products, such as interest-sensitive life,fixed annuities and funding agreements. The balance of contractholder funds isequal to the cumulative deposits received and interest credited to thecontractholder less cumulative contract maturities, benefits, surrenders,withdrawals and contract charges for mortality or administrative expenses.

The following table showsthe changes in contractholder funds.
|                                                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)**                                          | ** ** | **2006**                                             | ** ** | **2005**(1)                                         | ** ** | **2006** | ** ** | **2005**(1) | ** ** |
| ** **                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Contractholder funds, beginning  balance**                    |       | $                                                    | 60,208     |                                                | $          | 57,328 |   | $ | 58,190 |   | $ | 53,939 |   |
| **Deposits**                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Fixed annuities                                                 |       | 1,838                                                |       | 1,190                                               |       | 5,054 |   | 4,463 |   |
| Institutional products  (funding agreements)                    |       | —                                               |       | —                                              |       | 1,600 |   | 2,423 |   |
| Interest-sensitive life                                         |       | 333                                                  |       | 342                                                 |       | 989 |   | 980 |   |
| Variable annuity and  life deposits allocated to fixed accounts |       | —                                               |       | 107                                                 |       | 98 |   | 313 |   |
| Total deposits                                                  |       | 2,171                                                |       | 1,639                                               |       | 7,741 |   | 8,179 |   |
| ** **                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Interest credited**                                           |       | 669                                                  |       | 599                                                 |       | 1,937 |   | 1,726 |   |
| ** **                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Maturities, benefits,  withdrawals and other adjustments**    |       |                                                 |       |                                                |       |   |   |   |   |
| Maturities of  institutional products                           |       | (776                                                 | )          | (909                                                | )          | (2,039 | ) | (2,202 | ) |
| Benefits                                                        |       | (376                                                 | )          | (331                                                | )          | (1,132 | ) | (998 | ) |
| Surrenders and partial  withdrawals                             |       | (1,131                                               | )          | (929                                                | )          | (3,385 | ) | (2,595 | ) |
| Contract charges                                                |       | (173                                                 | )          | (163                                                | )          | (514 | ) | (482 | ) |
| Net transfers to  separate accounts                             |       | (1                                                   | )          | (94                                                 | )          | (146 | ) | (249 | ) |
| Fair value hedge  adjustments for institutional products        |       | 16                                                   |       | (64                                                 | )          | (4 | ) | (237 | ) |
| Other adjustments                                               |       | 15                                                   |       | 22                                                  |       | (26 | ) | 17 |   |
| Total maturities,  benefits, withdrawals and other adjustments  |       | (2,426                                               | )          | (2,468                                              | )          | (7,246 | ) | (6,746 | ) |
|                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| **Contractholder funds, ending balance**                        |       | $                                                    | 60,622     |                                                | $          | 57,098 |   | $ | 60,622 |   | $ | 57,098 |   |

----

(1)             Toconform to the current period presentation, certain prior period balances havebeen reclassified.

Contractholder funds increased 0.7% and 4.2% in thethird quarter and first nine months of 2006, respectively. In comparison,contractholder funds declined slightly in the third quarter of 2005 andincreased 5.9% in the first nine months of 2005. Average contractholder fundsincreased 5.6% and 7.0% in the third quarter and first nine months of 2006,respectively, compared to the same periods in 2005.

Contractholder deposits increased 32.5% in the thirdquarter and decreased 5.4% in the first nine months of 2006, compared to thesame periods of 2005. The increase in the third quarter was the result ofhigher deposits on fixed annuities, mostly driven by increased deposits ontraditional deferred annuities. The magnitude of this increase reflectsrelatively low deposits in the third quarter of 2005. Additionally, deposits onour innovative 

16

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Allstate® Treasury-LinkedAnnuity contracts were $283 million in thethird quarter of 2006, an increase of $226 million over the prior period. Thecrediting rate on this patented product is indexed to the 5-year treasury rate,which increases the crediting rate to the customer in a rising interest rateenvironment. The increase in fixed annuity deposits in the third quarter waspartially offset by the absence of variable annuity deposits allocated to thefixed accounts in the third quarter of 2006 due to the disposal ofsubstantially all of our variable annuity business on June 1, 2006. The declinein contractholder fund deposits in the first nine months of 2006 wasattributable to decreased deposits on funding agreements and, to a lesserextent, lower variable annuity and life deposits allocated to fixed accounts,partially offset by higher fixed annuity deposits. Higher fixed annuitydeposits in the first nine months of 2006 were mostly the result of a $584million increase in deposits on Allstate® Treasury-LinkedAnnuity contracts. Weprioritize the allocation of fixed income investments to support sales ofretail products having the best opportunity for sustainable growth and returnwhile maintaining a retail market presence. Partially as a result of thisstrategy, there were no sales of institutional products in the third quarter.The opportunistic manner in which we manage this business results influctuations in funding agreement deposits between periods.

Surrenders andpartial withdrawals on deferred fixed annuities and interest-sensitive lifeproducts increased 21.7% and 30.4% in the third quarter and first nine monthsof 2006, respectively, compared to the same periods of 2005. The annualizedwithdrawal rate on these products was 10.9% for the third quarter of 2006 and11.0% for the first nine months of 2006 based on the beginning of periodcontractholder funds balance. This compares to an annualized withdrawal rate of9.1% for the third quarter of 2005 and 8.9% for the first nine months of 2005.The relatively low interest rate environment of the prior three yearscontributed to favorable withdrawal rates through 2005, and also resulted in anincreased level of policies with little or no surrender charge protection. Theincreases in the withdrawal rate in the third quarter and first nine months of2006 are consistent with management’s expectation that in an increasinginterest rate environment contractholders whose contracts have relatively lowor no surrender charges may choose to move their funds to competing investmentalternatives. The aging of our in-force business may cause this trend tocontinue. In addition, we have implemented crediting rate strategies forrenewal business to improve investment spreads on selected contracts that mayalso have contributed to the increased withdrawal rate.

**Netinvestment income** increased 9.9% in the third quarter and10.2% in the first nine months of 2006 compared to the same periods of 2005 dueto increased investment yields and higher average portfolio balances. Thehigher portfolio yields were primarily due to increased yields on floating rateinstruments resulting from highermarket interest rates. Higher average portfolio balances resulted fromthe investment of cash flows from operating and financing activities relatedprimarily to deposits from fixed annuities, funding agreements andinterest-sensitive life policies.

17

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**Netincome** analysis is presented in the following table.
|                                                                                                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)**                                                                                 | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums                                                                                               |       | $                                                    | 129        |                                                | $          | 104 |   | $ | 392 |   | $ | 359 |   |
| Contract charges                                                                                       |       | 218                                                  |       | 275                                                 |       | 780 |   | 797 |   |
| Net investment income                                                                                  |       | 1,035                                                |       | 942                                                 |       | 3,026 |   | 2,745 |   |
| Periodic settlements  and accruals on non-hedge derivative instruments(1)                              |       | 14                                                   |       | 14                                                  |       | 44 |   | 49 |   |
| Contract benefits                                                                                      |       | (336                                                 | )          | (316                                                | )          | (989 | ) | (1,000 | ) |
| Interest credited to  contractholder funds(2)                                                          |       | (642                                                 | )          | (578                                                | )          | (1,857 | ) | (1,671 | ) |
| **Gross margin**                                                                                       |       | 418                                                  |       | 441                                                 |       | 1,396 |   | 1,279 |   |
|                                                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Amortization of DAC and  DSI(3)                                                                        |       | (140                                                 | )          | (125                                                | )          | (482 | ) | (352 | ) |
| Operating costs and  expenses                                                                          |       | (82                                                  | )          | (99                                                 | )          | (283 | ) | (325 | ) |
| Restructuring and  related charges                                                                     |       | (5                                                   | )          | —                                              |       | (23 | ) | — |   |
| Income tax expense                                                                                     |       | (58                                                  | )          | (63                                                 | )          | (200 | ) | (179 | ) |
| Realized capital gains  and losses, after-tax                                                          |       | (20                                                  | )          | 17                                                  |       | (89 | ) | 33 |   |
| DAC and DSI  amortization relating to realized capital gains and losses, after-tax(3)                  |       | 16                                                   |       | (2                                                  | )          | 40 |   | (106 | ) |
| Reclassification of  periodic settlements and accruals on non-hedge derivative instruments,  after-tax |       | (9                                                   | )          | (10                                                 | )          | (28 | ) | (32 | ) |
| Gain (loss) on disposition  of operations, after-tax                                                   |       | 2                                                    |       | —                                              |       | (57 | ) | (4 | ) |
| **Net income**                                                                                         |       | $                                                    | 122        |                                                | $          | 159 |   | $ | 274 |   | $ | 314 |   |

----

(1)             Periodicsettlements and accruals on non-hedge derivative instruments are reflected as acomponent of realized capital gains and losses on the Condensed ConsolidatedStatements of Operations.

(2)             Forpurposes of calculating gross margin, amortization of deferred salesinducements (“DSI”) is excluded from interest credited to contractholder fundsand aggregated with amortization of deferredpolicy acquisition costs (“DAC”) due to the similarity in the substanceof the two items. Amortization of DSI totaled $9 million and $11 million in thethree months ended September 30, 2006 and 2005, respectively, and $32 millionand $65 million in the first nine months of 2006 and 2005, respectively.

(3)             Amortizationof DAC and DSI relating to realized capital gains and losses is analyzedseparately because realized capital gains and losses may vary significantlybetween periods and obscure trends in our business. Amortization of DAC and DSIrelating to realized capital gains and losses was $25 million and $(3) millionin the third quarter of 2006 and 2005, respectively, and were $63 million and$(163) million in the first nine months of 2006 and 2005, respectively.

*Gross margin*, a non-GAAP measure,represents premiums and contract charges, net investment income and periodicsettlements and accruals on non-hedge derivative instruments, less contractbenefits and interest credited to contractholder funds excluding amortizationof DSI. We reclassify periodic settlements and accruals on non-hedge derivativeinstruments into gross margin to report them in a manner consistent with theeconomically hedged investments, replicated assets or product attributes (e.g.net investment income or interest credited to contractholder funds) and, bydoing so, appropriately reflect trends in product performance. We use grossmargin as a component of our evaluation of the profitability of our lifeinsurance and financial product portfolio. Additionally, for many of ourproducts, including fixed annuities, variable life and annuities, andinterest-sensitive life insurance, the amortization of DAC and DSI isdetermined based on actual and expected gross margin. Gross margin is comprisedof three components that are utilized to further analyze the business:investment margin, benefit margin, and contract charges and fees. We believegross margin and its components are useful to investors because they allow forthe evaluation of income components separately and in the aggregate whenreviewing performance. Gross margin, investment margin and benefit marginshould not be considered as a substitute for net income and do not reflect theoverall profitability of the business. Net income is the GAAP measure that ismost directly comparable to these margins. Gross margin is reconciled to GAAPnet income in the table above.

18

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The components of grossmargin are reconciled to the corresponding financial statement line items inthe following table. 
|                                                                           | ** ** | **Three Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                | ** ** | **Investment  Margin**                                   | ** ** | **Benefit Margin** | ** ** | **Contract Charges  and Fees** | ** ** | **Gross Margin** | ** ** |
| **(in millions)**                                                    | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Premiums                                                                  |       | $                                                        | —     |   | $ | — |   | $ | 129 |   | $ | 104 |   | $ | — |   | $ | — |   | $ | 129 |   | $ | 104 |   |
| Contract charges                                                          |       | —                                                   |       | — |   | 142 |   | 156 |   | 76 |   | 119 |   | 218 |   | 275 |   |
| Net investment income                                                     |       | 1,035                                                    |       | 942 |   | — |   | — |   | — |   | — |   | 1,035 |   | 942 |   |
| Periodic settlements  and accruals on non-hedge derivative instruments(1) |       | 14                                                       |       | 14 |   | — |   | — |   | — |   | — |   | 14 |   | 14 |   |
| Contract benefits                                                         |       | (138                                                     | )          | (134 | ) | (198 | ) | (182 | ) | — |   | — |   | (336 | ) | (316 | ) |
| Interest credited to  contractholder funds(2)                             |       | (642                                                     | )          | (578 | ) | — |   | — |   | — |   | — |   | (642 | ) | (578 | ) |
|                                                                      |       | $                                                        | 269        |   | $ | 244 |   | $ | 73 |   | $ | 78 |   | $ | 76 |   | $ | 119 |   | $ | 418 |   | $ | 441 |   |

 
|                                                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                | ** ** | **Investment  Margin**                                  | ** ** | **Benefit Margin** | ** ** | **Contract Charges  and Fees** | ** ** | **Gross Margin** | ** ** |
| **(in millions)**                                                    | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Premiums                                                                  |       | $                                                       | —     |   | $ | — |   | $ | 392 |   | $ | 359 |   | $ | — |   | $ | — |   | $ | 392 |   | $ | 359 |   |
| Contract charges                                                          |       | —                                                  |       | — |   | 452 |   | 459 |   | 328 |   | 338 |   | 780 |   | 797 |   |
| Net investment income                                                     |       | 3,026                                                   |       | 2,745 |   | — |   | — |   | — |   | — |   | 3,026 |   | 2,745 |   |
| Periodic settlements  and accruals on non-hedge derivative instruments(1) |       | 44                                                      |       | 49 |   | — |   | — |   | — |   | — |   | 44 |   | 49 |   |
| Contract benefits                                                         |       | (405                                                    | )          | (397 | ) | (584 | ) | (603 | ) | — |   | — |   | (989 | ) | (1,000 | ) |
| Interest credited to  contractholder funds(2)                             |       | (1,857                                                  | )          | (1,671 | ) | — |   | — |   | — |   | — |   | (1,857 | ) | (1,671 | ) |
|                                                                      |       | $                                                       | 808        |   | $ | 726 |   | $ | 260 |   | $ | 215 |   | $ | 328 |   | $ | 338 |   | $ | 1,396 |   | $ | 1,279 |   |

----

(1)             Periodicsettlements and accruals on non-hedge derivative instruments are reflected as acomponent of realized capital gains and losses on the Condensed ConsolidatedStatements of Operations.

(2)             Forpurposes of calculating gross margin, amortization of DSI is excluded frominterest credited to contractholder funds and aggregated with amortization ofDAC due to the similarity in the substance of the two items. Amortization ofDSI totaled $9 million and $11 million in the three months ended September 30,2006 and 2005, respectively, and $32 million and $65 million in the first ninemonths of 2006 and 2005, respectively.

Gross margindeclined 5.2% in the third quarter of 2006 and increased 9.1% in the first ninemonths of 2006 compared to the same periods of 2005. In the third quarter of2006, higher investment margin was more than offset by lower contract chargesand fees resulting from the absence of variable annuity contract charges in thecurrent period due to the disposal of substantially all of our variable annuitybusiness. In the first nine months of 2006, increased investment and benefitmargin more than offset the declines from the disposition of the variableannuity business.

19

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*Investment margin* is a component of grossmargin, both of which are non-GAAP measures. Investment margin represents theexcess of net investment income and periodic settlements and accruals oncertain non-hedge derivative instruments over interest credited tocontractholder funds and the implied interest on life-contingent immediateannuities included in the reserve for life-contingent contract benefits.Amortization of DSI is excluded from interest credited to contractholder fundsfor purposes of calculating investment margin. We use investment margin toevaluate our profitability related to the difference between investment returnson assets supporting certain products and amounts credited to customers (“spread”)during a fiscal period.

Investmentmargin by product group is shown in the following table.
|                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)**  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Annuities               |       | $                                                    | 188        |                                                | $          | 171 |   | $ | 579 |   | $ | 504 |   |
| Life insurance          |       | 50                                                   |       | 41                                                  |       | 134 |   | 133 |   |
| Institutional products  |       | 31                                                   |       | 32                                                  |       | 95 |   | 89 |   |
| Total investment margin |       | $                                                    | 269        |                                                | $          | 244 |   | $ | 808 |   | $ | 726 |   |

 

Investment marginincreased 10.2% in the third quarter and 11.3% in the first nine months of 2006compared to the same periods of 2005. The increase in both periods wasprimarily due to improved yields on assets supporting deferred fixed annuities,crediting rate actions relating to renewal business and growth incontractholder funds.

The followingtable summarizes the annualized weighted average investment yield, interestcrediting rates and investment spreads for the three months ended September 30.
|                                                                     | ** ** | **Weighted Average  Investment Yield** | ** ** | **Weighted Average  Interest Crediting Rate** | ** ** | **Weighted Average  Investment Spreads** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                         | ** ** | **2005**                                                     | ** ** | **2006**                                           | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Interest-sensitive life                                             |       | 6.2                                              | %          | 6.2                                                          | %          | 4.7                                                | %          | 4.6 | % | 1.5 | % | 1.6 | % |
| Deferred fixed  annuities                                           |       | 5.7                                              |       | 5.4                                                          |       | 3.8                                                |       | 3.8 |   | 1.9 |   | 1.6 |   |
| Immediate fixed  annuities with and without life contingencies      |       | 7.2                                              |       | 7.3                                                          |       | 6.7                                                |       | 6.7 |   | 0.5 |   | 0.6 |   |
| Institutional                                                       |       | 6.3                                              |       | 5.0                                                          |       | 5.4                                                |       | 3.9 |   | 0.9 |   | 1.1 |   |
| Investments supporting capital, traditional life and other products |       | 6.7                                              |       | 6.5                                                          |       | N/A                                                |       | N/A |   | N/A |   | N/A |   |

 

The followingtable summarizes the annualized weighted average investment yield, interestcrediting rates and investment spreads for the nine months ended September 30.
|                                                                     | ** ** | **Weighted Average  Investment Yield** | ** ** | **Weighted Average  Interest Crediting Rate** | ** ** | **Weighted Average  Investment Spreads** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                         | ** ** | **2005**                                                     | ** ** | **2006**                                           | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Interest-sensitive life                                             |       | 6.2                                              | %          | 6.3                                                          | %          | 4.7                                                | %          | 4.7 | % | 1.5 | % | 1.6 | % |
| Deferred fixed  annuities                                           |       | 5.7                                              |       | 5.5                                                          |       | 3.7                                                |       | 3.8 |   | 2.0 |   | 1.7 |   |
| Immediate fixed  annuities with and without life contingencies      |       | 7.2                                              |       | 7.4                                                          |       | 6.6                                                |       | 6.7 |   | 0.6 |   | 0.7 |   |
| Institutional                                                       |       | 6.0                                              |       | 4.4                                                          |       | 5.0                                                |       | 3.4 |   | 1.0 |   | 1.0 |   |
| Investments supporting capital, traditional life and other products |       | 6.7                                              |       | 6.8                                                          |       | N/A                                                |       | N/A |   | N/A |   | N/A |   |

 

20

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The following table summarizes the liabilities for these contracts andpolicies.
|                                                                       | ** ** | **As of September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------|------------|
| **(in millions)**                                                | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Immediate fixed  annuities with life contingencies                    |       | $                                      | 8,045      |   | $ | 7,847 |   |
| Other life contingent  contracts and other                            |       | 4,057                                  |       | 3,951 |   |
| Reserve for  life-contingent contract benefits                        |       | $                                      | 12,102     |   | $ | 11,798 |   |
|                                                                  |       |                                   |       |   |   |
| Interest-sensitive life                                               |       | $                                      | 8,286      |   | $ | 8,014 |   |
| Deferred fixed  annuities                                             |       | 35,762                                 |       | 33,383 |   |
| Immediate fixed  annuities without life contingencies                 |       | 3,723                                  |       | 3,429 |   |
| Institutional                                                         |       | 12,459                                 |       | 11,827 |   |
| Market value  adjustments related to derivative instruments and other |       | 392                                    |       | 445 |   |
| Contractholder funds                                                  |       | $                                      | 60,622     |   | $ | 57,098 |   |

 

*Benefit margin*is a component of gross margin, both of which arenon-GAAP measures. Benefit margin representslife and life-contingent immediate annuity premiums, cost of insurance contractcharges and, prior to the disposal of substantially all of our variable annuitybusiness through reinsurance, variable annuity contract charges for contractguarantees less contract benefits. Benefit margin excludes the implied intereston life-contingent immediate annuities, which is included in the calculation ofinvestment margin. We use benefit margin to evaluate our underwritingperformance, as it reflects the profitability of our products with respect tomortality or morbidity risk during a fiscal period.

Benefitmargin by product group is shown in the following table. 
|                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)** | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Life insurance         |       | $                                                    | 86         |                                                | $          | 94 |   | $ | 291 |   | $ | 270 |   |
| Annuities              |       | (13                                                  | )          | (16                                                 | )          | (31 | ) | (55 | ) |
| Total benefit margin   |       | $                                                    | 73         |                                                | $          | 78 |   | $ | 260 |   | $ | 215 |   |

 

Benefit margin decreased6.4% in the third quarter of 2006 compared to the third quarter of 2005 andincreased 20.9% in the first nine months of 2006 compared to the same period in2005. Benefit margin for the third quarter and first nine months of 2005included $15 million and $43 million, respectively, of amounts that wereclassified as contract charges and fees beginning in 2006. Excluding this item,benefit margin increased 15.9% and 51.2% in the third quarter and first ninemonths of 2006, respectively. The improvement in the third quarter of 2006 wasthe result of growth in life insurance in force and modest improvements inmortality experience. The increase in the first nine months of 2006 was dueprimarily to improved life insurance mortality experience, growth in businessin force and lower variable annuity benefits.

*Amortizationof DAC and DSI*, excluding amortization related to realizedcapital gains and losses, increased 12.0% in the third quarter of 2006 and36.9% in the first nine months of 2006 compared to the same periods of 2005.The increase in both periods was primarily due to improved gross profits oninvestment contracts resulting from increased investment and benefit margin,and lower expenses. Partially offsetting this impact, in both periods, was theabsence of amortization on the variable annuity contracts that were reinsuredeffective June 1, 2006. DAC and DSI amortization related to realized capitalgains and losses, after-tax, changed by a favorable $18 million and $146million in the third quarter and first nine months of 2006, respectively,compared to the same periods in 2005. The impact of realized capital gains andlosses on amortization of DAC and DSI is dependent upon the relationshipbetween the assets that give rise to the gain or loss and the product liabilitysupported by the assets. Fluctuations result from changes in the impact ofrealized capital gains and losses on actual and expected gross profits.

DAC and DSI werereduced by $726 million and $70 million, respectively, in the first nine monthsof 2006 as a result of the disposition of substantially all of our variableannuity business.

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*Operating costs and expenses* declined 17.2% and 12.9% in the third quarterand first nine months of 2006, respectively, compared to the same periods of 2005.The following table summarizes operating costs and expenses.
|                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in millions)**              | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                |       |                                                 |       |                                                |       |   |   |   |   |
| Non-deferrable  acquisition costs   |       | $                                                    | 23         |                                                | $          | 39 |   | $ | 95 |   | $ | 115 |   |
| Other operating costs  and expenses |       | 59                                                   |       | 60                                                  |       | 188 |   | 210 |   |
| Total operating costs  and expenses |       | $                                                    | 82         |                                                | $          | 99 |   | $ | 283 |   | $ | 325 |   |
|                                |       |                                                 |       |                                                |       |   |   |   |   |
| Restructuring and related charges   |       | $                                                    | 5          |                                                | $          | — |   | $ | 23 |   | $ | — |   |

 

Non-deferrableacquisition costs declined 41.0% in the third quarter of 2006 and 17.4% in thefirst nine months of 2006 compared to the same periods of 2005 due primarily toa reduction in non-deferrable commissions due to the disposal of substantiallyall of our variable annuity business. Other operating costs and expensesdeclined 1.7% in the third quarter of 2006 and 10.5% in the first nine monthsof 2006 compared to the same periods of 2005. The decline in other operatingcosts and expenses in both periods was primarily the result of lower variableannuity related expenses and lower general administrative expenses, partiallyoffset by higher pension expenses. The third quarter and first nine months of2006 reflect reduced tax benefits for adjustments to prior years’ taxliabilities compared to the same periods in the prior year.

Restructuring and related charges for the first nine months of 2006reflect costs related to the Voluntary Termination Offer (“VTO”).

**INVESTMENTS**

An important component ofour financial results is the return on our investment portfolio. Thecomposition of the investment portfolio at September 30, 2006 is presented inthe table below.
| (in millions)           | ** ** | **Investments** | ** ** | **Percent to  total** | ** ** |
|------------------------------|------------|-----------------|------------|----------------------------|------------|
| ** **                   | ** ** | ** **      | ** ** | ** **                 | ** ** |
| Fixed income securities  (1) |       | $               | 63,060     |                       | 84.1       | % |
| Mortgage loans               |       | 8,396           |       | 11.2                       |       |
| Equity securities            |       | 471             |       | 0.6                        |       |
| Short-term                   |       | 1,511           |       | 2.0                        |       |
| Policy loans                 |       | 745             |       | 1.0                        |       |
| Other                        |       | 830             |       | 1.1                        |       |
| Total                        |       | $               | 75,013     |                       | 100.0      | % |

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(1)             Fixedincome securities are carried at fair value. Amortized cost basis for thesesecurities was $61.33 billion.

Total investmentsincreased to $75.01 billion at September 30, 2006 from $72.76 billion atDecember 31, 2005, primarily due to positive cash flows from operating andfinancing activities including increased funds associated with securitieslending, partially offset by decreased net unrealized gains on fixed incomesecurities and payments totaling approximately $812 million related to thedisposition of substantially all of our variable annuity business.

Total investments atamortized cost related to collateral received in connection with securitieslending activities, funds received in connection with securities repurchaseagreements, and collateral posted by counterparties related to derivativetransactions, increased to $3.52 billion at September 30, 2006, from $2.23billion at December 31, 2005.

At September 30, 2006,95.1% of the fixed income securities portfolio was rated investment grade,which is defined as a security having a rating from the National Association ofInsurance Commissioners (“NAIC”) of 1 or 2; a rating of Aaa, Aa, A or Baa fromMoody’s or a rating of AAA, AA, A or BBB from S&P, Fitch or Dominion; or acomparable internal rating if an externally provided rating is not available.

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Theunrealized net capital gains on fixed income and equity securities at September30, 2006 were $1.74 billion, a decrease of $527 million or 23.3% since December31, 2005. The net unrealized gain for the fixed income portfolio totaled $1.73billion, comprised of $2.25 billion of unrealized gains and $523 million of unrealizedlosses at September 30, 2006. This is compared to a net unrealized gain for thefixed income portfolio totaling $2.26 billion at December 31, 2005, comprisedof $2.72 billion of unrealized gains and $461 million of unrealized losses.

Of thegross unrealized losses in the fixed income portfolio at September 30, 2006,$494 million or 94.5% were related to investment grade securities and arebelieved to be primarily a result of a rising interest rate environment. Of theremaining $29 million of losses in the fixed income portfolio, $24 million or82.8% were in the corporate fixed income portfolio. The $24 million ofcorporate fixed income gross unrealized losses were primarily comprised ofsecurities in the consumer goods, communications and capital goods sectors. Thegross unrealized losses in these sectors were primarily company specific andinterest rate related. Approximately $12 million of the total gross unrealizedlosses in the corporate fixed income portfolio were associated with theautomobile industry, which includes direct debt issuances of automobilemanufacturers, captive automotive financing companies and automobile parts andequipment suppliers, which are classified in the consumer goods and financialservices sectors. Fixed income security values in the automobile industry weredepressed primarily due to company specific conditions. Additionally,approximately $5 million of the total gross unrealized losses were associatedwith the airline industry for which values were depressed due to economicissues and industry conditions.

Thenet unrealized gain for the common and non-redeemable preferred stock portfoliototaled $10 million at September 30, 2006 and $5 million at December 31, 2005.

Our portfolio monitoringprocess identifies and evaluates, on a case-by-case basis, fixed income andequity securities whose carrying value may be other-than-temporarily impaired.The process includes a quarterly review of all securities using a screeningprocess to identify those securities whose fair value compared to amortizedcost for fixed income securities or cost for equity securities is belowestablished thresholds for certain time periods, or which are identifiedthrough other monitoring criteria such as ratings downgrades or paymentdefaults. As a result of approved programs involving the disposition ofinvestments such as changes in duration and revisions to strategic assetallocations, and certain dispositions anticipated by portfolio managers, wealso conduct a portfolio review to recognize impairment on securities in anunrealized loss position for which we do not have the intent and ability tohold until recovery. All securities in an unrealized loss position at September30, 2006 were included in our portfolio monitoring process for determining whichdeclines in value were not other-than-temporary.

We also monitor thequality of our fixed income portfolio by categorizing certain investments as “problem”,“restructured” or “potential problem.” Problem fixed income securities aresecurities in default with respect to principal or interest and/or securitiesissued by companies that have gone into bankruptcy subsequent to ouracquisition of the security. Restructured fixed income securities have ratesand terms that are not consistent with market rates or terms prevailing at thetime of the restructuring. Potential problem fixed income securities arecurrent with respect to contractual principal and/or interest, but because ofother facts and circumstances, we have concerns regarding the borrower’s abilityto pay future principal and interest, which causes us to believe thesesecurities may be classified as problem or restructured in the future.

The following tablesummarizes problem, restructured and potential problem fixed income securities.

 
|                                       | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(in millions)**                | ** ** | **Amortized  cost**              | ** ** | **Fair  value**                 | ** ** | **Percent of  total Fixed  Income  portfolio** | ** ** | **Amortized  cost** | ** ** | **Fair  value** | ** ** | **Percent of  total Fixed  Income  portfolio** | ** ** |
| Problem                               |       | $                                | 7          |                            | $          | 10 |   | — | % | $ | 70 |   | $ | 80 |   | 0.1 | % |
| Restructured                          |       | 4                                |       | 4                               |       | — |   | 4 |   | 4 |   | — |   |
| Potential problem                     |       | 112                              |       | 121                             |       | 0.2 |   | 122 |   | 135 |   | 0.2 |   |
| Total net carrying  value             |       | $                                | 123        |                            | $          | 135 |   | 0.2 | % | $ | 196 |   | $ | 219 |   | 0.3 | % |
| Cumulative write-downs recognized (1) |       | $                                | 183        |                            |       |   |   |   | $ | 188 |   |   |   |   |   |

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(1)             Cumulativewrite-downs recognized only reflects write-downs related to securities withinthe problem, potential problem and restructured categories.

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We have experienced adecrease in the amortized cost of fixed income securities categorized asproblem and potential problem as of September 30, 2006 compared to December 31,2005. The decrease was primarily due to dispositions and the removal ofsecurities upon improving conditions.

We also evaluated each ofthese securities through our portfolio monitoring process at September 30, 2006and recorded write-downs when appropriate. We further concluded that anyremaining unrealized losses on these securities were temporary in nature andthat we have the intent and ability to hold the securities until recovery.While these balances may increase in the future, particularly if economicconditions are unfavorable, management expects that****the total amount of securities in these categories willremain low relative to the total fixed income securities portfolio.

**Net Realized Capital Gains and Losses**Thefollowing table presents the components of realized capital gains and lossesand the related tax effect.
|                                              | ** ** | **Three Months EndedSeptember 30,** | ** ** | **Nine Months EndedSeptember 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in millions)**                       | ** ** | **2006**                                           | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                         |       |                                               |       |                                              |       |   |   |   |   |
| Investment  write-downs                      |       | $                                                  | (8         | )                                                 | $          | (9 | ) | $ | (17 | ) | $ | (22 | ) |
| Dispositions                                 |       | 33                                                 |       | 22                                                |       | (117 | ) | 120 |   |
| Valuation  of derivative instruments         |       | (47                                                | )          | (32                                               | )          | (33 | ) | (101 | ) |
| Settlement  of derivative instruments        |       | (8                                                 | )          | 45                                                |       | 30 |   | 54 |   |
| Realized  capital gains and losses, pretax   |       | (30                                                | )          | 26                                                |       | (137 | ) | 51 |   |
| Income  tax benefit (expense)                |       | 10                                                 |       | (9                                                | )          | 48 |   | (18 | ) |
| Realized capital gains and losses, after-tax |       | $                                                  | (20        | )                                                 | $          | 17 |   | $ | (89 | ) | $ | 33 |   |

 

Dispositionsin the above table include sales, losses recognized in anticipation ofdispositions and other transactions such as calls and prepayments. We may sellsecurities during the period in which fair value has declined below amortizedcost for fixed income securities or cost for equity securities. In certainsituations, new factors such as negative developments, subsequent creditdeterioration, relative value opportunities, market liquidity concerns andportfolio reallocations can subsequently change our previous intent to continueholding a security.

In the third quarter of2006, we recognized $1 million of losses related to a change in our intent tohold certain securities with unrealized losses until they recover in value. Thechange in our intent is primarily related to comprehensive reviews of ourportfolio. We identified $105 million of securities that may be sold to achievethese objectives.

Valuation and settlement of derivative instrumentsprimarily include gains and losses related to interest rate swaps, caps andfloors used to reduce the interest rate risk resulting from mismatches betweenexisting assets and liabilities, financial futures used to hedge the interestrate risk of anticipated purchases and sales of investments and product salesto customers, and the change in fair value of embedded equity options in fixedincome securities. For the three months ended September 30, 2006, the loss fromvaluation of derivative instruments primarily consisted of $56 million inlosses originating from changes in the fair value of interest rate caps, whichare used to economically hedge certain liabilities. The fair value of the capsdecreased due to declines in the related indices.

**CAPITALRESOURCES AND LIQUIDITY**

**CapitalResources** consist of shareholder’s equity and debt,representing funds deployed or available to be deployed to support businessoperations. The following table summarizes our capital resources.
| (in millions)                                                         | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Redeemable preferred  stock                                                |       | $                                | 5          |                            | $          | 5 |   |
| Common stock, retained  earnings and other shareholder’s equity items |       | 5,264                            |       | 5,415                           |       |
| Accumulated other  comprehensive income                                    |       | 371                              |       | 588                             |       |
| Total  shareholder’s equity                                           |       | 5,640                            |       | 6,008                           |       |
| Debt                                                                       |       | 263                              |       | 181                             |       |
| Total capital resources                                                    |       | $                                | 5,903      |                            | $          | 6,189 |   |

 

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*Shareholder’s equity* declined in the firstnine months of 2006, primarily due to lower unrealized net capital gains onfixed income securities and dividends, partially offset by net income.

*Debt*increased in the first nine months of 2006, due to increases in long-term debtpartially offset by the redemption of mandatorily redeemable preferred stock.In the first nine months of 2006, under an existing agreement with KennettCapital, Inc. (“Kennett”), an unconsolidated affiliate of ALIC, ALIC soldKennett a $100 million redeemable surplus note issued by ALIC ReinsuranceCompany, a wholly owned subsidiary of ALIC. The surplus note is due June 1,2036 with an initial rate of 6.18% that will reset once every ten years to thethen current ten year Constant Maturity Treasury yield (“CMT”), plus 1.14%. Aspayment, Kennett issued a full recourse note due June 1, 2036 to ALIC for thesame amount with an initial interest rate of 5.98% that will reset once everyten years to the then current ten year CMT, plus 0.94%. The note due fromKennett is classified as other investments and the related surplus note isclassified as long-term debt in the Condensed Consolidated Statements ofFinancial Position.

**Financial Ratings and Strength**Ourratings are influenced by many factors including our operating and financialperformance, asset quality, liquidity, asset/liability management, overallportfolio mix, financial leverage (i.e., debt), exposure to risks, the currentlevel of operating leverage, AIC’s ratings and other factors. There have beenno changes to our insurance financial strength ratings since December 31, 2005.

**Liquidity Sources and Uses** Asreflected in our Condensed Consolidated Statements of Cash Flows,****higher operating cash flows in the firstnine months of 2006, compared to the first nine months of 2005, primarilyrelated to higher investment income.

Cash flows used in investingactivities decreased in the first nine months of 2006 primarily due todecreased net cash provided by financing activities, partially offset by theinvestment of higher operating cash flows. Cash flows used in investingactivities also include the settlement of the disposal of substantially all ofour variable annuity business.

Cash flowsprovided by financing activities declined in the first nine months of 2006 as aresult of lower contractholder fund deposits and higher surrenders and partialwithdrawals. For quantification of the changes in contractholder funds, see theOperations section of the MD&A.

Dividends of $300million and $125 million in the third quarter and second quarter of 2006,respectively, were paid to AIC, primarily as a result of the disposal ofsubstantially all of our variable annuity business, which was completed in thesecond quarter of 2006. Subject to regulatory approval, we expect to payadditional dividends of approximately $150 million during the fourth quarter of2006.

We have access toadditional borrowing to support liquidity through the Corporation as follows:

·               Acommercial paper program with a borrowing limit of $1.00 billion to covershort-term cash needs. As of September 30, 2006, there were no balancesoutstanding and therefore the remaining borrowing capacity was $1.00 billion;however, the outstanding balance fluctuates daily.

·               A five-year revolving credit facility expiring in2009 totaling $1.00 billion to cover short-term liquidity requirements.This facility contains an increase provision that would make up to anadditional $500 million available for borrowing provided the increased portioncould be fully syndicated at a later date among existing or new lenders.Although the right to borrow under the facility is not subject to a minimumrating requirement, the costs of maintaining the facility and borrowing underit are based on the ratings of the Corporation’s senior, unsecured,nonguaranteed long-term debt. There were no borrowings under this line ofcredit during the first nine months of 2006. The total amount outstanding atany point in time under the combination of the commercial paper program and thecredit facility cannot exceed the amount that can be borrowed under the creditfacility.

·                  In May 2006, theCorporation filed a universal shelf registration statement with the Securitiesand Exchange Commission (“SEC”). In accordance with rules adopted by the SEC in2005, this registration statement covers an unspecified amount of securities.The Corporation can use it to issue debt securities, common stock, preferredstock, depositary shares, warrants, stock purchase contracts, stock purchaseunits and securities of subsidiaries. The specific terms of any securities theCorporation issues under this registration statement will be provided in theapplicable prospectus supplements. This registration statement, under which theCorporation has not yet issued any securities, replaced the 2003 universalshelf registration statement.

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**Item 4.Controls and Procedures**

*Evaluation of Disclosure Controls and Procedures.*Wemaintain disclosure controls and procedures as defined in Rule 13a-15(e) and 15(d)-15(e) under the SecuritiesExchange Act of 1934. Under the supervision and with the participation of ourmanagement, including our principal executive officer and principal financialofficer, we conducted an evaluation of the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this report.Based upon this evaluation, the principal executive officer and the principalfinancial officer concluded that our disclosure controls and procedures areeffective in providing reasonable assurance that material information requiredto be disclosed in our reports filed with or submitted to the Securities andExchange Commission under the Securities Exchange Act is made known tomanagement, including the principal executive officer and the principalfinancial officer, as appropriate to allow timely decisions regarding requireddisclosure.

*Changes in Internal Control over Financial Reporting.*During the fiscal quarter ended September 30, 2006, therehave been no changes in our internal control over financial reporting that havematerially affected, or are reasonably likely to materially affect, our internalcontrol over financial reporting.

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**PART II.OTHER INFORMATION**

**Item1.    Legal Proceedings**

Informationrequired for this Part II, Item 1 is incorporated by reference to thediscussion under the heading “Regulation” and under the heading “Legal andregulatory proceedings and inquiries” in Note 5 of the Company’s CondensedConsolidated Financial Statements in Part I, Item 1 of this Form 10-Q.

**Item 1A. Risk Factors**

This documentcontains “forward-looking statements” that anticipate results based on ourestimates, assumptions and plans that are subject to uncertainty. Thesestatements are made subject to the safe-harbor provisions of the PrivateSecurities Litigation Reform Act of 1995. We assume no obligation to update anyforward-looking statements as a result of new information or future events ordevelopments.

Theseforward-looking statements do not relate strictly to historical or currentfacts and may be identified by their use of words like “plans,” “seeks,” “expects,”“will,” “should,” “anticipates,” “estimates,” “intends,” “believes,” “likely,” “targets”and other words with similar meanings. These statements may address, amongother things, our strategy for growth, product development, regulatoryapprovals, market position, expenses, financial results, litigation andreserves. We believe that these statements are based on reasonable estimates,assumptions and plans. However, if the estimates, assumptions or plansunderlying the forward-looking statements prove inaccurate or if other risks oruncertainties arise, actual results could differ materially from thosecommunicated in these forward-looking statements. Risk factors which couldcause actual results to differ materially from those suggested by suchforward-looking statements include but are not limited to those discussed oridentified in this document, in our public filings with the Securities andExchange Commission, and those in Part I, Item 1A of Allstate Life InsuranceCompany Annual Report on Form 10-K for 2005, which are hereby incorporatedherein by reference. There have been no material changes from the risk factorspreviously disclosed in our Annual Report on Form 10-K.

**Item 6.Exhibits**

(a)                                  Exhibits

An Exhibit Index has been filed as part of this reporton page E-1.

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**SIGNATURE**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                  | Allstate Life Insurance Company |
|------------------|---------------------------------|
|             | (Registrant)                    |
|             |                            |
| November 7, 2006 | By                              | /s/ Samuel H. Pilch |
|             |                            | Samuel H. Pilch |
|             |                            | (chief accounting officer and duly authorized  officer of Registrant) |

 

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| Exhibit No. | ** ** | **Description**                                                                                                                           | ** ** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **       | ** ** | ** **                                                                                                                                | ** ** |
| 15               |       | Acknowledgment  of awareness from Deloitte & Touche LLP, dated November 6, 2006,  concerning unaudited interim financial information. |       |
|             |       |                                                                                                                                      |       |
| 31.1             |       | Rule  13a-14(a) Certification of Principal Executive Officer                                                                              |       |
|             |       |                                                                                                                                      |       |
| 31.2             |       | Rule  13a-14(a) Certification of Principal Financial Officer                                                                              |       |
|             |       |                                                                                                                                      |       |
| 32               |       | Section 1350  Certifications                                                                                                              |       |

 

E-1

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