** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**The Registrant meets the conditions set forth in GeneralInstruction H (1)(a) and (b) of Form 10-Q and is thereforefiling this Form with the reduced disclosure format.**

 

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

**OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008**

 

**OR**

 

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

**OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

** **

**Commission file number: 000-31248**

 

**ALLSTATELIFE INSURANCE COMPANY**

**(Exact name of registrant as 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 areacode:  (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 theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.**

**                                                                                                Yes****x****   No****o**

 

**Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company.  Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.  (Check one):**

 

| **Large accelerated filer****o** | ** ** | **Accelerated filer****o** | **Non-accelerated filer****x**                    | ** ** | **Smaller reporting company****o** |
|----------------------------------|------------|----------------------------|---------------------------------------------------|------------|------------------------------------|
| ** **                       | ** ** | ** **                 | **(Do not check if a smaller reporting company)** |

 

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

**Yes****o****    No****x**

 

**As of November 11, 2008, the registrant had 23,800common shares, $227 par value, outstanding, all of which are held by AllstateInsurance Company.**

 

 

** **

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**ALLSTATE LIFE INSURANCE COMPANY**

**INDEX TO QUARTERLY REPORT ON FORM 10-Q**

##### **September 30, 2008**

 
| **PART I**  | **FINANCIAL INFORMATION**                                                                                                                       | **PAGE**   |
|------------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|             |                                                                                                                                            |       |
| Item  1.         | Financial  Statements                                                                                                                           |       |
|             |                                                                                                                                            |       |
|             | Condensed  Consolidated Statements of Operations for the Three-Month and Nine-Month  Periods Ended September 30, 2008 and 2007 (unaudited) | 1          |
|             |                                                                                                                                            |       |
|             | Condensed  Consolidated Statements of Financial Position as of September 30, 2008  (unaudited) and December 31, 2007                  | 2          |
|             |                                                                                                                                            |       |
|             | Condensed  Consolidated Statements of Cash Flows for the Nine-Month Periods Ended  September 30, 2008 and 2007 (unaudited)                 | 3          |
|             |                                                                                                                                            |       |
|             | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                               | 4          |
|             |                                                                                                                                            |       |
|             | Report  of Independent Registered Public Accounting Firm                                                                                        | 21         |
|             |                                                                                                                                            |       |
| Item  2.         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                     | 22         |
|             |                                                                                                                                            |       |
| Item  4.         | Controls  and Procedures                                                                                                                        | 67         |
|             |                                                                                                                                            |       |
| **PART II** | **OTHER INFORMATION**                                                                                                                           | ** ** |
|             |                                                                                                                                            |       |
| Item  1.         | Legal  Proceedings                                                                                                                              | 68         |
|             |                                                                                                                                            |       |
| Item  1A.        | Risk  Factors                                                                                                                                   | 68         |
|             |                                                                                                                                            |       |
| Item  5.         | Other  Information                                                                                                                              | 69         |
|             |                                                                                                                                            |       |
| Item  6.         | Exhibits                                                                                                                                        | 69         |

 

----

 

##### **PART I. FINANCIAL INFORMATION**

**ITEM 1.FINANCIAL STATEMENTS**

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                             | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                          | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                             | ** ** | (Unaudited)                                          | ** ** | (Unaudited)                                         | ** ** |
| **Revenues**                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums                                                               |       | $                                                    | 138        |                                                | $          | 104 |   | $ | 425 |   | $ | 381 |   |
| Contract charges                                                       |       | 228                                                  |       | 236                                                 |       | 665 |   | 694 |   |
| Net investment income                                                  |       | 912                                                  |       | 1,062                                               |       | 2,826 |   | 3,145 |   |
| Realized capital gains and losses                                      |       | (568                                                 | )          | (128                                                | )          | (1,928 | ) | (2 | ) |
|                                                                   |       | 710                                                  |       | 1,274                                               |       | 1,988 |   | 4,218 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| **Costs and expenses**                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Contract benefits                                                      |       | 361                                                  |       | 315                                                 |       | 1,045 |   | 1,020 |   |
| Interest credited to contractholder funds                              |       | 573                                                  |       | 672                                                 |       | 1,732 |   | 1,967 |   |
| Amortization of deferred policy acquisition  costs                     |       | (26                                                  | )          | 129                                                 |       | (32 | ) | 410 |   |
| Operating costs and expenses                                           |       | 106                                                  |       | 84                                                  |       | 297 |   | 243 |   |
|                                                                   |       | 1,014                                                |       | 1,200                                               |       | 3,042 |   | 3,640 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Gain (loss) on disposition of operations                               |       | 2                                                    |       | 6                                                   |       | (7 | ) | 9 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| **(Loss) income from operations before income  tax (benefit) expense** |       | (302                                                 | )          | 80                                                  |       | (1,061 | ) | 587 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Income tax (benefit) expense                                           |       | (118                                                 | )          | 24                                                  |       | (394 | ) | 195 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| **Net (loss) income**                                                  |       | $                                                    | (184       | )                                                   | $          | 56 |   | $ | (667 | ) | $ | 392 |   |

 

See notes to condensed consolidated financial statements.

 

1

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF FINANCIAL POSITION**

** **
| ** **                                                                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **($ in millions, except par value data)**                              | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| ** **                                                                                            | ** ** | (Unaudited)            | ** ** | ** **            | ** ** |
| **Assets**                                                                                            |       |                   |       |                  |       |
| Investments                                                                                           |       |                   |       |                  |       |
| Fixed income securities, at fair value  (amortized cost $51,091 and $58,020)                          |       | $                      | 48,071     |                  | $          | 58,469 |   |
| Mortgage loans                                                                                        |       | 10,234                 |       | 9,901                 |       |
| Equity securities, at fair value (cost $116  and $102)                                                |       | 108                    |       | 102                   |       |
| Limited partnership interests                                                                         |       | 1,184                  |       | 994                   |       |
| Short-term                                                                                            |       | 3,045                  |       | 386                   |       |
| Policy loans                                                                                          |       | 809                    |       | 770                   |       |
| Other                                                                                                 |       | 1,363                  |       | 1,792                 |       |
|                                                                                                  |       |                   |       |                  |       |
| Total investments                                                                                     |       | 64,814                 |       | 72,414                |       |
|                                                                                                  |       |                   |       |                  |       |
| Cash                                                                                                  |       | 113                    |       | 185                   |       |
| Deferred policy acquisition costs                                                                     |       | 5,949                  |       | 3,905                 |       |
| Reinsurance recoverables                                                                              |       | 3,519                  |       | 3,410                 |       |
| Accrued investment income                                                                             |       | 620                    |       | 652                   |       |
| Other assets                                                                                          |       | 1,607                  |       | 622                   |       |
| Deferred income taxes                                                                                 |       | 285                    |       | —                |       |
| Separate Accounts                                                                                     |       | 10,603                 |       | 14,929                |       |
|                                                                                                  |       |                   |       |                  |       |
| **Total assets**                                                                                      |       | $                      | 87,510     |                  | $          | 96,117 |   |
|                                                                                                  |       |                   |       |                  |       |
| **Liabilities**                                                                                       |       |                   |       |                  |       |
| Contractholder funds                                                                                  |       | $                      | 57,790     |                  | $          | 60,464 |   |
| Reserve for life-contingent contract  benefits                                                        |       | 12,141                 |       | 12,598                |       |
| Unearned premiums                                                                                     |       | 31                     |       | 33                    |       |
| Payable to affiliates, net                                                                            |       | 109                    |       | 206                   |       |
| Other liabilities and accrued expenses                                                                |       | 2,404                  |       | 2,823                 |       |
| Deferred income taxes                                                                                 |       | —                 |       | 101                   |       |
| Surplus notes due to related parties                                                                  |       | 650                    |       | 200                   |       |
| Separate Accounts                                                                                     |       | 10,603                 |       | 14,929                |       |
|                                                                                                  |       |                   |       |                  |       |
| **Total liabilities**                                                                                 |       | 83,728                 |       | 91,354                |       |
|                                                                                                  |       |                   |       |                  |       |
| **Commitments and Contingent Liabilities  (Note 6)**                                                  |       |                   |       |                  |       |
|                                                                                                  |       |                   |       |                  |       |
| **Shareholder’s Equity**                                                                         |       |                   |       |                  |       |
| Redeemable preferred stock – series A, $100  par value, 1,500,000 shares authorized, none issued |       | —                 |       | —                |       |
| Redeemable preferred stock – series B, $100  par value, 1,500,000 shares authorized, none issued |       | —                 |       | —                |       |
| Common stock, $227 par value, 23,800 shares  authorized and outstanding                               |       | 5                      |       | 5                     |       |
| Additional capital paid-in                                                                            |       | 1,475                  |       | 1,108                 |       |
| Retained income                                                                                       |       | 3,089                  |       | 3,734                 |       |
| Accumulated other comprehensive loss:                                                                 |       |                   |       |                  |       |
| Unrealized net capital gains and losses                                                               |       | (787                   | )          | (84                   | )          |
|                                                                                                  |       |                   |       |                  |       |
| **Total accumulated other comprehensive loss**                                                        |       | (787                   | )          | (84                   | )          |
|                                                                                                  |       |                   |       |                  |       |
| **Total shareholder’s equity**                                                                   |       | 3,782                  |       | 4,763                 |       |
|                                                                                                  |       |                   |       |                  |       |
| **Total liabilities and shareholder’s equity**                                                   |       | $                      | 87,510     |                  | $          | 96,117 |   |

 

See notes to condensed consolidated financial statements.

 

2

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| ** **                                                                         | ** ** | **Nine months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**          | ** ** |
| **($ in millions)**                                                      | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| ** **                                                                         | ** ** | (Unaudited)                     | ** ** |
| **Cash flows from operating activities**                       |       |                            |       |   |   |   |   |
| Net (loss) income                                                                  |       | $                               | (667       | ) | $ | 392 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                            |       |   |   |
| Amortization and other non-cash items                                              |       | (313                            | )          | (218 | ) |
| Realized capital gains and losses                                                  |       | 1,928                           |       | 2 |   |
| Loss (gain) on disposition of operations                                           |       | 7                               |       | (9 | ) |
| Interest credited to contractholder funds                                          |       | 1,732                           |       | 1,967 |   |
| Changes in:                                                                        |       |                            |       |   |   |
| Contract benefit and other insurance  reserves                                     |       | (435                            | )          | (190 | ) |
| Unearned premiums                                                                  |       | (2                              | )          | (2 | ) |
| Deferred policy acquisition costs                                                  |       | (486                            | )          | 11 |   |
| Reinsurance recoverables, net                                                      |       | (59                             | )          | (212 | ) |
| Income taxes                                                                       |       | (277                            | )          | 68 |   |
| Other operating assets and liabilities                                             |       | 30                              |       | (5 | ) |
| Net cash provided by operating activities                                          |       | 1,458                           |       | 1,804 |   |
|                                                                               |       |                            |       |   |   |
| **Cash flows from investing activities**                                           |       |                            |       |   |   |
| Proceeds from sales:                                                               |       |                            |       |   |   |
| Fixed income securities                                                            |       | 8,617                           |       | 8,774 |   |
| Equity securities                                                                  |       | 120                             |       | 48 |   |
| Limited partnerships                                                               |       | 76                              |       | 155 |   |
| Mortgage loans                                                                     |       | 205                             |       | — |   |
| Other investments                                                                  |       | 131                             |       | 112 |   |
| Investment collections:                                                            |       |                            |       |   |   |
| Fixed income securities                                                            |       | 1,814                           |       | 2,289 |   |
| Mortgage loans                                                                     |       | 575                             |       | 1,234 |   |
| Other investments                                                                  |       | 77                              |       | 329 |   |
| Investment purchases:                                                              |       |                            |       |   |   |
| Fixed income securities                                                            |       | (5,112                          | )          | (10,685 | ) |
| Equity securities                                                                  |       | (130                            | )          | (80 | ) |
| Limited partnerships                                                               |       | (322                            | )          | (511 | ) |
| Mortgage loans                                                                     |       | (1,112                          | )          | (2,064 | ) |
| Other investments                                                                  |       | (102                            | )          | (577 | ) |
| Change in short-term investments, net                                              |       | (2,878                          | )          | 138 |   |
| Change in other investments, net                                                   |       | (295                            | )          | 52 |   |
| Net cash provided by (used in) investing  activities                               |       | 1,664                           |       | (786 | ) |
|                                                                               |       |                            |       |   |   |
| **Cash flows from financing activities**                                           |       |                            |       |   |   |
| Issuance of surplus notes to related  parties                                      |       | 400                             |       | — |   |
| Note payable to parent                                                             |       | —                          |       | (500 | ) |
| Redemption of redeemable preferred stock                                           |       | —                          |       | (11 | ) |
| Contractholder fund deposits                                                       |       | 8,249                           |       | 6,630 |   |
| Contractholder fund withdrawals                                                    |       | (11,843                         | )          | (7,193 | ) |
| Dividends paid                                                                     |       | —                          |       | (85 | ) |
| Net cash used in financing activities                                              |       | (3,194                          | )          | (1,159 | ) |
| ** **                                                                         |       |                            |       |   |   |
| **Net decrease in cash**                                                           |       | (72                             | )          | (141 | ) |
| **Cash at beginning of the period**                                                |       | 185                             |       | 273 |   |
| **Cash at end of period**                                                          |       | $                               | 113        |   | $ | 132 |   |

 

See notes to condensed consolidated financial statements.

 

3

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**ALLSTATE LIFE INSURANCE COMPANY ANDSUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.  General**

 

**Basis of presentation**

 

The accompanying condensed consolidatedfinancial statements include the accounts of Allstate Life Insurance Company (“ALIC”)and its wholly owned subsidiaries (collectively referred to as the “Company”).ALIC is wholly owned by Allstate Insurance Company (“AIC”), a wholly ownedsubsidiary of The Allstate Corporation (the “Corporation”).

 

The condensed consolidated financial statements and notes as of September 30,2008, and for the three-month and nine-month periods ended September 30,2008 and 2007 are unaudited.  Thecondensed consolidated financial statements reflect all adjustments (consistingonly of normal recurring accruals), which are, in the opinion of management,necessary for the fair presentation of the financial position, results ofoperations and cash flows for the interim periods.  These condensed consolidated financialstatements and notes should be read in conjunction with the consolidatedfinancial statements and notes thereto included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2007.  The results of operations for the interimperiods should not be considered indicative of results to be expected for thefull year.

 

To conform to the 2008 presentation, certainamounts in the prior year condensed consolidated financial statements and noteshave been reclassified.

 

**Premiums and Contract Charges**

 

The following table summarizes premiums andcontract charges by product.

 
| ** **                                  | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **($ in millions)**               | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Premiums**                                |       |                             |       |                            |       |   |   |   |   |
| Traditional life insurance (1)              |       | $                                | 90         |                            | $          | 62 |   | $ | 271 |   | $ | 192 |   |
| Immediate annuities with life contingencies |       | 25                               |       | 32                              |       | 91 |   | 161 |   |
| Accident, health and other                  |       | 23                               |       | 10                              |       | 63 |   | 28 |   |
| Total premiums                              |       | 138                              |       | 104                             |       | 425 |   | 381 |   |
|                                        |       |                             |       |                            |       |   |   |   |   |
| **Contract charges**                        |       |                             |       |                            |       |   |   |   |   |
| Interest-sensitive life insurance (1)       |       | $                                | 215        |                            | $          | 217 |   | $ | 625 |   | $ | 637 |   |
| Fixed annuities                             |       | 13                               |       | 19                              |       | 39 |   | 56 |   |
| Variable annuities                          |       | —                           |       | —                          |       | 1 |   | 1 |   |
| Total contract charges                      |       | 228                              |       | 236                             |       | 665 |   | 694 |   |
| Total premiums and contract charges         |       | $                                | 366        |                            | $          | 340 |   | $ | 1,090 |   | $ | 1,075 |   |

 

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(1)   Beginning in 2008, certain ceded reinsurancepremiums previously included as a component of traditional life insurancepremiums were reclassified prospectively to be reported as a component ofinterest-sensitive life insurance contract charges.  For the three months and nine months ended September 30,2007, these ceded reinsurance premiums were $25 million and $64 million,respectively.

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4

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**Adopted accounting standards**

 

*Statement ofPosition 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 of Certified Public Accountants (“AICPA”) issued SOP05-1.  SOP 05-1 provides accountingguidance for deferred policy acquisition costs (“DAC”) associated with internalreplacements of insurance and investment contracts other than those set forthin Statement of Financial Accounting Standards (“SFAS”) No. 97, “Accountingand Reporting by Insurance Enterprises for Certain Long-Duration Contracts andfor Realized Gains and Losses from the Sale of Investments”.  SOP 05-1 defines an internal replacement as amodification in product benefits, features, rights or coverages that occursthrough the exchange of an existing contract for a new contract, or byamendment, endorsement or rider to an existing contract, or by the election ofa feature or coverage within an existing contract.  The Company adopted the provisions of SOP 05-1on January 1, 2007 for internal replacements occurring in fiscal yearsbeginning after December 15, 2006. The adoption resulted in an $8 million after-tax reduction to retainedincome to reflect the impact on estimated future gross profits (“EGP”) from thechanges in accounting for certain costs associated with contract continuationsthat no longer qualify for deferral under SOP 05-1 and a reduction of DAC anddeferred sales inducement balances of $13 million pre-tax as of January 1,2007.

 

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

 

In February 2006, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 155, which permitsfair value remeasurement at the date of adoption of any hybrid financial instrumentcontaining an embedded derivative that otherwise would require bifurcationunder paragraph 12 or 13 of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities*”***(“SFASNo. 133”); clarifies which interest-only strips and principal-only stripsare not subject to the requirements of SFAS No. 133; establishes arequirement to evaluate interests in securitized financial assets to identifyinterests that are freestanding derivatives or hybrid financialinstruments that contain embedded derivatives requiring bifurcation; andclarifies that concentrations ofcredit risk in the form of subordination are not embedded derivatives.  The Company adopted the provisions of SFAS No. 155on January 1, 2007, which were effective for all financial instrumentsacquired, issued or subject to a remeasurement event occurring after thebeginning of the first fiscal year after September 15, 2006.  The Company elected not to remeasure existinghybrid financial instruments that contained embedded derivatives requiringbifurcation at the date of adoption pursuant to paragraph 12 or 13 of SFAS No. 133.  The adoption of SFAS No. 155 did nothave a material effect on the results of operations or financial position ofthe Company.

 

*FASB Interpretation No. 48, Accountingfor Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109and FASB Staff Position No. FIN 48-1, Definition of Settlement in FASBInterpretation No. 48 (collectively “FIN 48”)*

 

The FASB issued the interpretation in July 2006 and the relatedstaff position in May 2007.  FIN 48clarifies the accounting for uncertainty in income taxes recognized in anentity’s financial statements in accordance with SFAS No. 109, “Accountingfor Income Taxes”.  FIN 48 requires anentity to recognize the tax benefit of uncertain tax positions only when it ismore likely than not, based on the position’s technical merits, that theposition would be sustained upon examination by the respective taxingauthorities.  The tax benefit is measuredas the largest benefit that is more than fifty-percent likely of being realizedupon final settlement with the respective taxing authorities. On January 1,2007, the Company adopted the provisions of FIN 48, which were effective forfiscal years beginning after December 15, 2006.  No cumulative effect of a change inaccounting principle or adjustment to the liability for unrecognized taxbenefits was recognized as a result of the adoption of FIN 48.  Accordingly, the adoption of FIN 48 did nothave an effect on the results of operations or financial position of theCompany.

 

5

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*Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 109,Written Loan Commitments That are Recorded At Fair Value Through Earnings (“SAB109”)*

 

InOctober 2007, the SEC issued SAB 109, a replacement of SAB 105, “Applicationof Accounting Principles to Loan Commitments”. SAB 109 is applicable to both loan commitments accounted for under SFAS No. 133,and other loan commitments for which the issuer elects fair value accountingunder SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities”.  SAB 109 statesthat the expected net future cash flows related to the servicing of a loanshould be included in the fair value measurement of a loan commitment accountedfor at fair value through earnings.  Theexpected net future cash flows associated with loan servicing should bedetermined in accordance with the guidance in SFAS No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities”, as amended by SFAS No. 156, “Accounting for Servicing ofFinancial Assets”.  SAB 109 should beapplied on a prospective basis to loan commitments accounted for under SFAS No. 133that were issued or modified in fiscal quarters beginning after December 15,2007.  Earlier adoption was notpermitted.  The adoption of SAB 109 didnot have a material impact on the Company’s results of operations or financialposition.

 

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

 

In September 2006, the FASB issued SFAS No. 157, whichredefines fair value as the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants at the measurement date, establishes a framework for measuringfair value in accounting principles generally accepted in the United States ofAmerica (“GAAP”), and expands disclosures about fair value measurements.  SFAS No. 157 establishes a three-levelhierarchy for fair value measurements based upon the nature of the inputs tothe valuation of an asset or liability. SFAS No. 157 applies where other accounting pronouncements requireor permit fair value measurements.  InFebruary 2008, the FASB issued FASB Staff Position No. 157-2, “EffectiveDate of FASB Statement No. 157” (“FSP FAS 157-2”), which permits thedeferral of the effective date of SFAS No. 157 to fiscal years beginningafter November 15, 2008 for all non-financial assets and liabilities,except those that are recognized or disclosed at fair value in the financialstatements on a recurring basis.  TheCompany adopted the provisionsof SFAS No. 157 for financial assets and liabilities recognized ordisclosed at fair value on a recurring and non-recurring basis as of January 1,2008.  Consistent with the provisions ofFSP FAS 157-2, the Company decided to defer the adoption of SFAS No. 157 fornon-financial assets and liabilities measured at fair value on a non-recurringbasis until January 1, 2009.  In October 2008, the FASB issued FASBStaff Position No. FAS 157–3, “Determining the Fair Value of a FinancialAsset When the Market for That Asset Is Not Active” (“FSP FAS 157–3”), whichclarifies the application of SFAS 157 in a market that is not active.  The Company adopted the provisions of FSP FAS157–3 as of September 30, 2008.  Theadoption of SFAS No. 157 and FSP FAS 157-3 did not have a material effecton the Company’s results of operations or financial position (see Note 4).

 

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

 

InFebruary 2007, the FASB issued SFAS No. 159 which provides reportingentities, on an ongoing basis, an option to report selected financial assets,including investment securities, and financial liabilities, including mostinsurance contracts, at fair value through earnings.  SFAS No. 159 establishes presentationand disclosure requirements designed to facilitate comparisons betweencompanies that choose different measurement alternatives for similar types offinancial assets and liabilities.  Thestandard also requires additional information to aid financial statement users’understanding of the impacts of a reporting entity’s decision to use fair valueon its earnings and requires entities to display, on the face of the statementof financial position, the fair value of those assets and liabilities for whichthe reporting entity has chosen to measure at fair value.  SFAS No. 159 was effective as of thebeginning of a reporting entity’s first fiscal year beginning after November 15,2007.  The Company did not apply the fair value option to any existingfinancial assets or liabilities as of January 1, 2008.  Consequently, the initial adoption of SFAS No. 159had no impact on the Company’s results of operations or financial position.

 

6

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*FASB Staff Position  No. FIN39-1, Amendment of FASB Interpretation No. 39 (“FSP FIN 39-1”)*

 

InApril 2007, the FASB issued FSP FIN 39-1, which amends FASB InterpretationNo. 39, “Offsetting of Amounts Related to Certain Contracts”.  FSP FIN 39-1 replaces the terms “conditionalcontracts” and “exchange contracts” with the term “derivative instruments” andrequires a reporting entity to offset fair value amounts recognized for theright to reclaim cash collateral or the obligation to return cash collateralagainst fair value amounts recognized for derivative instruments executed withthe same counterparty under the same master netting arrangement that have beenoffset in the statement of financial position. FSP FIN 39-1 was effective forfiscal years beginning after November 15, 2007, with early adoptionpermitted.  The adoption of FSP FIN 39-1did not have a material impact on the Company’s results of operations orfinancial position.

 

## **Pending accounting standards**

## ** **

*SFAS No. 141(R), BusinessCombinations (“SFAS No. 141R”)*

 

InDecember 2007, the FASB issued SFAS No. 141R which replaces SFAS No. 141,“Business Combinations” (“SFAS No. 141”). Among other things, SFAS No. 141R broadens the scope of SFAS No. 141to include all transactions where an acquirer obtains control of one or moreother businesses; retains the guidance to recognize intangible assets separatelyfrom goodwill; requires, with limited exceptions, that all assets acquired andliabilities assumed, including certain of those that arise from contractualcontingencies, be measured at their acquisition date fair values; requires mostacquisition and restructuring-related costs to be expensed as incurred;requires that step acquisitions, once control is acquired, be recorded at thefull amounts of the fair values of the identifiable assets, liabilities and thenoncontrolling interest in the acquiree; and replaces the reduction of assetvalues and recognition of negative goodwill with a requirement to recognize again in earnings.  The provisions of SFASNo. 141R are effective for fiscal years beginning after December 15,2008 and are to be applied prospectively only. Early adoption is not permitted. The Company will apply the provisionsof SFAS No. 141R as required when effective.

 

*SFAS No. 160, Noncontrolling Interests in Consolidated FinancialStatements — an amendment of ARB No. 51 (“SFAS No. 160”)*

 

InDecember 2007, the FASB issued SFAS No. 160 which clarifies that anoncontrolling interest in a subsidiary is that portion of the subsidiary’sequity that is attributable to owners of the subsidiary other than its parentor parent’s affiliates.  Noncontrollinginterests are required to be reported as equity in the consolidated financialstatements and as such net income will include amounts attributable to both theparent and the noncontrolling interest with disclosure of the amountsattributable to each on the face of the consolidated statement ofoperations.  SFAS No. 160 requiresthat all changes in a parent’s ownership interest in a subsidiary when controlof the subsidiary is retained, be accounted for as equity transactions.  In contrast, when control over a subsidiaryis relinquished and the subsidiary is deconsolidated, SFAS No. 160requires a parent to recognize a gain or loss in net income as well as providecertain associated expanded disclosures. SFAS No. 160 is effective as of the beginning of a reporting entity’sfirst fiscal year beginning after December 15, 2008.  Early adoption is prohibited.  SFAS No. 160 requires prospectiveapplication as of the beginning of the fiscal year in which the standard isinitially applied, except for the presentation and disclosure requirementswhich are to be applied retrospectively for all periods presented.  The adoption of SFAS No. 160 is notexpected to have a material effect on the Company’s results of operations orfinancial position.

 

*SFAS No. 161, Disclosures about Derivative Instruments and HedgingActivities — an amendment of FASB Statement No. 133 (“SFAS No. 161”)*

 

InMarch 2008, the FASB issued SFAS No. 161, which amends and expandsthe disclosure requirements for derivatives currently accounted for inaccordance with SFAS No. 133.  The new disclosures are designed toenhance the understanding of how and why an entity uses derivative instrumentsand how derivative instruments affect an entity’s financial position, resultsof operations, and cash flows.  The standard requires, on a quarterlybasis, quantitative disclosures about the potential cash outflows associatedwith the triggering of credit-related contingent features, if any; tabulardisclosures about the classification and fair value amounts of derivativeinstruments reported in the statement of financial position; disclosure of thelocation and amount of gains and losses on derivative instruments reported inthe statement of operations; and qualitative information about how and why an entityuses derivative instruments and how derivative instruments and related hedgeditems affect the entity’s financial statements.  SFAS No. 161 iseffective for fiscal periods beginning after November 15, 2008, and is tobe applied on a prospective basis only.  SFAS No. 161 affectsdisclosures and therefore will not impact the Company’s results of operationsor financial position.

 

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*FASB Staff Position No. FAS133–1 and FIN 45–4, Disclosures about Credit Derivatives and CertainGuarantees: An Amendment of FASB Statement No. 133 and FASB InterpretationNo. 45; and Clarification of the Effective Date of FASB Statement No. 161(“FSP FAS 133–1 and FIN 45–4”)*

 

InSeptember 2008, the FASB issued FSP FAS 133–1 and FIN 45–4, which amendsSFAS No. 133, and FIN 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” (“FIN 45”), to both enhance and synchronize the disclosure requirementsof the two statements with respect to the potential for adverse effects ofchanges in credit risk on the financial statements of the sellers of creditderivatives and certain guarantees.  SFASNo. 133 was amended to require disclosures by sellers of credit derivatives,including credit derivatives embedded in a hybrid instrument.  FIN 45 was amended to require an additionaldisclosure about the current status of the payment/performance risk of aguarantee.  The FSP clarifies the FASB’sintent that the disclosures required by SFAS No. 161 should be providedfor any reporting period (annual or quarterly interim) beginning after November 15,2008.  The provisions of this FASB StaffPosition that amend SFAS No. 133 and FIN 45 are effective for reportingperiods ending after November 15, 2008; therefore, the disclosurerequirements which have no impact to the Company’s results of operations orfinancial position, will be adopted at December 31, 2008.

 

**2.    Related Party Transactions**

 

**Investment purchases**

 

In September 2008, in accordance with two sale agreements with itsparent AIC, the Company purchased investments from AIC.  The Company paid $944 million in cash for theinvestments, which included mortgage loans and privately placed corporate fixedincome securities with a fair value on the date of sale of $613 million and$325 million, respectively, and $6 million of accrued investment income.  Since the transaction was between affiliatesunder common control, the mortgage loans were recorded at the outstandingprincipal balance, net of unamortized premium or discount, on the date of saleof $634 million and the privately placed corporate fixed income securities wererecorded at the amortized cost basis on the date of sale of $338 million.  The difference between the fair value and theoutstanding principal balance, net of unamortized premium or discount, for themortgage loans, and the amortized cost basis for the privately placed corporatefixed income securities, on the date of sale, was recorded as an increase toretained income of $22 million after-tax ($34 million pre-tax).

 

**Capital contributions**

 

In June 2008, the Company received a capital contribution from itsparent AIC of $349 million, which was recorded as additional capital paid-in onthe Condensed Consolidated Statements of Financial Position.  The capital contribution included fixedincome securities of $337 million, accrued investment income of $5 million andcash of $7 million.

 

The Company and AIC have a Capital Support Agreement that went intoeffect in 2007.  Under the terms of thisagreement, AIC agrees to provide capital to maintain the amount of statutorycapital and surplus necessary to maintain a company action level risk-basedcapital (“RBC”) ratio of at least 150%. AIC’s obligation to provide capital to the Company under the agreementis limited to an aggregate amount of $1 billion.  Discretionary capital contributions made byAIC outside of the terms of this agreement, including the $349 millioncontribution made in June 2008, do not reduce AIC’s $1 billionobligation.  In exchange for providingthis capital, the Company will pay AIC an annual commitment fee of 1% of theamount of the Capital and Surplus maximum that remains available on January 1of such year.  The Company or AIC havethe right to terminate this agreement when: 1) the Company qualifies for afinancial strength rating from Standard and Poor’s, Moody’s or A.M. Best,without giving weight to the existence of this agreement, that is the same orbetter than its rating with such support; 2) the Company’s RBC ratio is atleast 300%; or 3) AIC no longer directly or indirectly owns at least 50% of thevoting stock of the Company.  At September 30,2008, no capital had been provided by AIC under this agreement.

 

8

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**Reinsurance transactions**

 

Effective January 1,2008, the Company’s coinsurance reinsurance agreement with its unconsolidatedaffiliate American Heritage Life Insurance Company (“AHL”), which went intoeffect in 2004, was amended to include the assumption by the Company of certainaccident and health insurance policies. In accordance with this amendment, the Company recorded cash of $16million, premium installment receivables of $5 million, DAC of $32 million,reserves for life-contingent contract benefits of $24 million and accruedliabilities of $2 million.  Since theCompany received assets in excess of net liabilities from an affiliate undercommon control, the Company recognized a gain of $27 million ($18 millionafter-tax), which was recorded as a non-cash capital contribution resulting inan increase to additional capital paid-in on the Company’s CondensedConsolidated Statements of Financial Position.

 

**Debt**

 

On August 29, 2008, theCompany issued a surplus note to AIC with a principal sum of $400 million inexchange for cash.  This surplus noteaccrues interest at a rate of 7.50% annually, which is due on the first day of April andOctober in each year beginning 2009 until maturity on August 29,2028.  The payment of interest and principalis subject to prior written approval from the Director of Insurance of theState of Illinois and can only be paid out of the Company’s statutory-basissurplus that is in excess of certain amounts specified in the surplusnote.  This surplus note is included as acomponent of surplus notes due to related parties on the Condensed ConsolidatedStatements of Financial Position.  Duringthe three months and nine months ended September 30, 2008, the Companyrecorded interest expense on this surplus note of $3 million, which is includedas a component of operating costs and expenses on the Condensed ConsolidatedStatements of Operations.

 

Under an existing agreement with KennettCapital, Inc. (“Kennett”), an unconsolidated affiliate of ALIC, ALIC soldKennett on June 30, 2008 a $50 million redeemable surplus note issued on May28, 2008 by ALIC Reinsurance Company (“ALIC Re”), a wholly owned subsidiary ofALIC.  The surplus note is due June 1,2038 with an initial rate of 5.93% that will reset every ten years to the thencurrent ten year Constant Maturity Treasury yield (“CMT”), plus 2.09%.   As payment, Kennett issued on June 30, 2008 afull recourse note due June 1, 2038 to ALIC for the same amount with aninitial interest rate of 5.73% that will reset every ten years to the thencurrent ten year CMT, plus 1.89%.  Thenote due from Kennett is classified as other investments and the relatedsurplus note is classified as surplus notes due to related parties in theCondensed Consolidated Statements of Financial Position.  During the three months and ninemonths ended September 30, 2008, the Company recorded interest expense onthis surplus note of $1 million, which is included as a component of operatingcosts and expenses on the Condensed Consolidated Statements of Operations.  Additionally, during the three months andnine months ended September 30, 2008, the company recorded net investmentincome on the note due from Kennett of $1 million.

 

Effective May 8, 2008, the Company, AIC and the Corporationentered into a one-year Amended and Restated Intercompany Liquidity Agreement (“LiquidityAgreement”) replacing the Intercompany Liquidity Agreement between the Companyand AIC, dated January 1, 2008.  Theagreement allows for short-term advances of funds to be made between partiesfor liquidity and other general corporate purposes. It shall be automaticallyrenewed for subsequent one-year terms unless terminated by the parties.  The Liquidity Agreement does not establish acommitment to advance funds on the part of either party.  The Company and AIC each serve as a lenderand borrower and the Corporation serves only as a lender.  The maximum amount of advances each party maymake or receive is limited to $1 billion. Netting or offsetting of advances made and received is notpermitted.  Advances between the partiesare required to have specified due dates less than or equal to 364 days fromthe date of the advance and be payable upon demand by written request from thelender at least ten business days prior to the demand date.  The borrower may make prepayments of theoutstanding principal balance of an advance without penalty. Advances will bearinterest equal to or greater than the rate applicable to 30-day commercialpaper issued by the Corporation on the date the advance is made with anadjustment on the first day of each month thereafter.

 

9

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**3.    Supplemental Cash FlowInformation**

 

Non-cash investment exchanges andmodifications, which primarily reflect refinancings of fixed income securitiesand mergers completed with equity securities and limited partnerships, totaled$9 million and $72 million for the nine-month periods ended September 30,2008 and 2007, respectively.

 

Liabilities for collateral received inconjunction with the Company’s securities lending and other business activitiesand for funds received from the Company’s security repurchase businessactivities are reported in either other liabilities and accrued expenses orother investments in the Condensed Consolidated Statements of FinancialPosition. As permitted under FSP FIN 39-1, the amount of cash collateral nettedand reclassified to other investments against the net derivative positions was$115 million as of September 30, 2008. The accompanying cash flows are included in cash flows from operatingactivities in the Condensed Consolidated Statements of Cash Flows along withthe activities resulting from management of the proceeds, which are as follows:

 
| ** **                                                             | ** ** | **Nine months ended** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                             | ** ** | **September 30,**          | ** ** |
| **($ in millions)**                                          | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| Net change in fixed income securities                                  |       | $                               | 314        |   | $ | (400 | ) |
| Net change in short-term investments                                   |       | 274                             |       | (34 | ) |
| Operating cash flow provided (used)                                    |       | $                               | 588        |   | $ | (434 | ) |
|                                                                   |       |                            |       |   |   |
| Liabilities for collateral and security  repurchase, beginning of year |       | $                               | (1,817     | ) | $ | (2,294 | ) |
| Liabilities for collateral and security  repurchase, end of period     |       | (1,229                          | )          | (2,728 | ) |
| Operating cash flow (used) provided                                    |       | $                               | (588       | ) | $ | 434 |   |

 

**4. Fair Value of Financial Assets and Financial Liabilities**

 

Themeasurement basis for a significant amount of the Company’s financial assets isfair value. Financial instruments measured at fair value on a recurring basisinclude:

 

*Financial Assets*   Primarily investments including U.S.treasuries, U.S. equities, international equities, money market funds,corporates, municipals, U.S. government and agencies, commercialmortgage-backed securities (“CMBS”), preferred stock,  mortgage-backed securities (“MBS”), foreigngovernments, asset-backed securities (“ABS”), commercial paper, derivatives(exchange traded and over-the-counter (“OTC”)), and separate account assets.

 

*Financial Liabilities*   Primarily free-standingderivatives (exchange listed and OTC) and derivatives embedded in certaincontractholder liabilities.

 

Financialinstruments measured at fair value on a non–recurring basis include:

 

*Financial Assets*   Primarily mortgage loans and otherinvestments written-down to fair value in connection with recognizing other–than–temporaryimpairments.

 

TheCompany adopted the provisions of SFAS No. 157 as of January 1, 2008for its financial assets and financial liabilities that are measured at fairvalue.  SFAS No. 157:

 

·                  Defines fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date, andestablishes a framework for measuring fair value;

 

·                  Establishes a three-level hierarchy for fairvalue measurements based upon the transparency of inputs to the valuation as ofthe measurement date;

 

·                  Expands disclosures about financialinstruments measured at fair value.

 

In determining fair value, the Company principallyuses the market approach which generally utilizes market transaction data forthe same or similar instruments.  To alesser extent, the Company uses the income approach 

 

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whichinvolves determining fair values from discounted cash flow methodologies.  SFAS No. 157 establishes a hierarchy forinputs used in determining fair value that maximizes the use of observableinputs and minimizes the use of unobservable inputs by requiring thatobservable inputs be used when available.

 

Observableinputs are those used by market participants in valuing financial instrumentsthat are developed based on market data obtained from independent sources.  In the absence of sufficient observableinputs, unobservable inputs reflect the Company’s estimates of the assumptionsmarket participants would use in valuing financial assets and financialliabilities and are developed based on the best information available in thecircumstances.  The Company uses pricesand inputs that are current as of the measurement date, including duringperiods of market disruption.  In periodsof market disruption, the ability to observe prices and inputs may be reducedfor many instruments.  This conditioncould cause an instrument to be reclassified from Level 1 to Level 2, or fromLevel 2 to Level 3.

 

Financialassets and financial liabilities recorded on the Condensed ConsolidatedStatements of Financial Position at fair value as of September 30, 2008are categorized in the fair value hierarchy based on the reliability of inputsto the valuation techniques as follows:

 

*Level 1:**    *Financial assets and financial liabilitieswhose values are based on unadjusted quoted prices for identical assets orliabilities in an active market that the Company can access.

 

*Level 2:***    **Financial assets and financial liabilitieswhose values are based on the following:

 

a)              Quoted prices for similar assets orliabilities in active markets;

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

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

 

*Level 3:*Financialassets and financial liabilities whose values are based on prices or valuationtechniques that require inputs that are both unobservable and significant tothe overall fair value measurement. These inputs reflect the Company’s estimates of the assumptions thatmarket participants would use in valuing the financial assets and financialliabilities.

 

Theavailability of observable inputs varies by instrument. In situations wherefair value is based on internally developed pricing models or inputs that areunobservable in the market, the determination of fair value requires morejudgment.  The degree of judgmentexercised by the Company in determining fair value is typically greatest forinstruments categorized in Level 3. In many instances, valuation inputs used tomeasure fair value fall into different levels of the fair valuehierarchy.  The category level in the fair value hierarchy is determinedbased on the lowest level input that is significant to the fair valuemeasurement in its entirety.

 

Certainfinancial assets are not carried at fair value on a recurring basis, includinginvestments such as mortgage loans, limited partnership interests, bank loansand policy loans.  Accordingly, suchinvestments are only included in the fair value hierarchy disclosure when theinvestment is subject to remeasurement at fair value after initial recognitionand the resulting measurement is reflected in the condensed consolidatedfinancial statements.  In addition,equity options embedded in fixed income securities are not disclosed in thehierarchy with free–standing derivatives as the embedded derivatives are presentedwith the host contract in fixed income securities.

 

**Summaryof Significant Valuation Techniques for Financial Assets and FinancialLiabilities on a Recurring Basis**

 

**Level 1 Measurements**

 

Fixedincome securities:  U.S. treasuries are in Level 1 and valuationis based on unadjusted quoted prices for identical assets in active marketsthat the Company can access.

 

Equitysecurities:  Comprise actively traded, exchange-listedU.S. and international equity securities. Valuation is based on unadjusted quotedprices for identical assets in active markets that the Company can access.

 

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

 

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Separateaccount assets:  Comprise actively traded mutual funds thathave daily quoted net asset values for identical assets that the Company canaccess.  Net asset values for theactively traded mutual funds in which the separate account assets are investedare obtained daily from the fund managers.

 

**Level 2 Measurements**

 

Fixedincome securities:

 

*Corporate, including privately placed*: Valued based on inputs including quoted prices for identical or similarassets in markets that are not active. Also includes privately placed securities totaling $3.6 billion whichhave market-observable external ratings from independent third party ratingagencies.

 

*Municipal:*  Externally rated municipals are valued basedon inputs including quoted prices for identical or similar assets in marketsthat are not active.  *U.S. government and agencies*:  Valued based on inputs including quotedprices for identical or similar assets in markets that are not active.

 

*CMBS*:  Valuation is principally based on inputsincluding quoted prices for identical or similar assets in markets that are notactive.

 

*Preferred stock; MBS; Foreign government; ABS – credit card, auto andstudent loans*:  Valued based on inputs including quotedprices for identical or similar assets in markets that are not active.

 

Equitysecurities:  Valued based on inputs including quotedprices for identical or similar assets in markets that are not active.

 

Short-term: Commercial paper and other short-term investments are valued based onquoted prices for identical or similar assets in markets that are not active oramortized cost.

 

Otherinvestments:  Free-standing exchange listed derivativesthat are not actively traded are valued based on quoted prices for identicalinstruments in markets that are not active.

 

OTCderivatives, including interest rate swaps, foreign currency swaps, foreignexchange forward contracts, certain credit default swaps, and commodity swaps,are valued using models that rely on inputs such as interest rate yield curves,currency rates, adjustment for counterparty credit risks, and commodity pricesthat are observable for substantially the full term of the contract.  The valuation techniques underlying themodels are widely accepted in the financial services industry and do notinvolve significant judgment.

 

Contractholderfunds:  Derivatives embedded in certain annuitycontracts are valued based on internal models that rely on inputs such asinterest rate yield curves and equity index volatility assumptions that aremarket observable for substantially the full term of the contract.  The valuation techniques are widely acceptedin the financial services industry and do not include significant judgment.

 

**Level 3 Measurements**

 

Fixedincome securities

 

*Corporate:*  Valued based on non–binding broker quotes andare categorized as Level 3.

 

*Corporate privately placed:*  Valued based on non-bindingbroker quotes and models that arewidely accepted in the financial services industry and use internally assignedcredit ratings as inputs and instrument specific inputs.  Instrument specific inputs used ininternal fair value determinations include coupon rate, weighted average life,sector of the issuer and call provisions. Privately placed securities are categorized as Level 3 as a result of the significance ofnon-market observable inputs.  The $10.4billion of privately placed fixed income securities included in Level 3primarily comprise $8.8 billion valued using an internal model and $1.5 billionvalued using non-binding broker quotes. The internally modeled securities are valued based on internal ratings,which are not observable in the market. Multiple internal ratings comprise a National Association of InsuranceCommissioners (“NAIC”) rating category and when used in the internal modelprovide a more refined determination of fair value.  The Company’s internal ratings are primarilyconsistent with the NAIC ratings which are generally updated annually.

 

*ABS residential mortgage-backed securities (“ABS RMBS”); Alt–A**residentialmortgage-backed securities (“Alt-A”):* ABS RMBS and Alt-A are principally valuedbased on inputs including quoted prices for identical or similar assets inmarkets that exhibit less liquidity relative to those markets supporting Level2 fair value measurements.  Certain ABSRMBS and Alt-A are valued based on non-binding broker quotes.  Due to the reduced availability of 

 

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actualmarket prices or relevant observable inputs as a result of the decrease inliquidity that has been experienced in the market for these securities, all ABSRMBS and Alt-A are categorized as Level 3.

 

*Other collateralized debt obligations (“CDO”); ABS collateralized debtobligations (“ABS CDO”):* Valued based on non-bindingbroker quotes received from brokers who are familiar with the investments.  Due to the reduced availability of actualmarket prices or relevant observable inputs as a result of the decrease inliquidity that has been experienced in the market for these securities, allcollateralized loan obligations (“CLO”), ABS CDO, and synthetic collateralizeddebt obligations are categorized as Level 3.

 

*CMBS;Commercial real estate collateralized debt obligations (“CRE CDO”):* CRECDO, which are reported as CMBS, and other CMBS, are valued based onnon-binding broker quotes and are categorized as Level 3.

 

*Municipal:*  ARSprimarily backed by student loans totaling $708 million that have becomeilliquid due to failures in the auction market and municipal bonds totaling $1million that are not rated by third party credit rating agencies but aregenerally rated by the NAIC are included in Level 3.  ARS backed by student loans are valued basedon a discounted cash flow model with certain inputs to the valuation model thatare significant to the valuation, butare not market observable, including estimates of future coupon rates ifauction failures continue, maturity assumptions, and illiquidity premium.  Non–rated municipal bonds are valued based onvaluation models that are widely accepted in the financial services industryand require projections of future cash flows that are not market–observable,and are categorized as Level 3 as a result of the significance of non–marketobservable inputs.

 

Otherinvestments:  Certain free-standing OTC derivatives, suchas caps, floors, certain credit default swaps and OTC options (includingswaptions), are valued using valuation models that are widely accepted in thefinancial services industry.  Inputsinclude non-market observable inputs such as volatility assumptions that aresignificant to the valuation of the instruments.

 

Contractholderfunds:  Derivatives embedded in annuity contracts arevalued internally using models widely accepted in the financial servicesindustry that determine a single bestestimate of fair value for the embedded derivatives within a block ofcontractholder liabilities.  The modelsuse stochastically determined cash flows based on the contractual elements ofembedded derivatives and other applicable market data.  These are categorized as Level 3 as a result of the significance of non-marketobservable inputs.

 

**FinancialAssets and Financial Liabilities on a Non-recurring Basis**

 

Mortgageloans, limited partnership interests and other investments written–down to fairvalue in connection with recognizing other–than–temporary impairments areprimarily valued using valuation models that are widely accepted in thefinancial services industry.  Inputsinclude non–market observable inputs such as credit spreads.  At September 30, 2008, mortgage loans,limited partnership interests and other investments with a fair value of $225million were included in the fair value hierarchy in Level 3 since they weresubject to remeasurement at fair value during the third quarter of 2008.

 

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The following table summarizes the Company’sfinancial assets and financial liabilities measured at fair value on arecurring and non-recurring basis as of September 30, 2008:

 
| ** **                                                 | ** ** | **Quoted  prices in  active  markets for  identical  assets** | ** ** | **Significant  other  observable  inputs** | ** ** | **Significant  unobservable  inputs** | ** ** | **Other  valuations** | ** ** | **Balance as of   September 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------|------------|-----------------------|------------|-------------------------------------------------------|------------|
| **($ in millions)**                              | ** ** | **(Level 1)**                                                      | ** ** | **(Level 2)**                         | ** ** | **(Level 3)**                    | ** ** | **and netting**  | ** ** | **2008**                                              | ** ** |
| **Financial assets:**                                      | ** ** | ** **                                                              | ** ** | ** **                                 | ** ** | ** **                            | ** ** | ** **            | ** ** | ** **                                            | ** ** |
| Fixed income securities                                    |       | $                                                                       | 654        |                                       | $          | 31,699                                |       | $                     | 15,718     |                                                  |       |   | $ | 48,071 |   |
| Equity securities                                          |       | 33                                                                      |       | 45                                         |       | 30                                    |       |                  |       | 108                                                   |       |
| Short–term investments                                |       | 155                                                                     |       | 2,710                                      |       | —                                |       |                  |       | 2,865                                                 |       |
| Other investments:                                         |       |                                                                    |       |                                       |       |                                  |       |                  |       |                                                  |       |
| Free-standing derivatives                                  |       | —                                                                  |       | 403                                        |       | 34                                    |       |                  |       | 437                                                   |       |
| **Total recurring basis assets**                           |       | 842                                                                     |       | 34,857                                     |       | 15,782                                |       |                  |       | 51,481                                                |       |
| Non-recurring basis                                        |       | —                                                                  |       | —                                     |       | 225                                   |       |                  |       | 225                                                   |       |
| Valued at cost, amortized cost or using the  equity method |       |                                                                    |       |                                       |       |                                  |       | $                     | 13,445     |                                                  | 13,445     |   |
| Counterparty and cash collateral netting (1)               |       |                                                                    |       |                                       |       |                                  |       | (337                  | )          | (337                                                  | )          |
| **Total investments**                                      | ** ** | **842**                                                                 | ** ** | **34,857**                                 | ** ** | **16,007**                            | ** ** | **13,108**            | ** ** | **64,814**                                            | ** ** |
| Separate account assets                                    |       | 10,603                                                                  |       | —                                     |       | —                                |       | —                |       | 10,603                                                |       |
| Other assets                                               |       | (3                                                                      | )          | —                                     |       | 2                                     |       | —                |       | (1                                                    | )          |
|                                                       |       |                                                                    |       |                                       |       |                                  |       |                  |       |                                                  |       |
| **Total financial assets**                                 | ** ** | **$**                                                                   | **11,442** | ** **                                 | **$**      | **34,857**                            | ** ** | **$**                 | **16,009** | ** **                                            | **$**      | **13,108** | ** ** | **$** | **75,416** | ** ** |
| % of Total financial assets                                |       | 15.2                                                                    | %          | 46.2                                       | %          | 21.2                                  | %          | 17.4                  | %          | 100.0                                                 | %          |
|                                                       |       |                                                                    |       |                                       |       |                                  |       |                  |       |                                                  |       |
| **Financial liabilities:**                                 |       |                                                                    |       |                                       |       |                                  |       |                  |       |                                                  |       |
| Contractholder funds:                                      |       |                                                                    |       |                                       |       |                                  |       |                  |       |                                                  |       |
| Derivatives embedded in annuity contracts                  |       | $                                                                       | —     |                                       | $          | (46                                   | )          | $                     | (42        | )                                                     |       |   | $ | (88 | ) |
| Other liabilities:                                         |       |                                                                    |       |                                       |       |                                  |       |                  |       |                                                  |       |
| Free-standing derivatives                                  |       | —                                                                  |       | (399                                       | )          | (68                                   | )          |                  |       | (467                                                  | )          |
| Non-recurring basis                                        |       | —                                                                  |       | —                                     |       | —                                |       |                  |       | —                                                |       |
| Counterparty and cash collateral netting (1)               |       |                                                                    |       |                                       |       |                                  |       | $                     | 222        |                                                  | 222        |   |
| **Total financial liabilities**                            | ** ** | **$**                                                                   | **—** | ** **                                 | **$**      | **(445**                              | **)**      | **$**                 | **(110**   | **)**                                                 | **$**      | **222** | ** ** | **$** | **(333** | **)** |
| % of Total financial liabilities                           |       | —                                                                  | %          | 133.6                                      | %          | 33.0                                  | %          | (66.6                 | )%         | 100.0                                                 | %          |

 

----

(1)   In accordance with FSP FIN 39-1, the Companynets all fair value amounts recognized for derivative instruments and fairvalue amounts recognized for the right to reclaim cash collateral or theobligation to return cash collateral executed with the samecounterparty under a master netting agreement.  At September 30,2008, the right to reclaim cash collateral was offset by securities held, andthe obligation to return collateral was $115 million.

----

 

Asrequired by SFAS No. 157, when the inputs used to measure fair value fallwithin different levels of the hierarchy, the level within which the fair valuemeasurement is categorized is based on the lowest level input that issignificant to the fair value measurement in its entirety.  Thus, a Level 3 fair value measurement mayinclude inputs that are observable (Level 1 or Level 2) and unobservable (Level3).  Gains and losses for such assets andliabilities categorized within the Level 3 table may include changes in fairvalue that are attributable to both observable inputs (Level 1 and Level 2) andunobservable inputs (Level 3).  Nettransfers in and/or out of Level 3 are reported as having occurred at thebeginning of the period; therefore, all realized and unrealized gains andlosses on these securities for the period are reflected in the tablebelow.  Further, it should be noted thatthe following table does not take into consideration the effect of offsettingLevel 1 and Level 2 financial instruments entered into that economically hedgecertain exposures to the Level 3 positions.

 

Thefollowing table provides a summary of changes in fair value during the three–monthperiod ended September 30, 2008 of Level 3 financial assets and financialliabilities held at fair value on a recurring basis at September 30, 2008.

 

14

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| ** **                                        | ** ** | ** **                                           | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | **Net**                                                               | ** ** | ** **                                                 | ** ** | **Total  gains (losses)  included in  net income for** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in millions)**                     | ** ** | **Balance as of  June 30, 2008** | ** ** | **Net  Income ****(1)**                                                                 | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases, sales,  issuances and  settlements, net** | ** ** | **transfers in  and/or  (out) of  Level 3** | ** ** | **Balance as of  September 30, 2008**                  | ** ** | **instruments  still held at  September 30,  2008 ****(4)** | ** ** |
| **Financial assets**                              |       |                                                 |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| Fixed income securities                           |       | $                                                    | 17,360     |                                                                                         | $          | (395                                                    | )          | $                                                                     | (703       | )                                                          | $          | (672                                                                       | )          | $ | 128 |   | $ | 15,718 |   | $ | (383 | ) |
| Equity securities                                 |       | 27                                                   |       | (1                                                                                           | )          | (1                                                      | )          | 5                                                                     |       | —                                                     |       | 30                                                                         |       | (1 | ) |
| Other investments:                                |       |                                                 |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| Free-standing derivatives, net                    |       | (25                                                  | )          | (34                                                                                          | )          | —                                                  |       | 25                                                                    |       | —                                                     |       | (34)                                                                       | (2)        | (3 | ) |
| **Total investments**                             |       | 17,362                                               |       | (430                                                                                         | )          | (704                                                    | )          | (642                                                                  | )          | 128                                                        |       | 15,714                                                                     | (3)        | (387 | ) |
| Other assets                                      |       | 2                                                    |       | —                                                                                       |       | —                                                  |       | —                                                                |       | —                                                     |       | 2                                                                          |       | — |   |
| **Total recurring Level 3 financial assets**      |       | $                                                    | 17,364     |                                                                                         | $          | (430                                                    | )          | $                                                                     | (704       | )                                                          | $          | (642                                                                       | )          | $ | 128 |   | $ | 15,716 |   | $ | (387 | ) |
|                                              |       |                                                 |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| **Financial liabilities**                         |       |                                                 |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| Contractholder funds:                             |       |                                                 |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| Derivatives embedded in annuity contracts         |       | $                                                    | (20        | )                                                                                            | $          | (23                                                     | )          | $                                                                     | —     |                                                       | $          | 1                                                                          |       | $ | — |   | $ | (42 | ) | $ | (23 | ) |
| **Total recurring Level 3 financial liabilities** |       | $                                                    | (20        | )                                                                                            | $          | (23                                                     | )          | $                                                                     | —     |                                                       | $          | 1                                                                          |       | $ | — |   | $ | (42 | ) | $ | (23 | ) |

 

----

(1)   Theamounts above total $(453) million and are reported in the CondensedConsolidated Statements of Operations as follows: $(461) million in realized capital gains and losses; $32 millionin net investment income; $(1) million in interest credited tocontractholder funds; and $(23) million in contract benefits.

(2)   Comprises$34 million of financial assets and $(68) million of financial liabilities.

(3)   Comprises$15.78 billion of investments and $(68) million of free-standing derivativesincluded in financial liabilities.

(4)   Theamounts above represent gains and losses included in net income for the periodof time that the financial asset or financial liability was determined to be inLevel 3.  These gains and losses total$(410) million and are reported in the Condensed Consolidated Statements ofOperations as follows:  $(419) million inrealized capital gains and losses; $32 million in net investment income; and$(23) million in contract benefits.

----

 

Thefollowing table provides a summary of changes in fair value during the nine–monthperiod ended September 30, 2008 of Level 3 financial assets and financialliabilities held at fair value on a recurring basis at September 30, 2008.

 
| ** **                                        | ** ** | ** **                                         | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | **Net**                                                               | ** ** | ** **                                                 | ** ** | **Total  gains (losses)  included in  Net Income for** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in millions)**                     | ** ** | **Balance as of  January 1,  2008** | ** ** | **Net  Income ****(1)**                                                                 | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases, sales,  issuances and  settlements, net** | ** ** | **transfers in  and/or  (out) of  Level 3** | ** ** | **Balance as of  September  30, 2008**                      | ** ** | **instruments  still held at  September 30,  2008 ****(4)** | ** ** |
| **Financial assets**                              |       |                                               |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| Fixed income securities                           |       | $                                                  | 18,830     |                                                                                         | $          | (1,223                                                  | )          | $                                                                     | (1,248     | )                                                          | $          | (1,530                                                                     | )          | $ | 889 |   | $ | 15,718 |   | $ | (1,012 | ) |
| Equity securities                                 |       | 61                                                 |       | (3                                                                                           | )          | (7                                                      | )          | 18                                                                    |       | (39                                                        | )          | 30                                                                         |       | (3 | ) |
| Other investments:                                |       |                                               |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| Free-standing derivatives, net                    |       | (6                                                 | )          | (65                                                                                          | )          | —                                                  |       | 37                                                                    |       | —                                                     |       | (34)                                                                       | (2)        | 18 |   |
| **Total investments**                             |       | 18,885                                             |       | (1,291                                                                                       | )          | (1,255                                                  | )          | (1,475                                                                | )          | 850                                                        |       | 15,714                                                                     | (3)        | (997 | ) |
| Other assets                                      |       | 2                                                  |       | —                                                                                       |       | —                                                  |       | —                                                                |       | —                                                     |       | 2                                                                          |       | — |   |
| **Total recurring Level 3 financial assets**      |       | $                                                  | 18,887     |                                                                                         | $          | (1,291                                                  | )          | $                                                                     | (1,255     | )                                                          | $          | (1,475                                                                     | )          | $ | 850 |   | $ | 15,716 |   | $ | (997 | ) |
|                                              |       |                                               |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| **Financial liabilities**                         |       |                                               |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| Contractholder funds:                             |       |                                               |       |                                                                                         |       |                                                    |       |                                                                  |       |                                                       |       |                                                                       |       |   |   |
| Derivatives embedded in annuity contracts         |       | $                                                  | 4          |                                                                                         | $          | (47                                                     | )          | $                                                                     | —     |                                                       | $          | 1                                                                          |       | $ | — |   | $ | (42 | ) | $ | (47 | ) |
| **Total recurring Level 3 financial liabilities** |       | $                                                  | 4          |                                                                                         | $          | (47                                                     | )          | $                                                                     | —     |                                                       | $          | 1                                                                          |       | $ | — |   | $ | (42 | ) | $ | (47 | ) |

 

----

(1)   Theamounts above total $(1.34) billion and are reported in the CondensedConsolidated Statements of Operations as follows: $(1.34) billion in realized capital gains and losses; $57 millionin net investment income; $(5) million in interest credited tocontractholder funds and; $(47) million in contract benefits.

(2)   Comprises$34 million of financial assets and $(68) million of financial liabilities.

(3)   Comprises$15.78 billion of investments and $(68) million of free-standing derivativesincluded in financial liabilities.

(4)   Theamounts above represent gains and losses included in net income for the periodof time that the financial asset or financial liability was determined to be inLevel 3.  These gains and losses total$(1.04) billion and are reported in the Condensed Consolidated Statements ofOperations as follows:  $(1.04) billionin realized capital gains and losses; $51 million in net investment income; $(1) millionin interest credited to contractholder funds; and $(47) million in contractbenefits.

----

 

15

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**5. ****Reinsurance**

 

The effects of reinsurance on premiums and contract charges are asfollows:

 
| ** **                                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                     | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Premiums and contract charges**                 |       |                                                 |       |                                                |       |   |   |   |   |
| Direct                                            |       | $                                                    | 560        |                                                | $          | 564 |   | $ | 1,688 |   | $ | 1,742 |   |
| Assumed                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                                         |       | 16                                                   |       | 4                                                   |       | 46 |   | 12 |   |
| Non-affiliate                                     |       | 7                                                    |       | 7                                                   |       | 19 |   | 20 |   |
| Ceded—non-affiliate                          |       | (217                                                 | )          | (235                                                | )          | (663 | ) | (699 | ) |
|                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums and contract charges, net of reinsurance |       | $                                                    | 366        |                                                | $          | 340 |   | $ | 1,090 |   | $ | 1,075 |   |

 

The effects of reinsurance on contractbenefits are as follows:

 
| ** **                            | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**         | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Contract benefits**                 |       |                                                 |       |                                                |       |   |   |   |   |
| Direct                                |       | $                                                    | 580        |                                                | $          | 478 |   | $ | 1,563 |   | $ | 1,471 |   |
| Assumed                               |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                             |       | 8                                                    |       | 3                                                   |       | 26 |   | 8 |   |
| Non-affiliate                         |       | 5                                                    |       | 6                                                   |       | 19 |   | 20 |   |
| Ceded—non-affiliate              |       | (232                                                 | )          | (172                                                | )          | (563 | ) | (479 | ) |
|                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Contract benefits, net of reinsurance |       | $                                                    | 361        |                                                | $          | 315 |   | $ | 1,045 |   | $ | 1,020 |   |

 

The effects of reinsurance on interestcredited to contractholder funds are as follows:

 
| ** **                                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Interest credited to contractholder funds**                  |       |                                                 |       |                                                |       |   |   |   |   |
| Direct                                                         |       | $                                                    | 580        |                                                | $          | 676 |   | $ | 1,744 |   | $ | 1,979 |   |
| Assumed                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                                                      |       | 2                                                    |       | 3                                                   |       | 8 |   | 10 |   |
| Non-affiliate                                                  |       | 5                                                    |       | 5                                                   |       | 12 |   | 14 |   |
| Ceded—non-affiliate                                       |       | (14                                                  | )          | (12                                                 | )          | (32 | ) | (36 | ) |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Interest credited to contractholder funds,  net of reinsurance |       | $                                                    | 573        |                                                | $          | 672 |   | $ | 1,732 |   | $ | 1,967 |   |

 

**6.   ****Guarantees and Contingent Liabilities**

 

**Guaranty funds**

 

Under state insurance guaranty fund laws, insurers doing business in astate can be assessed, up to prescribed limits, for certain obligations ofinsolvent insurance companies to policyholders and claimants.  Amounts assessed to each company aretypically related to its proportion of business written in each state.

 

The New York Liquidation Bureau (the “Bureau”) has publicly reportedthat Executive Life Insurance Company of New York (“Executive Life”), currentlyunder its jurisdiction as part of a 1992 court-ordered rehabilitation plan, mayonly be able to meet future obligations of its annuity contacts for the nextfifteen years. The shortfall is currently estimated to be $1.27 billion.  If Executive Life were to be declaredinsolvent in the future, the Company would likely have exposure to guarantyfund assessments or other costs.

 

16

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Based on currently available information, the outcome of this situationis uncertain at this time.  The Bureaumay eventually take actions to address this situation that may lead to guarantyfund assessments or other costs to the Company. Under current law, the Company may be allowed to recoup a portion of theamount of any additional guaranty fund assessment in periods subsequent to therecognition of the assessment by offsetting future premium taxes.  The Company’s market share in New York wasapproximately 5.5% in 2006 based on industry annuity premium.

 

**Guarantees**

 

The Company ownscertain fixed income securities that obligate the Company to exchange creditrisk or to forfeit principal due, depending on the nature or occurrence ofspecified credit events for the referenced entities.  In the event all such specified credit eventswere to occur, the Company’s maximum amount at risk on these fixed incomesecurities, as measured by the amount of the aggregate initial investment, was$195 million at September 30, 2008. The obligations associated with these fixed income securities expire atvarious times during the next six years.

 

Relatedto the disposal through reinsurance of substantially all of our variableannuity business to Prudential Financial, Inc. and its subsidiary (“Prudential”)in 2006, the Company has agreed to indemnify Prudential for certain pre–closingcontingent liabilities (including extra–contractual liabilities of the Companyand liabilities specifically excluded from the transaction) that the Companyhas agreed to retain.  In addition, theCompany will indemnify Prudential for certain post–closing liabilities that mayarise from the acts of the Company and its agents, including in connection withthe Company’s provision of transition services. The reinsurance agreements contain no limitations or indemnificationswith regard to insurance risk transfer, and transferred all of the future risksand responsibilities for performance on the underlying variable annuitycontracts to Prudential, including those related to benefit guarantees, inaccordance with the provisions of SFAS No. 113 “Accounting and Reportingfor Reinsurance of Short–Duration and Long–Duration Contracts”.  Management does not believe this agreementwill have a material adverse effect on results of operations, cash flows orfinancial position of the Company.

 

In the normal course of business, the Companyprovides standard indemnifications to contractual counterparties in connectionwith numerous transactions, including acquisitions and divestitures.  The types of indemnifications typicallyprovided include indemnifications for breaches of representations andwarranties, taxes and certain other liabilities, such as third party lawsuits.  The indemnification clauses are often standardcontractual terms and are entered into in the normal course of business basedon an assessment that the risk of loss would be remote.  The terms of the indemnifications vary induration and nature.  In many cases, themaximum obligation is not explicitly stated and the contingencies triggeringthe obligation to indemnify have not occurred and are not expected tooccur.  Consequently, the maximum amountof the obligation under such indemnifications is not determinable.  Historically, the Company has not made anymaterial payments pursuant to these obligations.

 

The aggregate liability balance related toall guarantees was not material as of September 30, 2008.

 

**Regulation**

 

The Company is subject to changing social, economic and regulatoryconditions.  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.  The ultimate changes and eventual effects ofthese initiatives on the Company’s business, if any, are uncertain.

 

**Legal and regulatory proceedings and inquiries**

 

***Background***

 

The Company and certain affiliates are involved in a number oflawsuits, regulatory inquiries, and other legal proceedings arising out ofvarious aspects of its business.  Asbackground to the “Proceedings” subsection below, please note the following:

 

17

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·             Thesematters raise difficult and complicated factual and legal issues and aresubject to many uncertainties and complexities, including the underlying factsof each matter; novel legal issues; variations between jurisdictions in whichmatters are being litigated, heard, or investigated; differences in applicablelaws and judicial interpretations; the length of time before many of thesematters might be resolved by settlement, through litigation or otherwise; thefact that some of the lawsuits are putative class actions in which a class hasnot been certified and in which the purported class may not be clearly defined;the fact that some of the lawsuits involve multi-state class actions in whichthe applicable law(s) for the claims at issue is in dispute and thereforeunclear; and the current challenging legal environment faced by largecorporations and insurance companies.

 

·             The outcome on these matters may also beaffected by decisions, verdicts, and settlements, and the timing of suchdecisions, verdicts, and settlements, in other individual and class actionlawsuits that involve the Company, other insurers, or other entities and byother legal, governmental, and regulatory actions that involve the Company,other insurers, or other entities.

 

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

 

·             In connection with regulatory examinationsand proceedings, government authorities may seek various forms of relief,including penalties, restitution and changes in business practices.  The Company may not be advised of the natureand extent of relief sought until the final stages of the examination orproceeding.

 

·             Forthe reasons specified above, it is often not possible to make meaningfulestimates of the amount or range of loss that could result from the mattersdescribed below in the “Proceedings” subsection.  The Company reviews these matters on anongoing basis and follows the provisions of SFAS No. 5, “Accounting forContingencies”, when making accrual and disclosure decisions.  When assessing reasonably possible andprobable outcomes, the Company bases its decisions on its assessment of theultimate 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 unfavorable outcome in one or more of these matters,the ultimate liability may be in excess of amounts currently reserved and maybe material to the Company’s operating results or cash flows for a particularquarterly or annual period.  However,based on information currently known to it, management believes that theultimate 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 andAIC may impact the Company, even when the Company is not directly involved,because the Company sells its products through a variety of distributionchannels including Allstate agencies. Consequently, information about the moresignificant of these proceedings is provided in the following paragraph.

 

18

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AIC is defending certain matters relating toits agency program reorganization announced in 1999. These matters are invarious stages of development.

 

·             Thesematters include a lawsuit filed in 2001 by the U.S. Equal EmploymentOpportunity Commission (“EEOC”) alleging retaliation under federal civil rightslaws (the “EEOC I” suit) and a class action filed in 2001 by former employeeagents alleging retaliation and age discrimination under the Age Discriminationin Employment Act (“ADEA”), breach of contract and ERISA violations (the “RomeroI” suit).  In 2004, in the consolidatedEEOC I and Romero I litigation, the trial court issued a memorandum and orderthat, among other things, certified classes of agents, including a mandatoryclass of agents who had signed a release, for purposes of effecting the court’sdeclaratory judgment that the release is voidable at the option of the releasesigner.  The court also ordered that anagent who voids the release must return to AIC “any and all benefits receivedby the [agent] in exchange for signing the release.”  The court also stated that, “on theundisputed facts of record, there is no basis for claims of age discrimination.”  The EEOC and plaintiffs have asked the courtto clarify and/or reconsider its memorandum and order and in January 2007,the judge denied their request.  In June 2007,the court granted AIC’s motions for summary judgment.  Following plaintiffs’ filing of a notice ofappeal, the Third Circuit issued an order in December 2007 stating thatthe notice of appeal was not taken from a final order within the meaning of thefederal law and thus not appealable at this time.  In March 2008, the Third Circuit decidedthat the appeal should not summarily be dismissed and that the question ofwhether the matter is appealable at this time will be addressed by the Courtalong with the merits of the appeal.

 

·             TheEEOC also filed another lawsuit in 2004 alleging age discrimination withrespect to a policy limiting the rehire of agents affected by the agencyprogram reorganization (the “EEOC II” suit). In EEOC II, in 2006, the court granted partial summary judgment to theEEOC.  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.  In June 2008,the Eighth Circuit Court of Appeals affirmed summary judgment in the EEOC’sfavor.  In September 2008, the Courtof Appeals granted AIC’s petition for rehearing *en banc*andvacated its earlier decision affirming the trial court’s grant of summaryjudgment in favor of the EEOC.  The Courtof Appeals then dismissed the appeal, determining that it lacked jurisdictionto consider the appeal at this stage in the litigation.

 

·             AIC is also defendinga certified class action filed by former employee agents who terminated theiremployment prior to the agency program reorganization.  Plaintiffs allege that they wereconstructively discharged so that AIC could avoid paying ERISA and otherbenefits offered under the reorganization. They claim that the constructive discharge resulted from theimplementation of agency standards, including mandatory office hours and arequirement to have licensed staff available during business hours.  The court approved the form of class noticewhich was sent to approximately 1,800 potential class members in November 2007.  Fifteen individuals opted out.  AIC’s motions for judgment on the pleadingswere partially granted.  In May 2008, the court granted summaryjudgment in AIC’s favor on all class claims. Plaintiffs moved for reconsideration and in the alternative to decertifythe class.  AIC opposed this motion andfiled a motion for summary judgment with respect to the remaining non–classclaim.  In August 2008, the court deniedplaintiffs’ motion to reconsider and to decertify the class.

 

·             Aputative nationwide class action has also been filed by former employee agentsalleging various violations of ERISA,including a worker classification issue. These plaintiffs are challenging certain amendments to the AgentsPension Plan and are seeking to have exclusive agent independent contractorstreated as employees for benefit purposes.  This matter was dismissed with prejudice bythe trial court, was the subject of further proceedings on appeal, and wasreversed and remanded to the trial court in 2005.  In June 2007, the court granted AIC’smotion to dismiss the case.  Followingplaintiffs’ filing of a notice of appeal, the Third Circuit issued an order in December 2007stating that the notice of appeal was not taken from a final order within themeaning of the federal law and thus not appealable at this time.  In March 2008, the Third Circuit decidedthat the appeal should not summarily be dismissed and that the question ofwhether the matter is appealable at this time will be addressed by the Courtalong with the merits of the appeal.

 

19

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In all of these variousmatters, plaintiffs seek compensatory and punitive damages, and equitablerelief.  AIC has been vigorouslydefending these lawsuits and other matters related to its agency programreorganization.

 

**Other Matters**

** **

Various other legal,governmental, and regulatory actions, including state market conduct exams, andother governmental and regulatory inquiries are currently pending that involvethe Company and specific aspects of its conduct of business. Like other membersof the insurance industry, the Company is the target of a number of classaction lawsuits and other types of proceedings, some of which involve claimsfor substantial or indeterminate amounts. These actions are based on a variety of issues and target a range of theCompany’s practices.  The outcome ofthese disputes is currently unpredictable.

 

One or more of these matters could have anadverse effect on the Company’s operating results or cash flows for aparticular quarterly or annual period. However, based on information currently known to it, management believesthat the ultimate outcome of all matters described in this “Other Matters”subsection, in excess of amounts currently reserved, as they are resolved overtime is not likely to have a material effect on the operating results, cashflows or financial position of the Company.

 

**7.   Other Comprehensive Income**

 

The components of other comprehensive (loss) income on a pre-tax andafter-tax basis are as follows:

 
| ** **                                                                       | ** ** | **Three months ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| **($ in millions)**                                                    | ** ** | **Pre-tax**                                              | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                             |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding losses arising  during the period, net of related offsets |       | $                                                        | (1,014     | ) | $ | 355 |   | $ | (659 | ) | $ | (52 | ) | $ | 18 |   | $ | (34 | ) |
| Less: reclassification adjustment of  realized capital gains and losses          |       | (489                                                     | )          | 171 |   | (318 | ) | 103 |   | (36 | ) | 67 |   |
| Unrealized net capital gains and losses                                          |       | (525                                                     | )          | 184 |   | (341 | ) | (155 | ) | 54 |   | (101 | ) |
| Other comprehensive loss                                                         |       | $                                                        | (525       | ) | $ | 184 |   | (341 | ) | $ | (155 | ) | $ | 54 |   | (101 | ) |
|                                                                             |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss) income                                                                |       |                                                     |       |   |   | (184 | ) |   |   |   |   | 56 |   |
| Comprehensive loss                                                               |       |                                                     |       |   |   | $ | (525 | ) |   |   |   |   | $ | (45 | ) |

 
| ** **                                                                       | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| **($ in millions)**                                                    | ** ** | **Pre-tax**                                             | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding losses arising  during the period, net of related offsets |       | $                                                       | (2,717     | ) | $ | 951 |   | $ | (1,766 | ) | $ | (335 | ) | $ | 117 |   | $ | (218 | ) |
| Less: reclassification adjustment of  realized capital gains and losses          |       | (1,635                                                  | )          | 572 |   | (1,063 | ) | 102 |   | (36 | ) | 66 |   |
| Unrealized net capital gains and losses                                          |       | (1,082                                                  | )          | 379 |   | (703 | ) | (437 | ) | 153 |   | (284 | ) |
| Other comprehensive loss                                                         |       | $                                                       | (1,082     | ) | $ | 379 |   | (703 | ) | $ | (437 | ) | $ | 153 |   | (284 | ) |
|                                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss) income                                                                |       |                                                    |       |   |   | (667 | ) |   |   |   |   | 392 |   |
| Comprehensive (loss) income                                                      |       |                                                    |       |   |   | $ | (1,370 | ) |   |   |   |   | $ | 108 |   |

 

20

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholder of

AllstateLife Insurance Company

Northbrook,Illinois

 

Wehave reviewed the accompanying condensed consolidated statement of financialposition of Allstate Life Insurance Company and subsidiaries (the “Company”),an affiliate of The Allstate Corporation, as of September 30, 2008, andthe related condensed consolidated statements of operations for the three-monthand nine-month periods ended September 30, 2008 and 2007, and thecondensed consolidated statements of cash flows for the nine-month periodsended September 30, 2008 and 2007. These interim financial statements are the responsibility of the Company’smanagement.

 

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

 

Basedon our reviews, we are not aware of any material modifications that should bemade to such condensed consolidated interim financial statements for them to bein conformity with accounting principles generally accepted in the UnitedStates of America.

 

Wehave previously audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated statement offinancial position of Allstate Life Insurance Company and subsidiaries as of December 31,2007, and the related consolidated statements of operations and comprehensiveincome, shareholder’s equity, and cash flows for the year then ended (notpresented herein); and in our report dated March 13, 2008, which reportincludes an explanatory paragraph relating to a change in the Company’s methodof accounting for uncertainty in income taxes and accounting for deferredacquisition costs associated with internal replacements in 2007, we expressedan unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth inthe accompanying condensed consolidated statement of financial position as of December 31,2007 is fairly stated, in all material respects, in relation to theconsolidated statement of financial position from which it has been derived.

 

 

/s/Deloitte & Touche LLP

 

Chicago,Illinois

November 10,2008

 

21

----

 

**Item 2.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE-MONTHAND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2008 AND 2007**

 

**OVERVIEW**

** **

Thefollowing discussion highlights significant factors influencing the condensedconsolidated financial position and results of operations of Allstate LifeInsurance Company (referred to in this document as “we”, “our”, “us”, or the “Company”).It should be read in conjunction with the condensed consolidated financialstatements and notes thereto found under Part I. Item 1. contained herein,and with the discussion, analysis, consolidated financial statements and notesthereto in Part I. Item 1. and Part II. Item 7. and Item 8. of theAllstate Life Insurance Company Annual Report on Form 10-K for 2007.  We operate as a single segment entity basedon the manner in which we use financial information to evaluate businessperformance and determine the allocation of resources.

** **

**HIGHLIGHTS**

 

·**                 **Net loss of $184 million and $667 million inthe third quarter and first nine months of 2008, respectively, compared to netincome of $56 million and $392 million in the third quarter and first ninemonths of 2007, respectively.

** **

·**                 **Net realized capital losses totaled $568million and $1.93 billion in the third quarter and first nine months of 2008,respectively.  Net realized capitallosses totaled $128 million and $2 million in the third quarter and first ninemonths of 2007, respectively.

 

·**                 **Contractholder fund deposits totaled $1.50billion and $8.25 billion for the third quarter and first nine months of 2008,respectively, compared to $1.89 billion and $6.62 billion for the third quarterand first nine months of 2007, respectively.

 

·**                 **Investments as of September 30, 2008decreased 10.5% to $64.81 billion from $72.41 billion as of December 31,2007 and net investment income decreased 14.1% to $912 million in the thirdquarter of 2008 from $1.06 billion in the same period of 2007, and 10.1% to$2.83 billion in the first nine months of 2008 from $3.15 billion in the sameperiod of 2007.

** **

·**                 **In addition to focusing on raising returns oninvestment products, principally fixed annuities and funding agreements, we arecurrently evaluating strategies to reduce our concentration in them.

 

·**                 **We are also evaluating our overall coststructure and ways to shift costs from fixed to variable.

** **

**OPERATIONS**

** **

Summarized financial data is presented in thefollowing table.

 
| ** **                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**             | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                |       |                                                 |       |                                                |       |   |   |   |   |
| **Revenues**                              |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums                                  |       | $                                                    | 138        |                                                | $          | 104 |   | $ | 425 |   | $ | 381 |   |
| Contract charges                          |       | 228                                                  |       | 236                                                 |       | 665 |   | 694 |   |
| Net investment income                     |       | 912                                                  |       | 1,062                                               |       | 2,826 |   | 3,145 |   |
| Realized capital gains and losses         |       | (568                                                 | )          | (128                                                | )          | (1,928 | ) | (2 | ) |
| Total revenues                            |       | 710                                                  |       | 1,274                                               |       | 1,988 |   | 4,218 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Costs and expenses**                    |       |                                                 |       |                                                |       |   |   |   |   |
| Contract benefits                         |       | (361                                                 | )          | (315                                                | )          | (1,045 | ) | (1,020 | ) |
| Interest credited to contractholder funds |       | (573                                                 | )          | (672                                                | )          | (1,732 | ) | (1,967 | ) |
| Amortization of DAC                       |       | 26                                                   |       | (129                                                | )          | 32 |   | (410 | ) |
| Operating costs and expenses              |       | (106                                                 | )          | (84                                                 | )          | (297 | ) | (243 | ) |
| Total costs and expenses                  |       | (1,014                                               | )          | (1,200                                              | )          | (3,042 | ) | (3,640 | ) |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Gain (loss) on disposition of operations  |       | 2                                                    |       | 6                                                   |       | (7 | ) | 9 |   |
| Income tax benefit (expense)              |       | 118                                                  |       | (24                                                 | )          | 394 |   | (195 | ) |
| Net (loss) income                         |       | $                                                    | (184       | )                                                   | $          | 56 |   | $ | (667 | ) | $ | 392 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Investments at September 30          |       |                                                 |       |                                                |       | $ | 64,814 |   | $ | 74,571 |   |

 

22

----

 

*Net loss* in the third quarter of 2008 of $184 million compared to net income of$56 million in the same period of 2007, and a net loss of $667 million in thefirst nine months of 2008 compared to net income of $392 million in the firstnine months of 2007.  The change in bothperiods was primarily the result of the recognition of higher net realizedcapital losses in the current year periods compared to the prior year periods.

** **

**Analysis of Revenues**Total revenues decreased 44.3% or $564million in the third quarter of 2008 and decreased 52.9% or $2.23 billion inthe first nine months of 2008, compared to the same periods of 2007, due mostlyto the recognition of higher net realized capital losses and, to a much lesserextent, lower net investment income.

* *

*Premiums*****represent revenues generated from traditionallife insurance, immediate annuities with life contingencies and other insuranceproducts that have significant mortality or morbidity risk.

 

*Contract charges* are revenues generated frominterest-sensitive and variable life insurance, fixed annuities andinstitutional products for which deposits are classified as contractholderfunds or separate accounts liabilities. Contract charges are assessed against the contractholder account valuesfor maintenance, administration, cost of insurance and surrender prior tocontractually specified dates.  As aresult, changes in contractholder funds are considered in the evaluation ofgrowth and as indicators of future levels of revenues.

 

The following table summarizes premiums and contract charges byproduct.

 
| ** **                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                  | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Premiums**                                |       |                                                 |       |                                                |       |   |   |   |   |
| Traditional life insurance (1)              |       | $                                                    | 90         |                                                | $          | 62 |   | $ | 271 |   | $ | 192 |   |
| Immediate annuities with life contingencies |       | 25                                                   |       | 32                                                  |       | 91 |   | 161 |   |
| Accident, health and other                  |       | 23                                                   |       | 10                                                  |       | 63 |   | 28 |   |
| **Total premiums**                          |       | 138                                                  |       | 104                                                 |       | 425 |   | 381 |   |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| **Contract charges**                        |       |                                                 |       |                                                |       |   |   |   |   |
| Interest-sensitive life insurance (1)       |       | 215                                                  |       | 217                                                 |       | 625 |   | 637 |   |
| Fixed annuities                             |       | 13                                                   |       | 19                                                  |       | 39 |   | 56 |   |
| Variable annuities                          |       | —                                               |       | —                                              |       | 1 |   | 1 |   |
| **Total contract charges**(2)               |       | 228                                                  |       | 236                                                 |       | 665 |   | 694 |   |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| **Total premiums and contract charges**     |       | $                                                    | 366        |                                                | $          | 340 |   | $ | 1,090 |   | $ | 1,075 |   |

 

----

(1)          Beginning in 2008, certain ceded reinsurance premiums previouslyincluded as a component of traditional life insurance premiums werereclassified prospectively to be reported as a component of interest-sensitivelife insurance contract charges.  In thethird quarter and first nine months of 2007, these ceded reinsurance premiumswere $25 million and $64 million, respectively.

(2)          Total contract charges for the third quarter of 2008 and 2007 includecontract charges related to the cost of insurance of $142 million and $156million, respectively.  Total contractcharges for the first nine months of 2008 and 2007 include contract chargesrelated to the cost of insurance of $419 million and $456 million,respectively.

----

 

Total premiums increased 32.7% and 11.5% in the third quarter and firstnine months of 2008, respectively, compared to the same periods of 2007,primarily due to the prospective reporting reclassification for certain cededreinsurance premiums.  Excluding theimpact of this reporting reclassification, total premiums increased 7.0% in thethird quarter of 2008 compared to the third quarter of 2007 and decreased 4.5%in the first nine months of 2008 compared to the same period in the prioryear.  The increase in the third quarterof 2008 reflects increased accident and health insurance premium assumed fromAmerican Heritage Life Insurance Company (“AHL”), an unconsolidated affiliate,and higher sales of traditional life insurance products, partially offset bylower sales of immediate annuities with life contingencies.  In the first nine months of 2008, increasedaccident and health insurance premium assumed from AHL and higher sales oftraditional life insurance products were more than offset by lower sales ofimmediate annuities with life contingencies.

 

23

----

 

Total contract charges decreased 3.4% and 4.2% in the third quarter andfirst nine months of 2008, respectively, compared to the same periods of 2007due primarily to the prospective reporting reclassification of certain cededreinsurance premiums.  Excluding theimpact of this reclassification noted above, total contract charges increased 8.1%and 5.6% in the third quarter and first nine months of 2008, respectively, dueto higher contract charges on interest-sensitive life insurance policiesresulting from increased contract charge rates and growth in business in force,partially offset by decreased contract charges on fixed annuities resultingprimarily from lower surrender charges.

 

*Contractholder funds*represent interest-bearing liabilitiesarising from the sale of individual and institutional products, such asinterest-sensitive life insurance, fixed annuities and funding agreements. Thebalance of contractholder funds is equal to the cumulative deposits receivedand interest credited to the contractholder less cumulative contractmaturities, benefits, surrenders, withdrawals and contract charges formortality or administrative expenses.

 

  The following table shows the changes incontractholder funds.

 
| ** **                                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Contractholder funds, beginning balance**                    |       | $                                                    | 60,886     |                                                | $          | 61,173 |   | $ | 60,464 |   | $ | 60,565 |   |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| **Deposits**                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Fixed annuities                                                |       | 1,178                                                |       | 1,064                                               |       | 3,101 |   | 2,639 |   |
| Institutional products (funding agreements)                    |       | —                                               |       | 500                                                 |       | 4,158 |   | 3,000 |   |
| Interest-sensitive life insurance                              |       | 324                                                  |       | 327                                                 |       | 989 |   | 982 |   |
| Other                                                          |       | —                                               |       | —                                              |       | 1 |   | 1 |   |
| Total deposits                                                 |       | 1,502                                                |       | 1,891                                               |       | 8,249 |   | 6,622 |   |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| **Interest credited**                                          |       | 588                                                  |       | 672                                                 |       | 1,785 |   | 1,976 |   |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| **Maturities, benefits, withdrawals and other  adjustments**   |       |                                                 |       |                                                |       |   |   |   |   |
| Maturities and retirements of institutional  products          |       | (3,330                                               | )          | (474                                                | )          | (7,460 | ) | (2,469 | ) |
| Benefits                                                       |       | (422                                                 | )          | (434                                                | )          | (1,302 | ) | (1,265 | ) |
| Surrenders and partial withdrawals                             |       | (1,062                                               | )          | (1,357                                              | )          | (3,096 | ) | (3,468 | ) |
| Contract charges                                               |       | (206                                                 | )          | (188                                                | )          | (605 | ) | (553 | ) |
| Net transfers from separate accounts                           |       | 4                                                    |       | 3                                                   |       | 16 |   | 9 |   |
| Fair value hedge adjustments for  institutional products       |       | (164                                                 | )          | 61                                                  |       | (165 | ) | 27 |   |
| Other adjustments (1)                                          |       | (6                                                   | )          | (30                                                 | )          | (96 | ) | (127 | ) |
| Total maturities, benefits, withdrawals and  other adjustments |       | (5,186                                               | )          | (2,419                                              | )          | (12,708 | ) | (7,846 | ) |
| **Contractholder funds, ending balance**                       |       | $                                                    | 57,790     |                                                | $          | 61,317 |   | $ | 57,790 |   | $ | 61,317 |   |

 

----

(1)          The table above illustrates the changes in contractholder funds, whichare presented gross of reinsurance recoverables on the Condensed ConsolidatedStatements of Financial Position.  Thetable above is intended to supplement our discussion and analysis of revenues,which are presented net of reinsurance on the Condensed Consolidated Statementsof Operations.  As a result, the net changein contractholder funds associated with products reinsured to third parties isreflected as a component of the other adjustments line.

----

 

Contractholderfunds decreased 5.1% in the third quarter of 2008, compared to an increase of0.2% in the third quarter of 2007, and decreased 4.4% in the first nine monthsof 2008, compared to an increase of 1.2% in the same period in the prioryear.  Average contractholder fundsdecreased 3.1% and 3.0% in the third quarter and first nine months of 2008,respectively, compared to the same periods of 2007.

 

Contractholderdeposits decreased 20.6% in the third quarter and increased 24.6% in the firstnine months of 2008, compared to the same periods of 2007.  The decrease in the third quarter of 2008 wasdue to the absence of institutional product deposits in the third quarter of2008 compared to $500 million in the third quarter of 2007, partially offset byhigher deposits on fixed annuities.  Theincrease in contractholder deposits for the first nine months of 2008 was drivenby higher deposits on institutional products, and to a lesser extent, higherdeposits on fixed annuities.  Sales ofour institutional products vary from period to period based on management’sassessment of 

 

24

----

 

market conditions, investor demand andoperational priorities.  Deposits onfixed annuities increased 10.7% and 17.5% in the third quarter and first ninemonths of 2008, respectively, compared to the same periods of 2007, dueprimarily to improvements in the attractiveness of fixed annuities relative tocompeting products.

 

Maturitiesand retirements of institutional products increased $2.86 billion and $4.99billion in the third quarter and first nine months of 2008, respectively,compared to the same periods in the prior year. During the third quarter and first nine months of 2008, we retired $2.25billion and $4.64 billion, respectively, of extendible institutional marketdeposits for which investors had elected to non-extend their maturity datethrough a combination of maturities, calls, and acquisitions in the secondarymarket.  Total outstanding non-extendedinstitutional market deposits were $1.34 billion as of September 30, 2008,all of which become due no later than the end of the third quarter of2009.  We have accumulated, and expect tomaintain, short-term and other maturing investments to fund the retirement ofthese obligations.

 

Surrenders and partial withdrawals decreased 21.7% and 10.7% in thethird quarter and first nine months of 2008, respectively, compared to the sameperiods of 2007.  These declines were dueto lower surrenders and partial withdrawals on market value adjusted annuities,partially offset by higher surrenders and partial withdrawals oninterest-sensitive life insurance products and traditional fixedannuities.  The annualized surrender andpartial withdrawal rate on deferred fixed annuities and interest-sensitive lifeinsurance products, based on the beginning of period contractholder funds, was9.8% for the first nine months of 2008 and 10.9% for the first nine months of2007.

 

*Net investment income* decreased 14.1% and 10.1% in the thirdquarter and first nine months of 2008, respectively, compared to the sameperiods of 2007.  The declines wereprimarily due to lower investment yields on floating rate securities, increasedshort-term investment balances reflecting liquidity management, lower averageinvestment balances, and valuation losses on limited partnership interestsaccounted for in accordance with the equity method of accounting.

 

*Realized capital gains and losses* reflected net losses of $568 million and$1.93 billion in the third quarter and first nine months of 2008, respectively,compared with net losses of $128 million and $2 million in the third quarterand first nine months of 2007, respectively. For further discussion of realized capital gains and losses, see theInvestments section of MD&A.

 

**Analysis of Costs and Expenses** Total costs and expenses decreased 15.5% and16.4% in the third quarter and first nine months of 2008, respectively,compared with the same periods of 2007 due to lower amortization of deferredpolicy acquisition costs (“DAC”) and interest credited to contractholder funds,partially offset by higher contract benefits and operating costs and expenses.

 

*Contract benefits* increased 14.6% or $46 million and 2.5% or $25 million in the thirdquarter and first nine months of 2008, respectively, compared to the sameperiods in 2007.  The increase in thethird quarter of 2008 was due to higher contract benefits on life insuranceproducts and immediate annuities with life contingencies resulting fromunfavorable mortality experience.  Theincrease in the first nine months of 2008 compared to the first nine months of2007 was due to higher contract benefits on life insurance products resultingfrom increased insurance in force and unfavorable mortality experience,partially offset by lower contract benefits on immediate annuities with lifecontingencies resulting primarily from the impact of lower sales, and therecognition in the prior year period of litigation related costs in the form ofadditional policy benefits.

 

Weanalyze our mortality and morbidity results using the difference betweenpremiums and contract charges earned for the cost of insurance and contractbenefits excluding the portion related to the implied interest on immediateannuities with life contingencies (“benefit spread”).  This implied interest totaled $137 million inboth the third quarter of 2008 and 2007, respectively, and totaled $413 millionand $412 million in the first nine months of 2008 and 2007, respectively.  The benefit spread by product group isdisclosed in the following table.

 
| ** **                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)** | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Life insurance                |       | $                                                    | 79         |                                                | $          | 86 |   | $ | 261 |   | $ | 247 |   |
| Annuities                     |       | (23                                                  | )          | (4                                                  | )          | (49 | ) | (18 | ) |
| Total benefit spread          |       | $                                                    | 56         |                                                | $          | 82 |   | $ | 212 |   | $ | 229 |   |

 

25

----

* *

*Interest credited to contractholder funds* decreased 14.7% or $99 million in the thirdquarter of 2008 compared to the third quarter of 2007 and 11.9% or $235 millionin the first nine months of 2008 compared to the same period of 2007.  These decreases were due primarily to adecline in average contractholder funds, decreased weighted average interestcrediting rates on institutional products due to a decline in market interestrates on floating rate obligations, and lower amortization of deferred salesinducements (“DSI”), partially offset by higher weighted average interestcrediting rates on deferred fixed annuities. Amortization of DSI reflected a credit to income of $2 million and $17million in the third quarter and first nine months of 2008, respectively,compared to a charge to income of $15 million and $44 million in the thirdquarter and first nine months of 2007, respectively. The changes of $17 millionand $61 million in the third quarter and first nine months of 2008,respectively, compared to the same periods in the prior year, were predominantlythe result of realized capital losses recorded in the current year periods onassets that support fixed annuities.

 

In order to analyze the impact of net investment income and interestcredited to contractholders on net income, we review the difference between netinvestment income and the sum of interest credited to contractholder funds andthe implied interest on immediate annuities with life contingencies, which isincluded as a component of contract benefits on the Condensed Consolidated Statementsof Operations (“investment spread”).  Theinvestment spread by product group is shown in the following table.

 
| ** **                                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                            | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Annuities                                                |       | $                                                    | 115        |                                                | $          | 126 |   | $ | 362 |   | $ | 384 |   |
| Life insurance                                           |       | 8                                                    |       | 13                                                  |       | 37 |   | 42 |   |
| Institutional products                                   |       | 13                                                   |       | 19                                                  |       | 56 |   | 64 |   |
| Net investment income on investments  supporting capital |       | 66                                                   |       | 95                                                  |       | 226 |   | 276 |   |
| Total investment spread                                  |       | $                                                    | 202        |                                                | $          | 253 |   | $ | 681 |   | $ | 766 |   |

 

Tofurther analyze investment spreads, the following table summarizes the weightedaverage investment yield on assets supporting product liabilities and capital,interest crediting rates and investment spreads for the three months ended September 30.

** **
| ** **                                                           | ** ** | **Weighted average  investment yield** | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                         | ** ** | **2007**                                                     | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest-sensitive life insurance                                    |       | 6.0                                              | %          | 6.2                                                          | %          | 4.7                                                | %          | 4.7 | % | 1.3 | % | 1.5 | % |
| Deferred fixed annuities                                             |       | 5.7                                              |       | 5.9                                                          |       | 3.8                                                |       | 3.8 |   | 1.9 |   | 2.1 |   |
| Immediate fixed annuities with and without  life contingencies       |       | 6.7                                              |       | 7.0                                                          |       | 6.5                                                |       | 6.5 |   | 0.2 |   | 0.5 |   |
| Institutional products                                               |       | 3.7                                              |       | 6.3                                                          |       | 3.2                                                |       | 5.5 |   | 0.5 |   | 0.8 |   |
| Investments supporting capital, traditional  life and other products |       | 5.0                                              |       | 5.9                                                          |       | N/A                                                |       | N/A |   | N/A |   | N/A |   |

 

Thefollowing table summarizes the weighted average investment yield on assetssupporting product liabilities and capital, interest crediting rates andinvestment spreads for the nine months ended September 30.

 
| ** **                                                           | ** ** | **Weighted average  investment yield** | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                         | ** ** | **2007**                                                     | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest-sensitive life insurance                                    |       | 6.1                                              | %          | 6.2                                                          | %          | 4.6                                                | %          | 4.6 | % | 1.5 | % | 1.6 | % |
| Deferred fixed annuities                                             |       | 5.6                                              |       | 5.8                                                          |       | 3.8                                                |       | 3.7 |   | 1.8 |   | 2.1 |   |
| Immediate fixed annuities with and without  life contingencies       |       | 6.8                                              |       | 7.1                                                          |       | 6.5                                                |       | 6.5 |   | 0.3 |   | 0.6 |   |
| Institutional products                                               |       | 4.3                                              |       | 6.1                                                          |       | 3.5                                                |       | 5.2 |   | 0.8 |   | 0.9 |   |
| Investments supporting capital, traditional  life and other products |       | 5.6                                              |       | 5.8                                                          |       | N/A                                                |       | N/A |   | N/A |   | N/A |   |

 

26

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The following table summarizes our product liabilities as of September 30and indicates the account value of those contracts and policies in which aninvestment spread is generated.

 
| ** **                                                     | ** ** | **As of September 30,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2008**                               | ** ** | **2007** | ** ** |
| Immediate fixed annuities with life  contingencies             |       | $                                      | 8,316      |   | $ | 8,249 |   |
| Other life contingent contracts and other                      |       | 3,825                                  |       | 4,047 |   |
| Reserve for life-contingent contract  benefits                 |       | $                                      | 12,141     |   | $ | 12,296 |   |
|                                                           |       |                                   |       |   |   |
| Interest-sensitive life                                        |       | $                                      | 9,220      |   | $ | 8,804 |   |
| Deferred fixed annuities                                       |       | 34,195                                 |       | 34,728 |   |
| Immediate fixed annuities without life  contingencies          |       | 3,891                                  |       | 3,816 |   |
| Institutional products                                         |       | 10,042                                 |       | 13,500 |   |
| Fair value adjustments related to fair  value hedges and other |       | 442                                    |       | 469 |   |
| Contractholder funds                                           |       | $                                      | 57,790     |   | $ | 61,317 |   |

* *

*Amortization of DAC* reflected a credit to income of $26 million in the third quarter of2008 compared to a charge to income of $129 million in the third quarter of 2007.  For the first nine months of 2008 and 2007,amortization of DAC reflected a credit to income of $32 million and a charge toincome of $410 million, respectively. The changes of $155 million and $442 million in the third quarter andfirst nine months of 2008, respectively, compared to the same periods in theprior year, were predominantly the result of reduced actual gross profits forfixed annuities and interest-sensitive life insurance products due to realizedcapital losses recorded in the current year periods.

 

Accretionof DAC related to realized capital gains and losses was $151 million and $15million in the third quarter of 2008 and 2007, respectively.  In the first nine months of 2008, accretionof DAC related to realized capital gains and losses was $375 million.  This compares to amortization of DAC in thefirst nine months of 2007 of $5 million. The impact of realized capital gains and losses on amortization of DACis dependent upon the relationship between the assets that give rise to the gainor loss and the product liability supported by the assets.  Fluctuations result from changes in theimpact of realized capital gains and losses on actual and expected grossprofits.

 

*Operating costs and expenses* increased 26.2% and 22.2% in the third quarterand first nine months of 2008, respectively, compared to the same periods of2007.   The following table summarizesoperating costs and expenses.

 
| ** **                         | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**      | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Non-deferrable acquisition costs   |       | $                                                    | 21         |                                                | $          | 24 |   | $ | 61 |   | $ | 72 |   |
| Other operating costs and expenses |       | 85                                                   |       | 60                                                  |       | 236 |   | 171 |   |
| Total operating costs and expenses |       | $                                                    | 106        |                                                | $          | 84 |   | $ | 297 |   | $ | 243 |   |

 

Non-deferrableacquisition costs decreased 12.5% or $3 million in the third quarter anddecreased 15.3% or $11 million in the first nine months of 2008, compared tothe same periods of 2007, primarily due to lower non-deferrablecommissions.  Other operating costs andexpenses increased 41.7% or $25 million in the third quarter and 38.0% or $65million in the first nine months of 2008, compared to the same periods of 2007,due primarily to increased spending on consumer research, product development,marketing and technology related to the effort to reinvent protection andretirement for consumers.  In addition,the prior periods benefitted from a servicing fee paid by Prudential FinancialInc. (“Prudential”) for our servicing of the variable annuity business that weceded to them during a transition period beginning in 2006.

 

*Gain on disposition of operations* declined $4 million in the third quarter of2008 compared to the third quarter of 2007. This decline was due to a favorable adjustment in the prior year quarterfor a reduction in accrued losses that relate to the anticipated disposition ofcertain non-strategic legal entities.  Inthe first nine months of 2008, a loss on disposition of operations of $7million was recognized and compares to a gain of $9 million in the first ninemonths 

 

27

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of2007.  This unfavorable change was theresult of losses accrued in the current year period associated with theanticipated disposition of our direct response long-term care business that iscurrently held for sale.

 

*Income tax benefit* of $118 million and $394 million wasrecognized for the third quarter and first nine months of 2008, respectively,compared to income tax expense of $24 million and $195 million in the thirdquarter and first nine months of 2007, respectively.  The change reflects the shift from netpre-tax income in the prior year periods to a net pre-tax loss in the currentyear periods.

 

**INVESTMENTS**

** **

During2008, we developed risk mitigation and return optimization programs as ouroutlook on the economy has experienced significant revisions as conditionsdeteriorated throughout the year.  By theend of the third quarter of 2008, we modified our outlook to a more severe andprolonged downturn in the global financial markets and economy.  This represents a significant change from ourassessment of the economy as of the end of the second quarter of 2008 where wehad an outlook for continued weakness in the global financial markets andeconomy including continued volatility in the financial markets, continuedreduced liquidity in certain asset classes and further unfavorable economictrends.  The risk mitigation and returnoptimization programs augment earlier actions to reduce investments in realestate and other market sectors as well as to mitigate exposures to risk-freeinterest rate spikes.  We expectcontinued volatility in the financial markets, significantly reduced liquidityin certain asset classes and unfavorable economic trends.  In addition, the potential for systemicinvestment supply and demand imbalances has remained above normal due to thedeteriorating credit strength of financial institutions and eroding investorconfidence.

 

Duringthe third quarter of 2008, reflecting decisions made and reported at the end ofthe second quarter of 2008, we pursued risk mitigation and return optimizationprograms to protect portfolio value. As part of these programs, hedges wereimplemented during the third quarter of 2008 to mitigate portfolio creditspread risk. These performed as intended. Another component of our overall portfolio protection (macro-hedging)program is less comprehensive since these derivatives are less effective andefficient and partially mitigates some general market credit spread risk.

 

Acomprehensive review identified specific investments that could besignificantly impacted by continued deterioration in the economy includingcertain real estate and financial-related market sectors that may be sold. Thisincluded a portion of our residential and commercial real estate securitiesincluding securities collateralized by residential and commercial mortgageloans, mortgage loans and securities issued by financial institutions.  The risk mitigation and return optimizationprograms as of the end of the second quarter of 2008, which resulted in changein intent write-downs, were designed to reduce our exposure to residential andcommercial real estate and financial related markets by approximately $3billion of amortized cost, prior to change in intent write-downs.

 

Asof June 30, 2008, we held $2.97 billion of investments for which we hadchanged our intent to hold to recovery. These investments included $2.64 billion that we believed to bevulnerable to significant additional credit and pricing pressures, and $329million related to individual securities. During the third quarter of 2008, we sold $1.06 billion of thesesecurities.  Change in intent write-downsof $262 million were recorded in the third quarter of 2008 including $229million related to securities for which we changed our intent to hold torecovery in the second quarter of 2008 that we still held at September 30,2008 and $33 million related to $275 million of securities for which we changedour intent to hold to recovery in the third quarter of 2008 due to unanticipatedchanges in facts and circumstances. Investments for which we changed our intent to hold to recovery totaled$1.78 billion as of September 30, 2008.

 

Asa part of our risk mitigation and return optimization activities, we have takenthe following actions:

 

·                  Developeda tactical positioning in liquid assets and assets that we can sell withoutsignificant loss.

·                  Continuedto reduce exposure in assets other than those for which we have asserted anintent to hold until recovery where we have credit concerns or where there hasbeen a significant change in facts and circumstances.

·                  Ourexposure to financial-related market sectors, which primarily includes fixedincome holdings in banks, brokerages, finance companies and insurance,decreased to $7.66 billion as of September 30, 2008 from $9.82 billion asof December 31, 2007, primarily as a result of targeted sales and declinesin fair value.

 

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·                  Ourexposure to residential and commercial real estate market sectors comprisedprimarily of mortgage-backed securities (“MBS”), commercial mortgage-backedsecurities (“CMBS”), asset-backed residential mortgage-backed securities (“ABSRMBS”), asset-backed collateralized debt obligations (“ABS CDO”) and mortgageloans decreased to $20.83 billion as of September 30, 2008 from $24.36billion as of December 31, 2007 as a result of targeted sales and declinesin fair value.

·                  Reducedoverall counterparty exposure replacing over-the-counter (“OTC”) derivativestransactions with exchange traded instruments where available and, in one case,terminating a counterparty relationship.

·                  Duringthe third quarter of 2008, we sold $592 million of government securities andrecognized realized capital gains of $132 million.  In addition, through October 20, 2008,we sold government securities with a carrying value of $506 million on which werealized capital gains of $87 million.

 

We continue to monitor the progress of theseprograms as market and economic conditions develop and will adapt our decisionsas appropriate.  Our continuing focus isto manage our risks and to position our portfolio to take advantage of marketopportunities while attempting to mitigate further adverse effects.

 

Fundsraised from the sales of securities will eventually be invested in accordancewith our asset-liability management strategies. To the extent markets remainunstable, however, we intend to deploy funds available forreinvestment in high quality, shorter term, and lower-risk investments.  Net investment income may be lower as afunction of current yields available on these investments as well as somewhathigher short term balances.

 

An important component ofour financial results is the return on our investment portfolio.  The composition of the investment portfolioat September 30, 2008 is presented in the table below.

 
| **($ in millions)**     | ** ** | **Investments** | ** ** | **Percent to  total** | ** ** |
|-----------------------------------|------------|-----------------|------------|----------------------------|------------|
| Fixed income securities (1)       |       | $               | 48,071     |                       | 74.2       | % |
| Mortgage loans                    |       | 10,234          |       | 15.8                       |       |
| Equity securities (2)             |       | 108             |       | 0.2                        |       |
| Limited partnership interests (3) |       | 1,184           |       | 1.8                        |       |
| Short-term                        |       | 3,045           |       | 4.7                        |       |
| Policy loans                      |       | 809             |       | 1.2                        |       |
| Other                             |       | 1,363           |       | 2.1                        |       |
| Total                             |       | $               | 64,814     |                       | 100.0      | % |

 

----

(1)         Fixed income securities are carried at fairvalue.  Amortized cost basis for thesesecurities was $51.09 billion.

(2)         Equity securities are carried at fairvalue.  Cost basis for these securitieswas $116 million.

(3)         We have commitments to invest in additionallimited partnership interests totaling $1.14 billion at September 30,2008.

----

 

Total investments decreasedto $64.81 billion at September 30, 2008, from $72.41 billion at December 31,2007, due to unrealized net capital losses, net realized capital losses, assetsales to fund the retirements and maturities of institutional market deposits,and lower funds associated with collateral received in conjunction withsecurities lending.

 

Total investments atamortized cost related to collateral received in connection with securitieslending business activities and collateral posted by counterparties related toderivative transactions decreased to $1.23 billion at September 30, 2008,from $1.82 billion at December 31, 2007. These investments are carried at fair value and classified in fixedincome securities totaling $682 million and $1.57 billion, respectively, andshort-term investments totaling $459 million and $219 million, as of September 30,2008 and December 31, 2007, respectively.

 

29

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Fixed income securities by type are listed in the table below.

 
| **($ in millions)**             | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  investments** | ** ** | **Fair value at  December 31, 2007** | ** ** | **% to Total  investments** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------|------------|
| U.S. government and agencies              |       | $                                                         | 3,612      |                                  | 5.6        | %                                                        | $          | 3,728                                 |       | 5.2 | % |
| Municipal                                 |       | 3,859                                                     |       | 6.0                                   |       | 4,311                                                    |       | 6.0                                   |       |
| Corporate                                 |       | 27,057                                                    |       | 41.7                                  |       | 31,735                                                   |       | 43.8                                  |       |
| Foreign government                        |       | 1,964                                                     |       | 3.0                                   |       | 2,185                                                    |       | 3.0                                   |       |
| MBS                                       |       | 2,809                                                     |       | 4.3                                   |       | 3,490                                                    |       | 4.8                                   |       |
| CMBS                                      |       | 5,096                                                     |       | 7.9                                   |       | 7,388                                                    |       | 10.2                                  |       |
| Asset-backed securities (“ABS”) |       | 3,659                                                     |       | 5.7                                   |       | 5,603                                                    |       | 7.7                                   |       |
| Redeemable preferred stock                |       | 15                                                        |       | —                                |       | 29                                                       |       | —                                |       |
| Total fixed income securities             |       | $                                                         | 48,071     |                                  | 74.2       |                                                     | $          | 58,469                                |       | 80.7 | % |

 

At September 30, 2008, 95.7% of the fixed income securitiesportfolio was rated investment grade, which is defined as a security having arating from the National Association of Insurance Commissioners (“NAIC”) of 1or 2; a rating of Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBBfrom Standard and Poor’s (“S&P’s”), Fitch or Dominion or a rating of aaa,aa, a or bbb from A.M. Best; or a comparable internal rating if anexternally provided rating is not available.

 

Duringthe third quarter of 2008, certain financial markets continued to experienceprice declines due to market and liquidity disruptions.  We experienced this illiquidity anddisruption particularly in our Prime residential mortgage-backed securities (“Prime”),Alt-A residential mortgage-backed securities (“Alt-A”), commercial real estatecollateralized debt obligations (“CRE CDO”), ABS RMBS and ABS CDO and othercollateralized debt obligations (“other CDO”) portfolios.  These portfolios totaled $3.96 billion, orapproximately 6.1% of our total investments at September 30, 2008.  Other securities markets, including certainother asset-backed and real estate-backed securities markets, experiencedilliquidity, but to a lesser degree.

 

Wedetermine the fair values of securities comprising the illiquid portfolios byobtaining information from an independent third-party valuation serviceprovider, brokers and other sources. We confirmed the reasonableness of thefair value of these portfolios as of September 30, 2008 by analyzingavailable market information including, but not limited to, collateral quality,anticipated cash flows, credit enhancements, default rates, loss severities,securities’ relative position within their respective capital structures, andcredit ratings from statistical rating agencies.

 

Impairmentwrite-downs during the third quarter of 2008 were recorded on our other CDO,ABS RMBS, Alt-A and CRE CDO totaling $170 million, $6 million, $2 million, and$2 million, respectively, for a total of $180 million.  Impairment write-downs during the first ninemonths of 2008 were recorded on our other CDO, ABS RMBS, ABS CDO, Alt-A, CRECDO and Prime totaling $188 million, $152 million, $63 million, $43 million,$41 million and $9 million, respectively, for a total of $496 million.  Change in intent write-downs for the thirdquarter of 2008 included losses on our ABS RMBS, CRE CDO, Alt-A, and Primetotaling $58 million, $50 million, $11 million and $3 million, respectively,for a total of $122 million.  Change inintent write-downs during the first nine months of 2008 included losses on ourCRE CDO, ABS RMBS, Alt-A and Prime totaling $298 million, $190 million, $40million and $11 million, respectively, for a total of $539 million.

 

The par value of our illiquid investment portfoliostotaled $6.33 billion and amortized cost totaled $5.32 billion or 84.0% of parvalue at September 30, 2008, which is primarily the result of write-downsof approximately $1.01 billion.  Fairvalue of these investments totaled $3.96 billion or 62.5% of par value.

 

30

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Theunrealized net capital losses as of September 30, 2008 on our illiquidportfolios are detailed in the following table.

 
| **($ in millions)** | ** ** | **Par  value ****(2)** | ** ** | **Amortized  cost ****(1) (2)** | ** ** | **% Amortized  cost to par  value** | ** ** | **Fair  value** | ** ** | **% Fair  value to  par value** | ** ** | **Unrealized  gain/loss** | ** ** |
|-------------------------------|------------|-----------------------------|------------|-------------------------------------------|------------|----------------------------------------------------|------------|-----------------|------------|------------------------------------------------|------------|---------------------------|------------|
| **MBS**                       |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| Prime                         |       | $                           | 685        |                                      | $          | 675                                                |       | 98.5            | %          | $                                              | 592        |                      | 86.4       | % | $ | (83 | ) |
| Alt-A                         |       | 519                         |       | 447                                       |       | 86.1                                               |       | 364             |       | 70.1                                           |       | (83                       | )          |
|                          |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| **CMBS**                      | ** ** | ** **                  | ** ** | ** **                                | ** ** | ** **                                         | ** ** | ** **      | ** ** | ** **                                     | ** ** | ** **                | ** ** |
| CRE CDO                       |       | 339                         |       | 114                                       |       | 33.6                                               |       | 115             |       | 33.9                                           |       | 1                         |       |
|                          |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| **ABS**                       |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| ABS RMBS                      |       | 2,406                       |       | 2,071                                     |       | 86.1                                               |       | 1,553           |       | 64.5                                           |       | (518                      | )          |
| ABS CDO                       |       | 137                         |       | 11                                        |       | 8.0                                                |       | 8               |       | 5.8                                            |       | (3                        | )          |
| Other CDO                     |       | 2,247                       |       | 2,001                                     |       | 89.1                                               |       | 1,326           |       | 59.0                                           |       | (675                      | )          |
|                          |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| Total                         |       | $                           | 6,333      |                                      | $          | 5,319                                              |       | 84.0            |       | $                                              | 3,958      |                      | 62.5       |   | $ | (1,361 | ) |

 

----

(1) Amortizedcost includes other-than-temporary impairment charges, as applicable.

(2) The difference between par value andamortized cost of $1.01 billion is primarily attributable to write-downs.  Par value has been reduced by principalpayments.

----

 

Unrealizednet capital losses as of September 30, 2008 included $83 million on Prime,$83 million on Alt-A, $518 million on ABS RMBS, $3 million on ABS CDO and $675million on other CDO, for a total of $1.36 billion.  Unrealized net capital gains as of September 30,2008 included $1 million on the CRE CDO.

 

Securitiesincluded in our illiquid portfolios with a fair value less than 70% ofamortized cost as of September 30, 2008 are shown in the following table.

 
| **($ in millions)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/loss** | ** ** |
|-------------------------------|------------|-----------------|------------|---------------------------|------------|
| **MBS**                       |       |            |       |                      |       |
| Prime                         |       | $               | —     |                      | $          | — |   |
| Alt-A                         |       | 25              |       | (17                       | )          |
|                          |       |            |       |                      |       |
| **CMBS**                      |       |            |       |                      |       |
| CRE CDO                       |       | —          |       | —                    |       |
|                          |       |            |       |                      |       |
| **ABS**                       |       |            |       |                      |       |
| ABS RMBS                      |       | 368             |       | (412                      | )          |
| ABS CDO                       |       | 2               |       | (1                        | )          |
| Other CDO                     |       | 657             |       | (559                      | )          |
| Total                         |       | $               | 1,052      |                      | $          | (989 | ) |

 

In addition, as of September 30, 2008, CMBS excluding CRE CDO parvalue totaled $5.87 billion and amortized cost totaled $5.74 billion or 97.8%of par value, which was primarily the result of write-downs.  Fair value totaled $4.98 billion or 84.8% ofpar value.

 

Wecontinue to believe that the unrealized losses on these securities are notnecessarily predictive of the ultimate performance of the underlyingcollateral.  In the absence of furtherdeterioration in the collateral relative to our positions in the securities’respective capital structures, which could be other-than-temporary, theunrealized losses should reverse over the remaining lives of the securities.

 

The cash flows of the underlying mortgages or collateral for MBS, CRECDO and ABS are generally applied in a pre-determined order and are designed sothat each security issued qualifies for a specific original rating.  The security issue is typically referred toas the “class”.  For example, the “senior”portion or “top” of the capital structure which would originally qualify for arating of Aaa is referred to as the “Aaa class” and typically has 

 

31

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priority in receiving theprincipal repayments on the underlying mortgages.  In addition, the portion of the capitalstructure originally rated Aaa may further be divided into multiplesub-classes, “super senior”, “senior” ,”senior support” for Prime and Alt-Aissues, “first”, “second”, “third” for ABS RMBS, and “senior” or “junior” fortrust preferred CDO issues.  Thesub-classes may receive principal repayments on a sequential or pro-ratapayment basis depending upon the structure. In a sequential structure, underlying collateral principal repaymentsare directed to the most senior rated Aaa class in the structure until paid infull, after which principal repayments are directed to the next most senior Aaaclass in the structure until it is paid in full.  Although the various Aaa classes may receiveprincipal sequentially, they may share any losses from the underlyingcollateral on a pro-rata basis after losses are absorbed by classes with loweroriginal ratings or what may be referred to as more “junior” or “subordinate”securities in the capital structure.  Theunderlying mortgages have fixed interest rates, variable interest rates (suchas adjustable rate mortgages (“ARM”)), or are hybrid, meaning that they containfeatures of both fixed and variable rate mortgages.

 

*MBS* totaled $2.81 billion and 99.6% were rated investment grade at September 30,2008.  The MBS portfolio is subject tointerest rate risk since price volatility and the ultimate realized yield areaffected by the rate of prepayment of the underlying mortgages.  The credit risk associated with our MBS ismitigated due to the fact that 66.0% of the portfolio consists of securitiesthat were issued by, or have underlying collateral that is guaranteed by U.S.government agencies or U.S. government sponsored entities (“U.S. Agency”).

 

The following table shows MBS by type and Moody’s equivalent rating.

 
| **($ in millions)** | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  investments** | ** ** | **Aaa** | ** ** | **Aa** | ** ** | **A**  | ** ** | **Ba or  lower** | ** ** |
|-------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|---------|------------|--------|------------|--------|------------|-----------------------|------------|
| **MBS**                       |       |                                                      |       |                                  |       |    |       |   |       |   |       |                  |       |
| U.S. Agency                   |       | $                                                         | 1,853      |                                  | 2.8        | %       | 100.0      | %      | —     |   | —     |                  | —     |   |
| Prime                         |       | 592                                                       |       | 0.9                                   |       | 98.8    |       | 1.2    | %          | — |       | —                |       |
| Alt-A                         |       | 364                                                       |       | 0.6                                   |       | 88.4    |       | 8.0    |       | — |       | 3.6                   | %          |
| Total MBS                     |       | $                                                         | 2,809      |                                  | 4.3        | %       |       |   |       |   |       |                  |       |   |

 

Primeare collateralized by residential mortgage loans issued to primeborrowers.  As of September 30,2008, fair value represents 87.7% of amortized cost of these securities.  There were no Prime securities with a fairvalue less than 70% of amortized.  During the third quarter and first nine months of 2008, we sold $67million and $179 million of Prime, respectively, recognizing net losses of $12million and $10 million in the third quarter and first nine months of 2008,respectively.  We also collected $17 millionand $57 million of principal repayments consistent with the expected cash flowsduring the third quarter and first nine months of 2008, respectively.  There have been no impairment write-downsrecognized during the third quarter and $9 million of impairment write-downswere recognized in the first nine months of 2008.  $3 million and $11 million of change inintent write-downs were recorded during the third quarter and first nine monthsof 2008, respectively, on Prime.  82.9%of our Prime positions are fixed rate mortgages and 99.7% of the Primeportfolio is in the Aaa class of the capital structure.

 

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Thefollowing table shows our Prime portfolio at September 30, 2008 by vintageyear, based upon our participation in the capital structure.

 
| **($ in millions)**                               | ** ** | **Vintage year** | ** ** | **Fair ** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|---------------|------------|----------------|------------|
| **Capital structure classification ****(2)** | ** ** | **2007**              | ** ** | **2006**       | ** ** | **2005**      | ** ** | **Pre-2005**   | ** ** | **value** | ** ** | **cost ****(1)** | ** ** | **gain/loss** | ** ** |
| ** **                                                  | ** ** | ** **            | ** ** | ** **     | ** ** | ** **    | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Aaa – Fixed rate**                                   | ** ** | ** **            | ** ** | ** **     | ** ** | ** **    | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Super Senior                                                |       | $                     | —     |           | $          | —        |       | $              | —     |   | $ | 44 |   | $ | 44 |   | $ | 50 |   | $ | (6 | ) |
| Senior                                                      |       | 97                    |       | 43             |       | 84            |       | 216            |       | 440 |   | 498 |   | (58 | ) |
| Senior Support                                              |       | —                |       | —         |       | —        |       | 5              |       | 5 |   | 5 |   | — |   |
|                                                        |       | 97                    |       | 43             |       | 84            |       | 265            |       | 489 |   | 553 |   | (64 | ) |
| **Aaa – Hybrid**                                       |       |                  |       |           |       |          |       |           |       |   |   |   |   |   |   |
| Super Senior                                                |       | —                |       | —         |       | 53            |       | 9              |       | 62 |   | 75 |   | (13 | ) |
| Senior                                                      |       | —                |       | —         |       | —        |       | 30             |       | 30 |   | 34 |   | (4 | ) |
| Senior Support                                              |       | —                |       | —         |       | 9             |       | —         |       | 9 |   | 11 |   | (2 | ) |
|                                                        |       | —                |       | —         |       | 62            |       | 39             |       | 101 |   | 120 |   | (19 | ) |
| **Aa – Fixed rate**                                    |       |                  |       |           |       |          |       |           |       |   |   |   |   |   |   |
| Senior Support                                              |       | —                |       | —         |       | —        |       | 2              |       | 2 |   | 2 |   | — |   |
|                                                        |       |                  |       |           |       |          |       |           |       |   |   |   |   |   |   |
| Total                                                       |       | $                     | 97         |           | $          | 43            |       | $              | 146        |   | $ | 306 |   | $ | 592 |   | $ | 675 |   | $ | (83 | ) |

 

----

(1)   Amortized cost includes other-than-temporaryimpairment charges, as applicable.

(2)   May not be consistentwith current ratings due to downgrades.

----

 

Includedin our mortgage-backed fixed income securities are Alt-A at fixed or variablerates.  The following table presentsinformation about the collateral in our Alt-A holdings.

 
| **($ in millions)** | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  investments** | ** ** |
|-------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|
| **Alt-A**                     |       |                                                      |       |                                  |       |
| Fixed rate                    |       | $                                                         | 291        |                                  | 0.5        | % |
| Variable rate                 |       | 73                                                        |       | 0.1                                   |       |
| Total Alt-A                   |       | $                                                         | 364        |                                  | 0.6        | % |

 

Alt-A can be issued by trusts backed by pools of residential mortgageswith either fixed or variable interest rates. The mortgage pools can include residential mortgage loans issued toborrowers with stronger credit profiles than sub-prime borrowers, but who donot qualify for prime financing terms due to high loan-to-value ratios orlimited supporting documentation.  As of September 30,2008, fair value represents 81.4% of the amortized cost of thesesecurities.  Alt-A securities with a fairvalue less than 70% of amortized cost totaled $25 million, with unrealizedlosses of $17 million.  During the thirdquarter and first nine months of 2008, we sold $40 million and $41 million ofAlt-A, respectively, recognizing a loss of $6 million in both the third quarterand first nine months of 2008.  We alsocollected $9 million and $41 million of principal repayments consistent withthe expected cash flows during the third quarter and first nine months of 2008,respectively.  Impairment write-downsduring the third quarter and first nine months of 2008 were recorded on ourAlt-A totaling $2 million and $43 million, respectively.  In addition, $11 million and $40 million ofchange in intent write-downs were recorded during the third quarter and firstnine months of 2008, respectively, on Alt-A.

 

33

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Thefollowing table shows our Alt-A portfolio at September 30, 2008 by vintageyear, based upon our participation in the capital structure.

 
| ** **                                                                               | ** ** | **Vintage year** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **   | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|--------------|------------|
| **($ in millions)****Capital structure classification ****(2)** | ** ** | **2007**              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-2005** | ** ** | **Fair  value** | ** ** | **Amortized  cost ****(1)** | ** ** | **Unrealized  gain/loss** | ** ** |
| ** **                                                                               | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Aaa – Fixed rate**                                                                | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Super Senior                                                                             |       | $                     | —     |       | $          | 7          |       | $            | 31         |   | $ | — |   | $ | 38 |   | $ | 57 |   | $ | (19 | ) |
| Senior                                                                                   |       | 27                    |       | 23         |       | 63         |       | 128          |       | 241 |   | 296 |   | (55 | ) |
| Senior Support                                                                           |       | 12                    |       | 2          |       | —     |       | —       |       | 14 |   | 14 |   | — |   |
|                                                                                     |       | 39                    |       | 32         |       | 94         |       | 128          |       | 293 |   | 367 |   | (74 | ) |
| ** **                                                                               |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| **Aaa – Hybrid**                                                                    |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| Super Senior                                                                             |       | —                |       | 21         |       | —     |       | —       |       | 21 |   | 28 |   | (7 | ) |
| Senior                                                                                   |       | —                |       | —     |       | 11         |       | 5            |       | 16 |   | 20 |   | (4 | ) |
| Senior Support                                                                           |       | —                |       | —     |       | —     |       | 2            |       | 2 |   | 2 |   | — |   |
|                                                                                     |       | —                |       | 21         |       | 11         |       | 7            |       | 39 |   | 50 |   | (11 | ) |
|                                                                                     |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| **Aaa - Option adjustable rate mortgage**                                                |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| Senior Support                                                                           |       | —                |       | —     |       | —     |       | 2            |       | 2 |   | 2 |   | — |   |
| Subordinate                                                                              |       | —                |       | —     |       | 4          |       | —       |       | 4 |   | 3 |   | 1 |   |
|                                                                                     |       | —                |       | —     |       | 4          |       | 2            |       | 6 |   | 5 |   | 1 |   |
|                                                                                     |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| **Aa – Fixed rate**                                                                 |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| Senior Support                                                                           |       | —                |       | 7          |       | 3          |       | —       |       | 10 |   | 10 |   | — |   |
|                                                                                     |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| **Aa – Option adjustable rate mortgage**                                            |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| Subordinate                                                                              |       | —                |       | —     |       | 1          |       | 15           |       | 16 |   | 15 |   | 1 |   |
|                                                                                     |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| Total                                                                                    |       | $                     | 39         |       | $          | 60         |       | $            | 113        |   | $ | 152 |   | $ | 364 |   | $ | 447 |   | $ | (83 | ) |

 

----

(1) Amortized cost includes other-than-temporaryimpairment charges, as applicable

(2) May not be consistent with currentratings due to downgrades.

----

 

*CMBS* totaled $5.10 billion and 99.9% were rated investment grade at September 30,2008.  The CMBS portfolio is subject tocredit risk, but unlike other structured securities, is generally not subjectto prepayment risk due to protections within the underlying commercialmortgages whereby borrowers are effectively restricted from prepaying theirmortgages due to changes in interest rates. Approximately 89.4% of the CMBS investments are pools of commercialmortgages, broadly diversified across property types and geographicalarea.  The following table shows CMBS bytype and Moody’s equivalent rating.

 
| **($ in millions)** | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  investments** | ** ** | **Aaa** | ** ** | **Aa** | ** ** | **A**  | ** ** | **Baa** | ** ** | **Ba or  lower** | ** ** |
|-------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|---------|------------|--------|------------|--------|------------|---------|------------|-----------------------|------------|
| **CMBS**                      |       |                                                      |       |                                  |       |    |       |   |       |   |       |    |       |                  |       |
| CMBS                          |       | $                                                         | 4,981      |                                  | 7.7        | %       | 84.6       | %      | 12.8       | %      | 2.3        | %       | 0.3        | %                     | —     | % |
| CRE CDO                       |       | 115                                                       |       | 0.2                                   |       | 23.5    |       | 26.1   |       | 33.0   |       | 16.5    |       | 0.9                   |       |
| Total CMBS                    |       | $                                                         | 5,096      |                                  | 7.9        | %       |       |   |       |   |       |    |       |                  |       |   |

 

CRECDO are investments secured primarily by commercial mortgage-backed securitiesand other commercial mortgage debt obligations. These securities are generally less liquid and have a higher riskprofile than other commercial mortgage-backed securities.  As of September 30, 2008, fair valuerepresents 100.9% of the amortized cost of these securities.  During the third quarter and first ninemonths of 2008, we sold $197 million and $233 million of CRE CDO, respectively,recognizing a loss of $9 million and $34 million in the third quarter and firstnine months of 2008, respectively.  Wealso collected $2 million and $5 million of principal repayments consistent

 

34

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withthe expected cash flows during the third quarter and first nine months of 2008,respectively.  Impairment write-downsduring both the third quarter and first nine months of 2008 were recorded onour CRE CDO totaling $2 million and $41 million, respectively.  In addition, $50 million and $298 million ofchange in intent write-downs were recorded during the third quarter and firstnine months of 2008, respectively, on CRE CDO. The following table shows our CRE CDO portfolio at September 30,2008 by vintage year, based upon our participation in the capital structure.

 
| ** **                                                    | ** ** | **Vintage year** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|----------------|------------|
| **($ in millions)  Capital structure ****(2)** | ** ** | **2007**              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-  2005** | ** ** | **Fair  value** | ** ** | **Amortized  cost ****(1)** | ** ** | **Unrealized  gain/loss** | ** ** |
| ** **                                                    |       |                  |       |       |       |       |       |           |       |   |   |   |   |   |   |
| Aaa                                                           |       | $                     | 15         |       | $          | 15         |       | $              | —     |   | $ | — |   | $ | 30 |   | $ | 30 |   | $ | — |   |
| Aa                                                            |       | 2                     |       | 39         |       | 3          |       | 2              |       | 46 |   | 45 |   | 1 |   |
| A                                                             |       | 9                     |       | 8          |       | 10         |       | 5              |       | 32 |   | 32 |   | — |   |
| Baa                                                           |       | 1                     |       | 1          |       | 5          |       | —         |       | 7 |   | 7 |   | — |   |
| Total                                                         |       | $                     | 27         |       | $          | 63         |       | $              | 18         |   | $ | 7 |   | $ | 115 |   | $ | 114 |   | $ | 1 |   |

 

----

(1) Amortized cost includes other-than-temporaryimpairment charges, as applicable.

(2) May not be consistent with currentratings due to downgrades.

----

 

*ABS* totaled $3.66 billion and 96.3% were rated investment grade at September 30,2008.  ABS by type are listed in thetable below.

 
| **($ in millions)**                                                         | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  investments** | ** ** | **Fair value as a  % of  amortized cost** | ** ** | **Aaa**    | ** ** | **Aa**     | ** ** | **A**      | ** ** | **Baa**    | ** ** | **Ba or  lower** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-----------------------|------------|
| **ABS**                                                                               | ** ** | ** **                                                | ** ** | ** **                            | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **            | ** ** |
| ABS RMBS non-insured                                                                  |       | $                                                         | 1,256      |                                  | 1.9        | %                                                                  | 80.4       | %          | 49.3       | %          | 38.2       | %          | 6.6        | %          | 2.5        | %                     | 3.4        | % |
| ABS RMBS insured                                                                      |       | 297                                                       |       | 0.5                                   |       | 58.3                                                               |       | 15.5       |       | 26.9       |       | 27.6       |       | 17.2       |       | 12.8                  |       |
| Total ABS RMBS                                                                        |       | 1,553                                                     |       | 2.4                                   |       | 75.0                                                               |       | 42.9       |       | 36.1       |       | 10.6       |       | 5.3        |       | 5.1                   |       |
| ABS CDO                                                                               |       | 8                                                         |       | —                                |       | 72.7                                                               |       | —     |       | —     |       | —     |       | —     |       | 100.0                 |       |
| Total asset-backed securities  collateralized by sub-prime residential mortgage loans |       | 1,561                                                     |       | 2.4                                   |       | 75.0                                                               |       | 42.6       |       | 35.9       |       | 10.6       |       | 5.3        |       | 5.6                   |       |
|                                                                                  |       |                                                      |       |                                  |       |                                                               |       |       |       |       |       |       |       |       |       |                  |       |
| Other CDO:                                                                            |       |                                                      |       |                                  |       |                                                               |       |       |       |       |       |       |       |       |       |                  |       |
| Cash flow collateralized loan   obligations (“CLO”)                    |       | 883                                                       |       | 1.4                                   |       | 71.0                                                               |       | 34.8       |       | 22.8       |       | 32.2       |       | 7.8        |       | 2.4                   |       |
| Synthetic CDO                                                                         |       | 126                                                       |       | 0.2                                   |       | 56.3                                                               |       | 22.2       |       | 29.4       |       | 21.4       |       | 27.0       |       | —                |       |
| Trust preferred CDO                                                                   |       | 100                                                       |       | 0.2                                   |       | 51.3                                                               |       | 72.0       |       | 28.0       |       | —     |       | —     |       | —                |       |
| Market value CDO                                                                      |       | 85                                                        |       | 0.1                                   |       | 69.7                                                               |       | —     |       | 24.7       |       | 32.9       |       | 42.4       |       | —                |       |
| Project finance CDO                                                                   |       | 45                                                        |       | 0.1                                   |       | 61.6                                                               |       | —     |       | 31.1       |       | 46.7       |       | 22.2       |       | —                |       |
| CDOs that invest in other CDOs (“CDO  squared”)                             |       | 24                                                        |       | —                                |       | 31.2                                                               |       | —     |       | 29.2       |       | 70.8       |       | —     |       | —                |       |
| Collateralized bond obligations                                                       |       | 24                                                        |       | —                                |       | 88.9                                                               |       | —     |       | —     |       | —     |       | 50.0       |       | 50.0                  |       |
| Other CLO                                                                             |       | 39                                                        |       | 0.1                                   |       | 97.5                                                               |       | 100.0      |       | —     |       | —     |       | —     |       | —                |       |
| Total other CDO                                                                       |       | 1,326                                                     |       | 2.1                                   |       | 66.3                                                               |       | 33.8       |       | 23.2       |       | 28.4       |       | 12.1       |       | 2.5                   |       |
| Other asset-backed securities                                                         |       | 772                                                       |       | 1.2                                   |       | 88.1                                                               |       | 31.9       |       | 21.5       |       | 29.1       |       | 8.9        |       | 8.6                   |       |
| Total ABS                                                                             |       | $                                                         | 3,659      |                                  | 5.7        | %                                                                  |       |       |       |       |       |       |       |       |       |                  |       |   |

 

35

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ABSRMBS portfolio includes securities that are collateralized by mortgage loansissued to borrowers that cannot qualify for Prime or Alt-A financing terms duein part to weak or limited credit history. It also includes securities that are collateralized by certain secondlien mortgages regardless of the borrower’s credit history.

 

The following table presents additional information about our ABS RMBSportfolio including a summary by first and second lien collateral.

 
| **($ in millions)** | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  investments** | ** ** |
|-------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|
| **ABS RMBS**                  |       |                                                      |       |                                  |       |
| First lien:                   |       |                                                      |       |                                  |       |
| Fixed rate (1)                |       | $                                                         | 465        |                                  | 0.7        | % |
| Variable rate (1)             |       | 820                                                       |       | 1.3                                   |       |
| Total first lien (2)          |       | 1,285                                                     |       | 2.0                                   |       |
| Second lien:                  |       |                                                      |       |                                  |       |
| Insured                       |       | 204                                                       |       | 0.3                                   |       |
| Other                         |       | 64                                                        |       | 0.1                                   |       |
| Total second lien (3)         |       | 268                                                       |       | 0.4                                   |       |
| Total ABS RMBS                |       | $                                                         | 1,553      |                                  | 2.4        | % |

 

----

| (1)    |   | Fixed  rate and variable rate refer to the primary interest rate characteristics of  the underlying mortgages at the time of issuance.          |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | The  credit ratings of the first lien ABS RMBS were 48.0% Aaa, 39.5% Aa, 6.5% A,  2.5% Baa and 3.5% Ba or lower at September 30, 2008.     |
| (3)    |   | The  credit ratings of the second lien ABS RMBS were 17.9% Aaa, 19.4% Aa, 30.6% A,  19.0% Baa and 13.1% Ba or lower at September 30, 2008. |
|   |   |                                                                                                                                                 |

 

Asof September 30, 2008, the ABS RMBS portfolio had net unrealized losses of$518 million.  Fair value represents75.0% of the amortized cost of these securities.  ABS RMBS securities with a fair value less than70% of amortized cost totaled $368 million, with unrealized losses of $412million.  Duringthe third quarter and first nine months of 2008, we sold $69 million and $88million of ABS RMBS, respectively, recognizing a loss of $15 million and $32million, respectively.  We also collected$68 million and $220 million of principal repayments consistent with theexpected cash flows during the third quarter and first nine months of 2008,respectively.  Impairment write-downsduring the third quarter and first nine months of 2008 were recorded on our ABSRMBS totaling $6 million and $152 million, respectively.  In addition, $58 million and $190 million ofchange in intent write-downs were recorded during the third quarter and firstnine months of 2008, respectively, on ABS RMBS.

 

When buying ABS RMBS securities from 2006 and 2007 vintages, weconcentrated our holdings in securities that were senior or at the top of thestructure and that were generally within the first three Aaa sub-classes of thecapital structure, as it was expected that, in the unlikely event of losses inthe underlying collateral, these sub-classes within the Aaa class would likelyeither be paid in full or receive substantial principal repayments beforeunderlying mortgage losses would breach that level.  However, when the underlying mortgage productwas fixed-rate in nature, which we assessed to have stronger underwritingorigination standards than variable rate collateral, we invested somewhat lowerin the capital structure, such as securities below the first three Aaasub-classes.  The vast majority of ourABS RMBS from 2006 and 2007 are concentrated within originally rated Aaa or Aasecurities.

 

36

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Thefollowing table includes first lien non-insured ABS RMBS by vintage, theinterest rate characteristics of the underlying mortgage product and ourparticipation in the capital structure. The information in this table, together with the second liennon-insured, comprise the $1.26 billion of non-insured ABS RMBS.

 
| ** **                                                                             | ** ** | **2007**           | ** ** | **2006**        | ** ** | **2005**              | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|-----------------------|------------|
| **($ in millions)  Capital structure classification ****(3)** | ** ** | **Variable  rate** | ** ** | **Fixed  rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized  cost ****(1)** | ** ** | **Variable  rate** | ** ** | **Fixed  rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized  cost ****(1)** | ** ** | **Variable  rate** | ** ** | **Fixed  rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized  cost ****(1)** | ** ** |
|                                                                                   |       |               |       |            |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| First or second  Aaa class                                                             |       | $                  | 74         |            | $          | 22                    |       | $ | 96 |   | $ | 105 |   | $ | 204 |   | $ | 9 |   | $ | 213 |   | $ | 227 |   | $ | 2 |   | $ | — |   | $ | 2 |   | $ | 2 |   |
| Third Aaa class                                                                        |       | —             |       | —          |       | —                |       | — |   | 47 |   | 34 |   | 81 |   | 96 |   | 1 |   | — |   | 1 |   | 2 |   |
| Fourth Aaa class                                                                       |       | —             |       | —          |       | —                |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Last cash flow  Aaa class                                                              |       | —             |       | —          |       | —                |       | — |   | — |   | 7 |   | 7 |   | 10 |   | 9 |   | 15 |   | 24 |   | 24 |   |
| Other Aaa (2)                                                                          |       | 22                 |       | 84              |       | 106                   |       | 105 |   | — |   | 53 |   | 53 |   | 56 |   | 22 |   | 35 |   | 57 |   | 59 |   |
| Total Aaa                                                                              |       | 96                 |       | 106             |       | 202                   |       | 210 |   | 251 |   | 103 |   | 354 |   | 389 |   | 34 |   | 50 |   | 84 |   | 87 |   |
| Aa                                                                                     |       | 5                  |       | 69              |       | 74                    |       | 196 |   | 5 |   | 9 |   | 14 |   | 24 |   | 164 |   | 9 |   | 173 |   | 229 |   |
| A                                                                                      |       | —             |       | 4               |       | 4                     |       | 10 |   | — |   | 5 |   | 5 |   | 7 |   | 2 |   | 1 |   | 3 |   | 4 |   |
| Baa                                                                                    |       | —             |       | —          |       | —                |       | — |   | — |   | 1 |   | 1 |   | 1 |   | — |   | — |   | — |   | — |   |
| Total first lien   Non-insured ABS RMBS                                                |       | $                  | 101        |            | $          | 179                   |       | $ | 280 |   | $ | 416 |   | $ | 256 |   | $ | 118 |   | $ | 374 |   | $ | 421 |   | $ | 200 |   | $ | 60 |   | $ | 260 |   | $ | 320 |   |

 
| ** **                                                                             | ** ** | **Pre- 2005**       | ** ** | **Total**       | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------|------------|
| **($ in millions)  Capital structure classification ****(3)** | ** ** | **Variable   rate** | ** ** | **Fixed  rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized  cost ****(1)** | ** ** | **Variable  rate** | ** ** | **Fixed  rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized  cost ****(1)** | ** ** | **Unrealized  gain/loss** | ** ** |
|                                                                                   |       |                     |       |            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| First or second  Aaa class                                                             |       | $                        | —     |            | $          | — |   | $ | — |   | $ | — |   | $ | 280 |   | $ | 31 |   | $ | 311 |   | $ | 334 |   | $ | (23 | ) |
| Third Aaa class                                                                        |       | 4                        |       | —          |       | 4 |   | 4 |   | 52 |   | 34 |   | 86 |   | 102 |   | (16 | ) |
| Fourth Aaa class                                                                       |       | —                   |       | —          |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Last cash flow  Aaa class                                                              |       | 7                        |       | 6               |       | 13 |   | 14 |   | 16 |   | 28 |   | 44 |   | 48 |   | (4 | ) |
| Other Aaa (2)                                                                          |       | —                   |       | 22              |       | 22 |   | 22 |   | 44 |   | 194 |   | 238 |   | 242 |   | (4 | ) |
| Total Aaa                                                                              |       | 11                       |       | 28              |       | 39 |   | 40 |   | 392 |   | 287 |   | 679 |   | 726 |   | (47 | ) |
| Aa                                                                                     |       | 188                      |       | 15              |       | 203 |   | 227 |   | 362 |   | 102 |   | 464 |   | 676 |   | (212 | ) |
| A                                                                                      |       | 36                       |       | —          |       | 36 |   | 50 |   | 38 |   | 10 |   | 48 |   | 71 |   | (23 | ) |
| Baa                                                                                    |       | —                   |       | —          |       | — |   | — |   | — |   | 1 |   | 1 |   | 1 |   | — |   |
| Total first lien   Non-insured ABS RMBS                                                |       | $                        | 235        |            | $          | 43 |   | $ | 278 |   | $ | 317 |   | $ | 792 |   | $ | 400 |   | $ | 1,192 |   | $ | 1,474 |   | $ | (282 | ) |

 

----

| (1)    |   | Amortized  cost includes other-than-temporary impairment charges, as applicable.                                                                                                                                                                                   |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | Includes  primarily pass-through securities and “NAS” bonds. NAS bonds are typically  locked out from receiving principal prepayments for a specified period of  time after which they receive prepayment allocations according to a specified  formula. |
| (3)    |   | May not  be consistent with current ratings due to downgrades.                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                    |

 

Wealso own approximately $64 million of second lien ABS RMBS non-insuredsecurities, representing 72.7% of amortized cost.  Approximately $23 million, or 35.9%, of thisportfolio are 2006 and 2007 vintage years.

 

At September 30, 2008, $297 million or 19.1% of the total ABS RMBSsecurities are insured by 4 bond insurers and 87.2% of these insured securitieswere rated investment grade.  $261 millionor 87.9% of the portfolio consisted of securities that were issued during 2005,2006 and 2007.  At September 30,2008, 17.6% of securities issued during 2005, 2006 and 2007 were rated Aaa,20.7% rated Aa, 30.7% rated A, 19.5% rated Baa and 11.5% rated Ba or lower.

 

37

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Thefollowing table shows our insured ABS RMBS portfolio at September 30, 2008by bond insurer and vintage year for the first lien and second lien collateral.

 
| ** **                                                | ** ** | **Vintage year** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **   | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|--------------|------------|
| **($ in millions)**                             | ** ** | **2007**              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-2005** | ** ** | **Fair  value** | ** ** | **Amortized  cost ****(1)** | ** ** | **Unrealized  gain/loss** | ** ** |
| **First Lien:**                                           |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| Ambac Financial Group, Inc.  (“AMBAC”)     |       | $                     | —     |       | $          | 3          |       | $            | 20         |   | $ | 4 |   | $ | 27 |   | $ | 37 |   | $ | (10 | ) |
| Financial Guarantee Insurance Company  (“FGIC”) |       | 11                    |       | 5          |       | 9          |       | 8            |       | 33 |   | 46 |   | (13 | ) |
| Financial Security Assurance Inc.  (“FSA”)      |       | 26                    |       | —     |       | —     |       | —       |       | 26 |   | 25 |   | 1 |   |
| MBIA, Inc. (“MBIA”)                        |       | —                |       | —     |       | 7          |       | —       |       | 7 |   | 7 |   | — |   |
| Total First Lien                                          |       | 37                    |       | 8          |       | 36         |       | 12           |       | 93 |   | 115 |   | (22 | ) |
| **Second Lien:**                                          |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| AMBAC                                                     |       | 8                     |       | 13         |       | 2          |       | 22           |       | 45 |   | 71 |   | (26 | ) |
| FGIC                                                      |       | 13                    |       | 47         |       | 4          |       | —       |       | 64 |   | 127 |   | (63 | ) |
| FSA                                                       |       | 9                     |       | 4          |       | —     |       | —       |       | 13 |   | 36 |   | (23 | ) |
| MBIA                                                      |       | 76                    |       | 4          |       | —     |       | 2            |       | 82 |   | 160 |   | (78 | ) |
| Total Second Lien                                         |       | 106                   |       | 68         |       | 6          |       | 24           |       | 204 |   | 394 |   | (190 | ) |
| Total Insured ABS RMBS                                    |       | $                     | 143        |       | $          | 76         |       | $            | 42         |   | $ | 36 |   | $ | 297 |   | $ | 509 |   | $ | (212 | ) |

 

----

| (1)    |   | Amortized  cost includes other-than-temporary impairment charges, as applicable. |
|--------|--------|----------------------------------------------------------------------------------|
|   |   |                                                                                  |

 

ABSCDO are securities collateralized by a variety of residential mortgage-backedsecurities and other securities, which may include sub-prime RMBS.  Fair value represents 72.7% of the amortizedcost of these securities.  ABS CDOsecurities with a fair value less than 70% of amortized cost totaled $2million, with unrealized losses of $1 million. During the third quarter and first nine months of 2008, we sold $1million and $2 million of ABS CDO, respectively.  There were no impairment write-downs duringthe third quarter of 2008.  Impairmentwrite-downs during the first nine months of 2008 were recorded on our ABS CDOtotaling $63 million.  As of September 30,2008, the ABS CDO portfolio had unrealized losses of $3 million.

 

OtherCDO totaled $1.33 billion and 97.5% are rated investment grade at September 30,2008.  Other CDO consist primarily ofobligations secured by high yield and investment grade corporate credits.  As of September 30, 2008, the other CDOportfolio had unrealized losses of $675 million.  As of September 30, 2008, fair valuerepresents 66.3% of the amortized cost of these securities.  Other CDO securities with a fair value lessthan 70% of amortized cost totaled $657 million, with unrealized losses of $559million.  During the third quarter andfirst nine months of 2008, we sold $2 million and $22 million of other CDO,respectively, recognizing a gain of $1 million and $3 million in the thirdquarter and first nine months of 2008, respectively.  We also collected $4 million and $14 millionof principal repayments consistent with the expected cash flows during thethird quarter and first nine months of 2008, respectively.  Impairment write-downs during the thirdquarter and first nine months of 2008 were recorded on our other CDO totaling$170 million and $188 million, respectively.

 

Cashflow CLO are structures where the underlying assets are primarily comprised ofbelow investment grade senior secured corporate loans.  The collateral is actively managed byexternal managers that monitor the collateral performance.  The underlying investments are welldiversified across industries and among issuers and there have been nodowngrades in the portfolio.

 

Cashflow CLO issues differ by seniority.  Atransaction will typically issue notes with various capital structureclassifications (i.e. Aaa, Aa, A, etc.) as well as equity.  Approximately 89% of cash flow CLO wereinvested in A or higher rated tranches at origination.  As of September 30, 2008, fair valuerepresents 71.0% of the amortized cost of these securities.  Cash flow CLO securities with a fair valueless than 70% of amortized cost totaled $384 million, with unrealized losses of$263 million.  Duringthe third quarter and first nine months of 2008, we sold $1 million and $6million, of cash flow CLO, respectively. We collected $1 million and $5 million of principal repaymentsconsistent with the expected cash flows during the third quarter and first ninemonths of 2008, respectively.  There were no impairment or change inintent write-downs recognized during the third quarter and first nine months of2008.

 

38

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Thefollowing table shows our cash flow CLO portfolio at September 30, 2008 byvintage year, based upon our participation in the capital structure.

 
| ** **                                                                             | ** ** | **Vintage year** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|------------|------------|
| **($ in millions)  Capital structure classification ****(1)** | ** ** | **2008**              | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-  2005** | ** ** | **Fair  value** | ** ** | **Amortized  cost** | ** ** | **Unrealized  gain/loss** | ** ** |
|                                                                                   |       |                  |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Aaa                                                                                    |       | $                     | —     |       | $          | —     |       | $          | 89         |   | $ | 60 |   | $ | 159 |   | $ | 308 |   | $ | 350 |   | $ | (42 | ) |
| Aa                                                                                     |       | 4                     |       | 77         |       | 89         |       | 13         |       | 18 |   | 201 |   | 296 |   | (95 | ) |
| A                                                                                      |       | 2                     |       | 69         |       | 72         |       | 56         |       | 85 |   | 284 |   | 455 |   | (171 | ) |
| Baa                                                                                    |       | 3                     |       | —     |       | 16         |       | 29         |       | 27 |   | 75 |   | 109 |   | (34 | ) |
| Ba or below                                                                            |       | —                |       | 12         |       | 3          |       | —     |       | — |   | 15 |   | 33 |   | (18 | ) |
| Total                                                                                  |       | $                     | 9          |       | $          | 158        |       | $          | 269        |   | $ | 158 |   | $ | 289 |   | $ | 883 |   | $ | 1,243 |   | $ | (360 | ) |

 

----

| (1) |   | May not  be consistent with current ratings due to downgrades. |
|-----|--------|---------------------------------------------------------------------|
|     |

 

SyntheticCDO primarily consist of a portfolio of corporate credit default swaps (“CDS”)which are collateralized by Aaa rated LIBOR-based securities (i.e. “fullyfunded” synthetic CDO).  Approximately52% of the portfolio is rated Aa or better. Our synthetic CDO collateral primarily is actively managed by anexternal manager monitoring the CDS selection and performance.

 

Ongoingperformance of the synthetic CDO has been consistent with expectations.  During the third quarter and first ninemonths of 2008, we had no sales of synthetic CDO.  Synthetic CDO only generate principalrepayments at maturity and the average remaining life of the portfolio isapproximately 6.5 years.  As of September 30,2008, fair value represents 56.3% of the amortized cost of thesesecurities.  Synthetic CDO securitieswith a fair value less than 70% of amortized cost totaled $91 million, withunrealized losses of $98 million.  There were no maturities during the thirdquarter and first nine months of 2008, respectively.  Impairment write-downs during both the thirdquarter and first nine months of 2008 were recorded on our synthetic CDOtotaling $170 million.  In addition, nochange in intent write-downs were recorded during the third quarter and firstnine months of 2008.  The following tableshows our synthetic CDO at September 30, 2008 by vintage year, based uponour participation in the capital structure.

* *
| ** **                                                                             | ** ** | **Vintage year** | ** ** | ** ** | ** ** | ** **      | ** ** | ** **          | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|-----------------|------------|---------------------|------------|
| **($ in millions)  Capital structure classification ****(1)** | ** ** | **2007**              | ** ** | **2006**   | ** ** | **Fair  value** | ** ** | **Amortized  cost** | ** ** | **Unrealized  gain/loss** | ** ** |
|                                                                                   |       |                  |       |       |       |            |       |                |       |   |   |
| Aaa                                                                                    |       | $                     | 49         |       | $          | —          |       | $                   | 49         |   | $ | 93 |   | $ | (44 | ) |
| Aa                                                                                     |       | 34                    |       | 43         |       | 77              |       | 131                 |       | (54 | ) |
| Total                                                                                  |       | $                     | 83         |       | $          | 43              |       | $                   | 126        |   | $ | 224 |   | $ | (98 | ) |

 

----

| (1)    |   | May not  be consistent with current ratings due to downgrades. |
|--------|--------|---------------------------------------------------------------------|
|   |   |                                                                     |

 

Trustpreferred CDO underlying assets are primarily comprised of portfolios ofpreferred securities issued by a diversified portfolio of domestic banks andother financial institutions.  Theunderlying collateral for our trust preferred CDO portfolio is not activelymanaged and is diversified by issuer, predominately regional banks, with asmall percentage of insurance companies.

 

Marketvalue CDO are structurally similar to cash flow CLO.  The primary difference is that the marketvalue of the underlying assets is managed in order to enhance returns and thestructure is governed by market value based tests.  The managers are also offered moreflexibility to purchase other asset types including secured leveraged loans,public and private high yield bonds, structured products, mezzanineinvestments, and equities.

 

Projectfinance CDO underlying assets are primarily below investment grade seniorsecured project finance loans and energy finance investments.

 

CDOsquared transactions are CDOs where the underlying assets are primarily othercash flow CLO tranches, typically with an average rating of Baa.

 

Otherasset-backed securities totaled $772 million at September 30, 2008 andconsist primarily of investments secured by portfolios of credit card loans,auto loans, student loans and other consumer and corporate obligations. As of September 30,2008, the net unrealized losses on these securities were $104 million.Additionally, 25.3% of 

 

39

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theother asset-backed securities that are rated Aaa, Aa, A and Baa were insured byfour bond insurers.  During the firstnine months of 2008, we sold $96 million of these securities, recognizing nogain or loss during the first nine months of 2008.  In addition, we acquired $2 million and $28million of securities during the third quarter and the first nine months of2008, respectively.  We also collected$17 million and $59 million of principal repayments consistent with theexpected cash flows during the third quarter and first nine months of 2008,respectively.

 

*Insured Investments*As of September 30, 2008, we hold $2.56billion of fixed income securities that are insured by bond insurers, includingapproximately $1.99 billion or 51.5% of our municipal bond portfolio, $297million of our ABS RMBS and $204 million of our other asset-backedsecurities.  Additionally, we hold $14million of corporate bonds and credit default swaps that were directly issuedby these bond insurers.  51.5% of our municipalbond portfolio is insured by six bond insurers and 46.4% have a Moody’sequivalent rating of Aaa or Aa.  Ourpractices for acquiring and monitoring municipal bonds primarily are based onthe quality of the primary obligor.  Asof September 30, 2008, we believe the valuations already reflected adecline in the value of the insurance, and further such declines, if any, arenot expected to be material.  While thevaluation of these holdings may be temporarily impacted by negative and rapidlychanging market developments, we continue to have the intent and ability tohold the bonds and expect to receive all of the contractual cash flows.  As of September 30, 2008, 37.6% of ourinsured municipal bond portfolio was insured by MBIA, 16.6% by AMBAC, 18.2% byFSA and 24.0% by FGIC.

 

*Municipal Bonds *Included inour municipal bond portfolio at September 30, 2008 are $708 million ofauction rate securities (“ARS”) that have long-term stated maturities, with theinterest rate reset based on auctions that historically occurred every 7, 28 or35 days depending on the specific security. This is compared to a balance of ARS at December 31, 2007 of $866million, with the decline representing primarily redemptions from calls orrefunding proceeds since December 31, 2007.  Our holdings primarily have a Moody’s equivalent rating of Aaa.  We make our investment decisions based on theunderlying credit of each security. Approximately $708 million of our holdings are pools of student loansfor which at least 85% of the collateral was insured by the U.S. Department ofEducation at the time we purchased the security.  As of September 30, 2008, $482 millionof our ARS backed by student loans was 100% insured by the U.S. Department ofEducation, $163 million was 90% to 99% insured and $63 million was 80% to 89%insured.  During the third quarter of2008, all of our student loan ARS holdings experienced failed auctions and wereceived the failed auction rate or, for those which contain maximum reset rateformulas, we received the contractual maximum rate.  We anticipate that failed auctions maypersist and most of our holdings will continue to pay the failed auction rateor, for those that contain maximum rate reset formulas, the maximum rate, asdescribed below.  Auctions continue to beconducted as scheduled for each of the securities.

 

 We estimate that approximately one third ofour student loan backed ARS include maximum rate reset formulas whereby whenthe failed auction rate exceeds an annual contractual maximum rate over apreceding stipulated period, the coupon interest rate is temporarily reset to themaximum rate, which can vary between zero and the failed auction rate.  This maximum rate formula causes the resetinterest rate on these securities to be lower than the failed auction rate inorder to reduce the annual interest rate so that it does not exceed the annualcontractual maximum rate.  Generally, theannual contractual maximum rate is higher than the historical rates paid onthese securities.  During the third quarterof 2008, $55 million of our ARS reset using the maximum rate reset formula.

 

Duringthe third quarter of 2008, regulatory authorities announced preliminarysettlements in principle with some of the largest broker-dealers of ARSfollowing extensive investigations into the February 2008 ARS marketcollapse.  According to press releases,the settlements require broker-dealers to expeditiously provide liquiditysolutions to institutional customers within specified timeframes.  While the press release descriptions of thepreliminary settlement terms vary in details for institutional investors, atleast one description calls for liquidation at par, while other descriptionscall for a “best efforts” approach.

 

Alsoincluded in our municipal bond holdings at September 30, 2008 are $1million of municipal securities which are not rated by third party creditrating agencies, but are rated by the NAIC and also internally rated byus.  These holdings mainly comprise thehigh yield portion of our overall municipal bond portfolio.  The high yield municipal bonds generallyprovide a higher yield than the municipals rated investment grade by the thirdparty credit rating agencies and provide the opportunity to achieve incrementalreturns and enhanced diversification of our overall investments portfolio.  Our initial investment decisions and ongoingmonitoring procedures for these securities are based on a thorough duediligence process that includes, among other things, an assessment of thecredit, structure, and liquidity risks of the issue and issuer.  Our internal ratings are generally updated annually;however, they are updated more frequently if developments occur.

 

40

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*Credit default swaps (“CDS”)* are utilized for both buying and sellingcredit protection against a specified credit event. In selling protection, CDSare used to replicate fixed income securities and to complement the cash marketwhen credit exposure to certain issuers is not available or when the derivativealternative is less expensive than the cash market alternative. When buyingprotection, the objective is to mitigate credit risk on fixed income holdingsin our portfolio. Credit risk includes both default risk and market valueexposure due to spread widening. CDS typically have a five–year term. Thefollowing table shows the CDS notional amount and fair value of protectionbought or sold as of September 30, 2008.

 
| **($ in millions)**   | ** ** | **Notional   amount** | ** ** | **Fair value** | ** ** | **Fair value  to  notional   amount** | ** ** |
|---------------------------------|------------|----------------------------|------------|---------------------|------------|-------------------------------------------------|------------|
| Buying protection (recoverable) |       |                       |       |                |       |                                            |       |
| Single name                     |       | $                          | 161        |                | $          | 9                                               |       | 5.6 | % |
| Index                           |       | 550                        |       | 7                   |       | 1.3                                             |       |
| Total buying protection         |       | $                          | 711        |                | $          | 16                                              |       | 2.3 |   |
|                            |       |                       |       |                |       |                                            |       |
| Selling protection (payable)    |       |                       |       |                |       |                                            |       |
| Single name                     |       | $                          | 291        |                | $          | (11                                             | )          | (3.8 | ) |
| First-to-default                |       | 245                        |       | (27                 | )          | (11.0                                           | )          |
| Total selling protection        |       | $                          | 536        |                | $          | (38                                             | )          | (7.1 | ) |

 

Inbuying and selling protection CDS, we buy or sell credit protection on anidentified single name, credit derivative index (“CDX”) that is generallyinvestment grade, or a basket of names in a first-to-default (“FTD”) structure,and in return pay or receive periodic premiums through expiration ortermination. With single name CDS, this premium or credit spread generallycorresponds to the difference between the yield on the referenced name’s publicfixed maturity cash instruments and swap rates, at the time the agreement isexecuted. A CDX index is utilized to take a position on multiple (generally125) credit entities. With FTDbaskets, because of the additional credit risk inherent in a basket of namedcredits, the premium generally corresponds to a high proportion of the sum ofthe credit spreads of the names in the basket. If there is an event of defaultby the referenced name or one of the referenced names in a basket, as definedby the agreement, in the case of buying protection, we are entitled to receivefrom the counterparty, or in the case of selling protection, we are obligatedto pay the counterparty, the referenced notional amount of the contract.   In such an event, in regards to buyingprotection, we must surrender to the counterparty the referenced defaultedsecurity or similar security.  In such anevent, in regards to selling protection, we are entitled to receive in returnthe referenced defaulted security or similar security.  When such an event occurs in a single name orFTD (for FTD, the first such event occurring for any one name in the basket),the transaction terminates at the time of settlement of the default.  For CDX, the reference credit name incurringsuch event is removed from the index at the time of settlement of the defaultwhile the CDX transaction continues until expiration.  For all CDS, once a credit event occurs and asettlement has occurred, there may be subsequent recoveries. Recovery amounts,if any, vary and they may reduce the ultimate amount of net gain or loss.

 

*Exposure to certain financial institutions*Our direct exposure to American InternationalGroup, Bank of America Corporation (including Countrywide), Goldman SachsGroup, LLP, JP Morgan Chase & Company (including Bear Stearns andWashington Mutual), Lehman Brothers Holdings, Merrill Lynch and Company, MorganStanley, Wachovia Corporation, Fannie Mae, and Freddie Mac totals $1.34 billionor 2.1% of our total investment portfolio as of September 30, 2008.  On these names, we had $130 million inimpairment write-downs and $24 million in intent write-downs during the thirdquarter of 2008, and $134 million in impairment write-downs and $88 million inchange in intent write-downs during the first nine months of 2008.

 

*Limited partnership interests* consist of investments in privateequity/debt funds, real estate funds and hedge funds.  The overall limited partnership interestsportfolio is well diversified across a number of metrics including fundsponsors, vintage years, strategies, geography (including international), andcompany/property types.  At September 30,2008, our limited partnership interests comprise:

 

Privateequity/debt funds - Approximately 58% or $697 million of the limitedpartnership interests are comprised of private equity/debt funds diversifiedacross the following fund types: buyout, mezzanine, distressed 

 

41

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security,and secondary offerings.  Private/equitydebt funds were spread across 70 sponsors and 104 individual funds.  The largest exposure to any single privateequity/debt fund is $22 million.

 

Realestate funds - Approximately 35% or $410 million of the limited partnershipinterests are comprised of real estate funds diversified across a variety ofstrategies including opportunistic, value-add platforms, distressed property,and property/market specific.  Realestate funds were spread across 32 sponsors and 51 individual funds.  The largest exposure to any single real estatefund is $36 million.

 

Hedgefunds - Approximately 7% or $77 million of the limited partnership interestscomprised hedge funds with the majority invested with fund of fundsadvisors.  Hedge funds were spread across2 sponsors and 3 individual funds. The largest exposure to any single hedgefund is $43 million.

 

Ouraggregate limited partnership exposure represented 1.8% and 1.4% of totalinvested assets as of September 30, 2008 and December 31, 2007,respectively.

 

Lossfrom limited partnership interests was $4 million for the third quarter of 2008versus income of $20 million for the same quarter period in 2007.  The decline in income from limitedpartnership interests is primarily related to reduced income from partnershipsaccounted for under the equity method of accounting (“EMA”) resulting fromreduced valuations on net asset value of the partnerships.  Further, investment income on limitedpartnership interests accounted for under the equity method of accounting isrecognized on a delay due to the availability of the related financialstatements.  The recognition of income onhedge funds is primarily on a one month delay and the income recognition onprivate equity/debt funds and real estate funds are generally on a six monthdelay.  As such, the income recognizedthrough September 30, 2008 for limited partnership interests accounted forunder the equity method of accounting may not include the full impact forcurrent year changes in valuation of the underlying assets or liabilitieswithin the partnerships.  Limitedpartnership interests accounted for under the cost method of accountingrecognize income only upon cash distributions by the partnership.

 

Thefollowing table shows the income from our limited partnership interests by fundtype, accounting classification and fund strategy.

 
| ** **                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|
| ** **                    | ** ** | **September 30,**           | ** ** |
| ** **                    | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| **($ in millions)** | ** ** | **Cost**                         | ** ** | **Equity method  of accounting** | ** ** | **Total** | ** ** | **Cost** | ** ** | **Equity method  of accounting** | ** ** | **Total** | ** ** |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Private equity/ debt funds    |       | $                                | 5          |   | $ | — |   | $ | 5 |   | $ | 10 |   | $ | 3 |   | $ | 13 |   |
| Real estate funds             |       | —                           |       | (6 | ) | (6 | ) | 7 |   | 1 |   | 8 |   |
| Hedge funds                   |       | —                           |       | (3 | ) | (3 | ) | — |   | (1 | ) | (1 | ) |
| Total                         |       | $                                | 5          |   | $ | (9 | ) | $ | (4 | ) | $ | 17 |   | $ | 3 |   | $ | 20 |   |

 
| ** **                    | ** ** | **Nine  Months Ended** | ** ** |
|-------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **September 30,** | ** ** |
| ** **                    | ** ** | **2008**               | ** ** | **2007** | ** ** |
| **($ in millions)** | ** ** | **Cost**               | ** ** | **Equity  method  of accounting** | ** ** | **Total** | ** ** | **Cost** | ** ** | **Equity  method  of accounting** | ** ** | **Total** | ** ** |
|                          |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Private equity/ debt funds    |       | $                      | 16         |   | $ | 26 |   | $ | 42 |   | $ | 30 |   | $ | (1 | ) | $ | 29 |   |
| Real estate funds             |       | 3                      |       | (7 | ) | (4 | ) | 14 |   | 4 |   | 18 |   |
| Hedge funds                   |       | —                 |       | (5 | ) | (5 | ) | — |   | 5 |   | 5 |   |
| Total                         |       | $                      | 19         |   | $ | 14 |   | $ | 33 |   | $ | 44 |   | $ | 8 |   | $ | 52 |   |

 

42

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*Unrealized net capital losses* totaled $3.04 billion as of September 30,2008, compared to unrealized net capital gains of $417 million at December 31,2007.  The decline was primarily due towidening credit spreads.  Net unrealizedcapital losses increased despite the realization of capital losses on sales andimpairments, including change in intent write-downs during the third quarterand first nine months of 2008.  We continue to experience volatility in thebalance of our unrealized net capital gains and losses as we did between theyears 2004/2005 and 2006/2007.  Thefollowing tables present total unrealized gains and losses pre-tax andafter-tax.

 
| ** **                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **($ in millions)**            | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| U.S. government and agencies             |       | $                      | 715        |                  | $          | 880 |   |
| Municipal                                |       | (141                   | )          | 76                    |       |
| Corporate                                |       | (1,697                 | )          | 111                   |       |
| Foreign government                       |       | 319                    |       | 371                   |       |
| MBS                                      |       | (158                   | )          | (9                    | )          |
| CMBS                                     |       | (757                   | )          | (310                  | )          |
| ABS                                      |       | (1,300                 | )          | (670                  | )          |
| Redeemable preferred stock               |       | (1                     | )          | —                |       |
| Fixed income securities                  |       | (3,020                 | )          | 449                   |       |
| Equity securities                        |       | (8                     | )          | —                |       |
| Derivatives                              |       | (10                    | )          | (32                   | )          |
| Unrealized net gains and losses, pre-tax |       | $                      | (3,038     | )                     | $          | 417 |   |

 
| ** **                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **($ in millions)**                               | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Fixed income securities                                     |       | $                      | (3,020     | )                     | $          | 449 |   |
| Equity securities                                           |       | (8                     | )          | —                |       |
| Derivative instruments                                      |       | (10                    | )          | (32                   | )          |
| Unrealized net gains and losses, pre-tax                    |       | (3,038                 | )          | 417                   |       |
|                                                        |       |                   |       |                  |       |
| Amounts recognized for:                                     |       |                   |       |                  |       |
| Insurance reserves (1)                                      |       | (456                   | )          | (1,059                | )          |
| Deferred policy acquisition and sales  inducement costs (2) |       | 2,283                  |       | 513                   |       |
| Total                                                       |       | 1,827                  |       | (546                  | )          |
|                                                        |       |                   |       |                  |       |
| Deferred income taxes                                       |       | 424                    |       | 45                    |       |
| Unrealized net capital gains and losses,  after-tax         |       | $                      | (787       | )                     | $          | (84 | ) |

 

----

| (1)    |   | The  insurance reserves adjustment represents the amount by which the reserve  balance would increase if the net unrealized gains in the applicable product  portfolios were realized. Since these products have a long-term expected  life, the proceeds from investments sold in an unrealized gain position would  be reinvested at current lower interest rates, resulting in a premium  deficiency. The adjustment primarily relates to structured settlement  annuities with life contingencies, in addition to annuity buy-outs and  certain payout annuities with life contingencies. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | The  deferred policy acquisition and sales inducement costs adjustment represents  the amount by which the amortization of DAC and DSI would increase or  decrease if the unrealized gains or losses in the respective product  portfolios were realized.                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

 

43

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Thenet unrealized loss for the fixed income portfolio totaled $3.02 billion,comprised of $1.48 billion of unrealized gains and $4.50 billion of unrealizedlosses at September 30, 2008.  Thisis compared to a net unrealized gain for the fixed income portfolio totaling$449 million at December 31, 2007, comprised of $2.26 billion ofunrealized gains and $1.81 billion of unrealized losses.

 

Of the gross unrealized losses in the fixed incomeportfolio at September 30, 2008, $4.14 billion or 92.1% were related toinvestment grade securities and are primarily related to widening creditspreads.  Of the remaining $357 millionof unrealized losses in the fixed income portfolio, $250 million or 70.0% werein the corporate fixed income portfolio and primarily comprised securities inthe consumer goods, financial services, capital goods, communications andutilities sectors.  The gross unrealizedlosses in these sectors were primarily related to changes in interest rates andcredit spreads, and company specific conditions.

 

Includedin gross unrealized losses at September 30, 2008 were $2.30 billion offixed income securities with a fair value below 70% of amortized cost, or 4.8%of our fixed income portfolio at September 30, 2008.  The percentage of fair value to amortizedcost for the remaining fixed income gross unrealized losses at September 30,2008 are shown in the following table.

 
| **($ in millions)**                               | ** ** | **Unrealized  (loss) gain** | ** ** | **Fair value** | ** ** | **% to Total fixed  income  investments** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|---------------------|------------|----------------------------------------------------------|------------|
| > 80% of amortized cost                                  |       | $                                | (1,946     | )                   | $          | 26,411                                                   |       | 54.9 | % |
| 70% to 80% of amortized cost                                |       | (749                             | )          | 2,313               |       | 4.8                                                      |       |
| < 70% of amortized cost                                  |       | (1,805                           | )          | 2,302               |       | 4.8                                                      |       |
| Gross unrealized losses on fixed income  securities         |       | (4,500                           | )          | 31,026              |       | 64.5                                                     |       |
| Gross unrealized gains on fixed income  securities          |       | 1,480                            |       | 17,045              |       | 35.5                                                     |       |
|                                                        |       |                             |       |                |       |                                                     |       |
| Net unrealized gains and losses on fixed  income securities |       | $                                | (3,020     | )                   | $          | 48,071                                                   |       | 100.0 | % |

 

Includedin the fixed income securities with a fair value less than 70% of amortizedcost totaling $2.30 billion were $1.81 billion of unrealized losses comprisedof other CDO of $559 million (which primarily includes $263 million of cashflow CLO and $98 million of synthetic CDO), ABS RMBS of $412 million, corporatebonds of $459 million, and CMBS of $304 million.  We continue to believe that the unrealizedlosses on these securities are not necessarily predictive of the ultimateperformance.  The unrealized lossesshould reverse over the remaining lives of the securities, in the absence offurther deterioration in the collateral relative to our positions in thesecurities’ respective capital structures.

 

Thenet unrealized loss for the equity portfolio totaled $8 million, comprised of$10 million of unrealized losses and $2 million of unrealized gains at September 30,2008.  This is compared to $5 millioneach for both unrealized gains and losses at December 31, 2007.  Within the equity portfolio, the losses wereprimarily concentrated in the financial services and banking industrysectors.  The unrealized losses in thesesectors were company and sector specific.

 

We have a comprehensiveportfolio monitoring process to identify and evaluate, on a case-by-case basis,fixed income and equity securities whose carrying value may beother-than-temporarily impaired.  Theprocess includes a quarterly review of all securities using a screening processto identify situations where the fair value, compared to amortized cost for fixedincome securities and cost for equity securities, is below establishedthresholds for certain time periods, or which are identified through othermonitoring criteria such as ratings, ratings downgrades or paymentdefaults.  The securities identified, inaddition to other securities for which we may have a concern, are evaluatedbased on facts and circumstances for inclusion on our watch-list.  All investments in an unrealized lossposition at September 30, 2008 were included in our portfolio monitoringprocess for determining whether declines in value wereother-than-temporary.  We also conduct aportfolio review to recognize impairment on securities in an unrealized lossposition for which we do not have the intent and ability to hold until recoveryas a result of approved programs involving the disposition of investments forreasons such as negative developments that would change the view of long terminvestors and their intent to continue to hold the investment, subsequentcredit deterioration of an issuer or holding, subsequent further deteriorationof capital markets (i.e. debt and equity) and of economic conditions,subsequent further deterioration in the financial services and real estateindustries, changes in duration, revisions to strategic asset allocations,liquidity needs, unanticipated federal income tax situations involving capitalgains and capital loss carrybacks and carryforwards with specific expirationdates, investment risk mitigation actions, and other new facts andcircumstances that would cause a change in our previous intent to hold asecurity to recovery or maturity.

 

44

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Thefollowing table summarizes fixed income and equity securities in a grossunrealized loss position according to significance, aging and investment gradeclassification.

 
| ** **                                                                                                                                                       | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                       | ** ** | **Fixed income**            | ** ** | ** **                      | ** ** | ** ** | ** ** | **Fixed income** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **($ in millions, except number  of issues)**                                                                                           | ** ** | **Investment  Grade**            | ** ** | **Below  Investment  Grade**    | ** ** | **Equity** | ** ** | **Total** | ** ** | **Investment  Grade** | ** ** | **Below  Investment  Grade** | ** ** | **Equity** | ** ** | **Total** | ** ** |
|                                                                                                                                                             |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (I): Unrealized loss less  than 20% of cost(1)                                                                                                     |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of Issues                                                                                                                                                 |       | 2,734                            |       | 193                             |       | 51 |   | 2,978 |   | 2,403 |   | 227 |   | 9 |   | 2,639 |   |
| Fair Value                                                                                                                                                       |       | $                                | 25,256     |                            | $          | 1,128 |   | $ | 62 |   | $ | 26,446 |   | $ | 22,615 |   | $ | 1,517 |   | $ | 64 |   | $ | 24,196 |   |
| Unrealized                                                                                                                                                       |       | $                                | (1,826     | )                               | $          | (113 | ) | $ | (9 | ) | $ | (1,948 | ) | $ | (1,129 | ) | $ | (106 | ) | $ | (5 | ) | $ | (1,240 | ) |
|                                                                                                                                                             |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (II): Unrealized loss greater than  or equal to 20% of cost for a period of less than 6 consecutive months(1)                                           |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of Issues                                                                                                                                                 |       | 404                              |       | 77                              |       | 2 |   | 483 |   | 156 |   | 18 |   | — |   | 174 |   |
| Fair Value                                                                                                                                                       |       | $                                | 3,259      |                            | $          | 412 |   | $ | 2 |   | $ | 3,673 |   | $ | 945 |   | $ | 107 |   | $ | — |   | $ | 1,052 |   |
| Unrealized                                                                                                                                                       |       | $                                | (1,466     | )                               | $          | (169 | ) | $ | (1 | ) | $ | (1,636 | ) | $ | (514 | ) | $ | (62 | ) | $ | — |   | $ | (576 | ) |
|                                                                                                                                                             |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (III): Unrealized loss greater  than or equal to 20% of cost for a period of 6 or more consecutive months,  but less than 12 consecutive months(1) |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of Issues                                                                                                                                                 |       | 145                              |       | 18                              |       | — |   | 163 |   | — |   | — |   | — |   | — |   |
| Fair Value                                                                                                                                                       |       | $                                | 895        |                            | $          | 73 |   | $ | — |   | $ | 968 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Unrealized                                                                                                                                                       |       | $                                | (846       | )                               | $          | (75 | ) | $ | — |   | $ | (921 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                                                                                                             |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (IV): Unrealized loss greater than  or equal to 20% of cost for 12 or more consecutive months(1)                                                        |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of Issues                                                                                                                                                 |       | 3                                |       | —                          |       | — |   | 3 |   | — |   | — |   | — |   | — |   |
| Fair Value                                                                                                                                                       |       | $                                | 2          |                            | $          | — |   | $ | — |   | $ | 2 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Unrealized                                                                                                                                                       |       | $                                | (5         | )                               | $          | — |   | $ | — |   | $ | (5 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                                                                                                             |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Number of Issues                                                                                                                                           |       | 3,286                            |       | 288                             |       | 53 |   | 3,627 |   | 2,559 |   | 245 |   | 9 |   | 2,813 |   |
| Total Fair Value                                                                                                                                                 |       | $                                | 29,412     |                            | $          | 1,613 |   | $ | 64 |   | $ | 31,089 |   | $ | 23,560 |   | $ | 1,624 |   | $ | 64 |   | $ | 25,248 |   |
| Total Unrealized Losses                                                                                                                                          |       | $                                | (4,143     | )                               | $          | (357 | ) | $ | (10 | ) | $ | (4,510 | ) | $ | (1,643 | ) | $ | (168 | ) | $ | (5 | ) | $ | (1,816 | ) |

 

----

(1)   For fixed income securities, cost representsamortized cost.

----

 

Thelargest individual unrealized loss was $8 million for category (I), $22 millionfor category (II), $24 million for category (III), and $2 million for category (IV) asof September 30, 2008.

 

Categories(I) and (II) have generally been adversely affected by overalleconomic conditions including interest rate increases and the market’sevaluation of certain sectors.  Thedegree to which and/or length of time that the securities have been in anunrealized loss position does not suggest that these securities pose a highrisk of being other-than-temporarily impaired. Categories (III) and (IV) have primarily been historicallyadversely affected by industry and issue specific, or issuer specificconditions.  All of the securities inthese categories are monitored for other-than-temporary impairment.

 

AtSeptember 30, 2008, Category (III) for fixed income comprisedprimarily $425 million of other CDO, $147 million of ABS RMBS and $240 millionof CMBS with unrealized losses of $400 million, $244 million and $160 million,respectively, for a total of $804 million unrealized losses.  Included in the $804 million of unrealizedlosses were assets with a fair value of $788 million with a fair value lessthan 70% of amortized cost.

 

Wecontinue to believe that the unrealized losses on these securities are notnecessarily predictive of the ultimate performance of the underlyingcollateral.  In the absence of furtherdeterioration in the collateral relative to our positions in the securities’respective capital structures, which could be other-than-temporary, theunrealized losses should reverse over the remaining lives of the securities.

 

45

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Whenever our initial analysis indicates that a fixed income security’sunrealized loss of 20% or more for at least 36 months or any equity security’sunrealized loss of 20% or more for at least 12 months is temporary, additionalevaluations and management approvals are required to substantiate that awrite-down is not appropriate.  As of September 30,2008, no securities met these criteria.

 

Wealso monitor the quality of our fixed income and bank loan portfolios bycategorizing certain investments as “problem”, “restructured” or “potentialproblem.”  Problem fixed incomesecurities and bank loans are in default with respect to principal or interestand/or are investments issued by companies that have gone into bankruptcysubsequent to our acquisition or loan. Restructured fixed income and bank loan investments have rates and termsthat are not consistent with market rates or terms prevailing at the time ofthe restructuring.  Potential problemfixed income or bank loan investments are current with respect to contractualprincipal and/or interest, but because of other facts and circumstances, wehave concerns regarding the borrower’s ability to pay future principal andinterest, which causes us to believe these investments may be classified asproblem or restructured in the future.

 

The following table summarizes problem, restructured and potentialproblem fixed income securities and bank loans.

 
| ** **                            | ** ** | **September 30, 2008** | ** ** | **December 31, 2007**  | ** ** |
|---------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| **($ in millions)**         | ** ** | **Par  value ****(1)**      | ** ** | **Amortized  cost ****(1)** | ** ** | **Fair  value** | ** ** | **Percent of  total fixed  income and  bank loan  portfolios** | ** ** | **Par  value** | ** ** | **Amortized  cost** | ** ** | **Fair  value** | ** ** | **Percent of  total fixed  income and  bank loan  portfolios** | ** ** |
| Problem                               |       | $                                | 576        |                             | $          | 91 |   | $ | 91 |   | 0.2 | % | $ | 237 |   | $ | 14 |   | $ | 14 |   | — | % |
| Restructured                          |       | 9                                |       | 5                                |       | 5 |   | — |   | 9 |   | 5 |   | 6 |   | — |   |
| Potential problem                     |       | 986                              |       | 460                              |       | 381 |   | 0.8 |   | 277 |   | 218 |   | 172 |   | 0.3 |   |
| Total net carrying value              |       | $                                | 1,571      |                             | $          | 556 |   | $ | 477 |   | 1.0 | % | $ | 523 |   | $ | 237 |   | $ | 192 |   | 0.3 | % |
| Cumulative write-downs recognized (2) |       |                             |       | $                                | 932        |   |   |   |   |   |   |   | $ | 261 |   |   |   |   |   |
|                                  |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                       |

 
| (1)    |   | The difference between par value and amortized cost of $1.02 billion  at September 30, 2008, is primarily attributable to write-downs. Par  value has been reduced by principal payments. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | Cumulative write-downs recognized only reflects write-downs related to  investments within the problem, potential problem and restructured  categories.                                        |
|   |   |                                                                                                                                                                                                |

 

For our problem category, par value totaled $576 million and amortizedcost totaled $91 million, or 15.8% of par value, at September 30, 2008,compared to a par value total of $237 million and amortized cost total of $14million, or 5.9% of par value, at December 31, 2007.  Fair value for this category totaled $91million, or 15.8% of par value, at September 30, 2008, a $77 millionincrease from a fair value total of $14 million, or 5.9% of par value, at December 31,2007.  At September 30, 2008, theproblem category comprised primarily $28 million related to a real estateinvestment trust, and $17 million of bank loans, and also included $9 millionof financial sector related holdings, $9 million of CRE CDO, $8 million of ABSCDO, $6 million of ABS RMBS, and $4 million of Alt-A.  The increase over December 31, 2007 isattributable to the addition of fixed income and bank loan holdings that eitherare in default with respect to principal or interest and/or are investmentsissued by companies that went into bankruptcy during the period.   Problem investments with a fair value lessthan 70% of amortized cost totaled $2 million, with unrealized losses of $1million.

 

For our potential problem category, par value totaled $986 million andamortized cost totaled $460 million, or 46.7% of par value, at September 30,2008, compared to a par value total of $277 million and amortized cost total of$218 million, or 78.7% of par value, at December 31, 2007.  Fair value for this category totaled $381million, or 38.6% of par value, at September 30, 2008, a $209 millionincrease from a fair value total of $172 million, or 62.1% of par value, at December 31,2007.  At September 30, 2008 thepotential problem category comprised primarily $81 million of Alt-A, $42million of ABS RMBS, and $8 million of CRE CDO, as well as $51 million offinancial sector related holdings, $33 million of market value CDO, and $34million of synthetic CDO.  Also includedwere $36 million of municipal bonds and $59 million of beneficial interests insecuritized financial assets accounted for under Emerging Issues Task ForceIssue No. 99-20.  The increase over December 31,2007 is primarily attributable to the additions of certain real estate relatedholdings, including securities collateralized by residential and commercialmortgage loans.  Also contributing to theincrease were financial sector related holdings and market value and syntheticCDO.  Potential problem investments witha fair value less that 70% of amortized cost totaled $92 million, withunrealized losses of $62 million.

 

We also evaluated each of these investments through our portfoliomonitoring process at September 30, 2008 and recorded write-downs whenappropriate.  We further concluded thatany remaining unrealized losses on these 

 

46

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investments were temporary in nature and that we have the intent andability to hold the securities until recovery. While these balances may increase in the future, particularly ifeconomic conditions are unfavorable, management expects that****the total amount of investments in thesecategories will remain low relative to the total fixed income securities and bankloans portfolios.

 

**Recent developments**Between September 30, 2008 and October 31, 2008, the S&P500 index has declined 17%, the Muni Bond buyer index yields have increased 12basis points (“bps”) and while risk free interest rates have increased as illustratedby the increase of 16 bps in U.S. Treasury 10 year yields, credit spreads havewidened, as illustrated by the 42 bps spread increase in the Barclays CapitalAggregate index resulting in an overall increase of 40 bps in the BarclaysCapital Aggregate Yield.  This hasresulted in an increase in our unrealized losses on our fixed income and equitysecurities.  Our unrealized gains andlosses can vary significantly between periods. The U.S. government is seeking to reverse these economic trends and we believethat they will be successful.

 

**Net Investment Income** The following table presents net investmentincome.

 
| ** **                        | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **($ in millions)**     | ** ** | **2008**                                                   | ** ** | **2007**                                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|                              |       |                                                       |       |                                                      |       |   |   |   |   |
| Fixed income securities           |       | $                                                          | 772        |                                                      | $          | 911 |   | $ | 2,370 |   | $ | 2,704 |   |
| Equity securities                 |       | 2                                                          |       | 1                                                         |       | 6 |   | 3 |   |
| Mortgage loans                    |       | 143                                                        |       | 140                                                       |       | 434 |   | 406 |   |
| Limited partnership interests     |       | (4                                                         | )          | 20                                                        |       | 33 |   | 52 |   |
| Short-term                        |       | 31                                                         |       | 15                                                        |       | 79 |   | 60 |   |
| Other                             |       | (2                                                         | )          | 45                                                        |       | 11 |   | 129 |   |
| Investment income, before expense |       | 942                                                        |       | 1,132                                                     |       | 2,933 |   | 3,354 |   |
| Investment expense                |       | (30                                                        | )          | (70                                                       | )          | (107 | ) | (209 | ) |
| Net investment income             |       | $                                                          | 912        |                                                      | $          | 1,062 |   | $ | 2,826 |   | $ | 3,145 |   |

 

Totalinvestment expenses decreased $40 million and $102 million for the three monthsand nine months ended September 30, 2008, respectively.  These decreases were primarily due to lowerexpenses associated with a lower amount of collateral received in connectionwith securities lending transactions. The average amount of collateral held in connection with securitieslending was approximately $1.71 billion and $1.95 billion in the third quarterand first nine months of 2008, respectively, compared to approximately $2.84billion and $2.97 billion in the third quarter and first nine months of 2007, respectively,as a result of actions to reduce our securities lending balances.

 

**Net Realized Capital Gains and Losses**The following table presents the componentsof realized capital gains and losses and the related tax effect.

 
| ** **                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                 | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Sales (1)                                     |       | $                                                    | 119        |                                                | $          | (24 | ) | $ | 63 |   | $ | 26 |   |
| Impairment write-downs (2)                    |       | (354                                                 | )          | (18                                                 | )          | (757 | ) | (23 | ) |
| Change in intent write-downs (1) (3)     |       | (262                                                 | )          | (7                                                  | )          | (1,016 | ) | (72 | ) |
| Valuation of derivative instruments           |       | (146                                                 | )          | (58                                                 | )          | (340 | ) | 57 |   |
| Settlement of derivative instruments          |       | 75                                                   |       | (21                                                 | )          | 122 |   | 10 |   |
| Realized capital gains and losses, pre-tax    |       | (568                                                 | )          | (128                                                | )          | (1,928 | ) | (2 | ) |
| Income tax benefit                            |       | 198                                                  |       | 45                                                  |       | 674 |   | — |   |
| Realized capital gains and losses,  after-tax |       | $                                                    | (370       | )                                                   | $          | (83 | ) | $ | (1,254 | ) | $ | (2 | ) |

 

----

| (1)    |   | To  conform to the current quarter presentation, certain amounts in the prior  periods have been reclassified.                                                                                      |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | Impairment  write-downs reflect issue specific other-than-temporary declines in fair  value, including instances where we could not reasonably assert that the  recovery period would be temporary. |
| (3)    |   | Change  in intent write-downs reflect instances where we cannot assert a positive  intent to hold until recovery.                                                                                   |
|   |   |                                                                                                                                                                                                     |

 

47

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Wemay sell or change our assertion to hold a security until recovery for impairedfixed income or equity securities that were in an unrealized loss position atthe previous reporting date, or other investments where the fair value hasdeclined below the carrying value, in situations where significantunanticipated new facts and circumstances emerge or existing facts andcircumstances increase in significance and are anticipated to adversely impacta security’s future valuations more than previously expected; includingnegative developments that would change the view of long term investors andtheir intent to continue to hold the investment, subsequent creditdeterioration of an issuer or holding, subsequent further deterioration incapital markets (i.e. debt and equity) and of economic conditions, subsequentfurther deterioration in the financial services and real estate industries,liquidity needs, unanticipated federal income tax situations involving capitalgains and capital loss carrybacks and carryforwards with specific expirationdates, investment risk mitigation actions, and other new facts andcircumstances that would cause a change in our previous intent to hold asecurity to recovery or maturity.

 

Uponapproval of programs involving the expected disposition of investments,portfolio managers identify a population of suitable investments, typicallylarger than needed to accomplish the objective, from which specific securitiesare selected to sell.  Due to a change inintent to hold until recovery, we recognize impairments on investments withinthe population that are in an unrealized loss position.  Further unrealized loss positions thatdevelop subsequent to the original write-down are recognized in the reportingperiod in which they occur through the date the program is closed.  The program is closed when the objectives ofthe program are accomplished or a decision is made not to fully complete it, atwhich time an evaluation is performed of any remaining securities and whereappropriate they are redesignated as intent to hold to recovery.  Reasons resulting in a decision not tocomplete an approved program include matters such as the mitigation of concernsthat led to the initial decision, changes in priorities or new complicationsthat emerge from significant unanticipated developments, such as subsequentsignificant deterioration which we view to be temporary in nature, to the pointat which securities could only be sold at prices below our view of theirintrinsic values, or subsequent favorable developments that support a return tothe intent to hold to recovery. Subsequent other-than-temporary impairment evaluations utilize theamortized cost or cost basis that reflect the write-downs.  Fixed income securities subject to change inintent write-downs, and including those redesignated as intent to hold,continue to earn investment income and any discount or premium from theamortized cost basis that reflects the write-downs is recognized using the effectiveyield method over the expected life of the security.

 

Impairment write-downs for the three months ended September 30,2008 comprised $326 million from fixed income securities, $1 million fromequity securities and $27 million from limited partnership interests comparedto $18 million from fixed income securities for the same period of the prioryear.  Impairment write-downs for thenine months ended September 30, 2008 comprised $712 million from fixedincome securities, $7 million from equity securities, $34 million from limitedpartnership interests and $4 million from other investments compared to $22million from fixed income securities and $1 million from short-term investmentsfor the same period of the prior year. $232 million, or 71.2%, and $548 million, or 77.0%, of the fixed incomesecurity write-downs for the three months and nine months ended September 30,2008, respectively, related to impaired securities that were performing in linewith anticipated or contractual cash flows, but which were written downprimarily because of further expected deterioration in the performance of theunderlying collateral.  As of September 30,2008, for these securities, there have been no defaults or defaults that haveoccurred in classes lower in the capital structure as of September 30,2008.  $94 million and $164 million ofthe fixed income security write-downs for the three months and nine monthsended September 30, 2008, respectively, primarily related to securitiesexperiencing a significant departure from anticipated residual cash flows,however, we believe they retain economic value.

 

48

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Impairmentwrite-downs and cash received, inclusive of sales, on these investments were asfollows:

 
| ** **                                                                                                      | ** ** | **Three months ended  September 30, 2008** | ** ** | **Nine months ended  September 30, 2008 ****(3)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in millions)**                                                                                   | ** ** | **Impairment  write-downs**                                    | ** ** | **Cash  received****(4)**                                                  | ** ** | **Impairment  write-downs** | ** ** | **Cash  received ****(4)** | ** ** |
| **Performing in accordance with anticipated or contractual cash flows** |       |                                                           |       |                                                                       |       |   |   |   |   |
| Alt–A                                                                                                      |       |                                                           |       |                                                                       |       |   |   |   |   |
| No defaults in underlying collateral                                                                            |       | $                                                              | (2         | )                                                                          | $          | 3 |   | $ | (32 | ) | $ | 11 |   |
| Defaults lower in capital structure                                                                             |       | —                                                         |       | 2                                                                          |       | (11 | ) | 8 |   |
|                                                                                                            |       | (2                                                             | )          | 5                                                                          |       | (43 | ) | 19 |   |
| ABS RMBS                                                                                                        |       | (6                                                             | )          | 3                                                                          |       | (148 | ) | 12 |   |
| ABS CDO                                                                                                         |       | —                                                         |       | 1                                                                          |       | (63 | ) | 3 |   |
| CMBS/CRE CDO                                                                                                    |       | (3                                                             | )          | 4                                                                          |       | (42 | ) | 6 |   |
| Synthetic CDO                                                                                                   |       | (170                                                           | )          | 2                                                                          |       | (170 | ) | 6 |   |
| Corporate                                                                                                       |       |                                                           |       |                                                                       |       |   |   |   |   |
| Bond insurer                                                                                                    |       | —                                                         |       | —                                                                     |       | (17 | ) | 1 |   |
| Bond reinsurer – convertible to perpetual  security                                                        |       | (2                                                             | )          | —                                                                     |       | (22 | ) | 1 |   |
| Financials                                                                                                      |       | (48                                                            | )          | 2                                                                          |       | (40 | ) | 4 |   |
| Other                                                                                                           |       | (1                                                             | )          | 1                                                                          |       | (3 | ) | 3 |   |
| **Subtotal****(1)**                                                                                             | ** ** | **(232**                                                       | **)**      | **18**                                                                     | ** ** | **(548** | **)** | **55** | ** ** |
|                                                                                                            |       |                                                           |       |                                                                       |       |   |   |   |   |
| **Departure from anticipated or contractual  cash flows**                                                       |       |                                                           |       |                                                                       |       |   |   |   |   |
| Future cash flows expected –                                                                               |       |                                                           |       |                                                                       |       |   |   |   |   |
| Corporate                                                                                                       |       |                                                           |       |                                                                       |       |   |   |   |   |
| Equity structured note                                                                                          |       | (27                                                            | )          | —                                                                     |       | (27 | ) | — |   |
| Financials                                                                                                      |       | (17                                                            | )          | 8                                                                          |       | (7 | ) | 9 |   |
| Real Estate Investment Trust                                                                                    |       | (12                                                            | )          | 1                                                                          |       | (12 | ) | 2 |   |
| Food manufacturer                                                                                               |       | —                                                         |       | —                                                                     |       | (3 | ) | — |   |
| Other                                                                                                           |       | —                                                         |       | —                                                                     |       | (1 | ) | — |   |
| **Subtotal****(2)**                                                                                             | ** ** | **(56**                                                        | **)**      | **9**                                                                      | ** ** | **(50** | **)** | **11** | ** ** |
| Future cash flows very uncertain -                                                                              |       |                                                           |       |                                                                       |       |   |   |   |   |
| Cash flow CLO                                                                                                   |       | —                                                         |       | —                                                                     |       | (18 | ) | — |   |
| ABS RMBS                                                                                                        |       | —                                                         |       | —                                                                     |       | (4 | ) | 1 |   |
| Corporate                                                                                                       |       |                                                           |       |                                                                       |       |   |   |   |   |
| Financials                                                                                                      |       | (38                                                            | )          | 1                                                                          |       | (38 | ) | 7 |   |
| Bond insurer                                                                                                    |       | —                                                         |       | —                                                                     |       | (10 | ) | — |   |
| **Subtotal**                                                                                                    | ** ** | **(38**                                                        | **)**      | **1**                                                                      | ** ** | **(70** | **)** | **8** | ** ** |
| Investments disposed during the quarter                                                                         |       | —                                                         |       | 3                                                                          |       | (44 | ) | 91 |   |
|                                                                                                            |       |                                                           |       |                                                                       |       |   |   |   |   |
| **Total fixed income securities**                                                                               | ** ** | **$**                                                          | **(326**   | **)**                                                                      | **$**      | **31** | ** ** | **$** | **(712** | **)** | **$** | **165** | ** ** |
| ** **                                                                                                      | ** ** | ** **                                                     | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total equity securities**                                                                                     | ** ** | **$**                                                          | **(1**     | **)**                                                                      | **$**      | **7** | ** ** | **$** | **(7** | **)** | **$** | **9** | ** ** |
| ** **                                                                                                      | ** ** | ** **                                                     | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total limited partnership interests**                                                                         | ** ** | **$**                                                          | **(27**    | **)**                                                                      | **$**      | **2** | ** ** | **$** | **(34** | **)** | **$** | **3** | ** ** |
| ** **                                                                                                      | ** ** | ** **                                                     | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total other investments**                                                                                     | ** ** | **$**                                                          | **—** | ** **                                                                 | **$**      | **—** | ** ** | **$** | **(4** | **)** | **$** | **—** | ** ** |

 

----

| (1)    |   | Written  down primarily because of expected deterioration in the performance of the  underlying collateral. As of September 30, 2008, for the securities  with direct interest in the lender, there have been no defaults. For  securities supported by collateral, there have been no defaults or defaults  that have occurred in classes lower in the capital structure. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | While  these fixed income security write-downs were valued at a significant discount  to cost, we believe these securities retain economic value.                                                                                                                                                                                                                                    |
| (3)    |   | During  the third quarter of 2008, we sold our mortgage lender securities that were  written down at June 30, 2008 recognizing a gain of $2 million.                                                                                                                                                                                                                            |
| (4)    |   | Cash  received includes both income and principal collected during the period.                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |

 

Notwithstandingour intent and ability to hold these securities with impairment write-downs, weconcluded that we could not reasonably assert that the recovery period would betemporary.

 

Changein intent write-downs for the three months ended September 30, 2008comprised net realized losses on fixed income securities of $251 million andmortgage loans of $11 million, compared to realized losses on fixed income of$4 million and mortgage loans of $3 million for the same period of the prioryear.  Change in intent write-downs forthe nine months ended September 30, 2008 comprised net realized losses onfixed income of $960 

 

49

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million,equity of $12 million and mortgage loans of $44 million compared to netrealized losses on fixed income of $50 million and mortgage loans of $22million for the same period of the prior year.

 

Change in intent write-downs for the three months ended September 30,2008 are presented in the table below.

 
| ** **                                                                                                                                                                                                                                                                                                                                | ** ** | ** **                    | ** ** | **Financial  Accounting  Standards Board  Statement No. 157,**    | ** ** | ** **                                            | ** **        | **Net realized  capital loss**               | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|----------------------------------------------------------------------------------|------------|-------------------------------------------------------|-------------------|--------------------------------------------------------|------------|
| **($ in millions)**                                                                                                                                                                                                                                                                                                             | ** ** | **Security type**        | ** ** | **Fair Value  Measurements****(“SFAS No. 157”)  Level** | ** ** | **Fair value at  September 30,  2008** | ** **        | **Three Months  Ended  September 30,  2008** | ** ** | **Nine Months  Ended  September 30,  2008** | ** ** |
| **Criteria**                                                                                                                                                                                                                                                                                                                              |       |                          |       |                                                                             |       |                                                  |              |                                                   |       |   |   |
| *Risk Mitigation*                                                                                                                                                                                                                                                                                                                         |       |                          |       |                                                                             |       |                                                  |              |                                                   |       |   |   |
|                                                                                                                                                                                                                                                                                                                                      |       |                          |       |                                                                             |       |                                                  |              |                                                   |       |   |   |
| Targeted reductions in commercial real  estate exposure where it is anticipated that future downside risk remains.  Considerations included position held in the capital structure, vintage year,  illiquidity and deteriorating fundamentals.                                                                                            |       | CRE CDO

CMBS

Mortgage loans |       | 3

2  3

3                                                                       |       | $                                                     | 115  113  2   244 |                                                   | $          | (50  (30  (2   (10 | )  )  )  ) | $ | (298  (125  (34  (42 | )  )  )  ) |
|                                                                                                                                                                                                                                                                                                                                      |       |                          |       |                                                                             |       |                                                  |              |                                                   |       |   |   |
| Targeted reductions in residential real  estate where management believes there is a risk of future material declines  in price in the event of continued deterioration in the economy.  Considerations included position held in the capital structure, projected  performance of the collateral, and expected internal rates of return. |       | Prime

Alt-A

ABS RMBS        |       | 2

3

3                                                                          |       | 21  56  485                                           |              | (3  (11  (58                                           | )  )  )    | (11  (40  (190 | )  )  ) |
|                                                                                                                                                                                                                                                                                                                                      |       |                          |       |                                                                             |       |                                                  |              |                                                   |       |   |   |
| Targeted reductions in financial sector  exposure included securities issued by certain regional banks and certain  large financial institutions.                                                                                                                                                                                         |       | Financial  Sector             |       | 2

3                                                                             |       | 281  24                                               |              | (57  (3                                                | )  )       | (170  (13 | )  ) |
|                                                                                                                                                                                                                                                                                                                                      |       |                          |       |                                                                             |       |                                                  |              |                                                   |       |   |   |
|                                                                                                                                                                                                                                                                                                                                      |       | Other                         |       | 2                                                                                |       | 21                                                    |              | (2                                                     | )          | (17 | ) |
| Total Risk Mitigation (1)                                                                                                                                                                                                                                                                                                                 |       |                          |       |                                                                             |       | 1,362                                                 |              | (226                                                   | )          | (940 | ) |
| Individual Identification (2)                                                                                                                                                                                                                                                                                                             |       |                          |       |                                                                             |       | 414                                                   |              | (36                                                    | )          | (67 | ) |
| Other                                                                                                                                                                                                                                                                                                                                     |       |                          |       |                                                                             |       | 5                                                     |              | —                                                 |       | (9 | ) |
|                                                                                                                                                                                                                                                                                                                                      |       |                          |       |                                                                             |       |                                                  |              |                                                   |       |   |   |
| Total change in intent                                                                                                                                                                                                                                                                                                                    |       |                          |       |                                                                             |       | $                                                     | 1,781             |                                                   | $          | (262 | ) | $ | (1,016 | ) |

 

----

| (1)    |   | After  changing our intent at June 30, 2008 for our risk mitigation and return  optimization programs, the mortgage and asset backed markets and financial  sector experienced significant deterioration, to the point at which securities  could only be sold at prices below our view of their intrinsic values. As a  result only approximately one third of the securities were sold during the  third quarter of 2008. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | During  the third quarter of 2008, additional securities with a fair value of $275  million had change in intent write-downs of $33 million related to Individual  identification.                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

50

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Thefollowing table summarizes the third quarter activity related to securitieswritten down due to a change in intent.

 
| **($ in millions)**                        | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
|                                                 |       |       |       |
| Carrying value as of June 30, 2008              |       | $          | 2,966      |   |
| Sales:                                               |       |       |       |
| Risk mitigation and return optimization  program (1) |       | (923       | )          |
| Other programs                                       |       | (137       | )          |
| Net realized capital gains and losses on  sales:     |       |       |       |
| Risk mitigation and return optimization  program (1) |       | (36        | )          |
| Other programs                                       |       | (1         | )          |
| Additional change in intent designations             |       | 275        |       |
| Write-downs (2)                                      |       | (353       | )          |
| Other                                                |       | (10        | )          |
| Carrying value as of September 30,  2008        |       | $          | 1,781      |   |

 

----

| (1)    |   | Net  proceeds from the sales of second quarter risk mitigation and return  optimization actions totaled $923 million with an additional loss of $36  million or 96% of fair values reported at June 30, 2008. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | Includes  change in intent write-downs of $262 million and impairment write-downs of  $91 million.                                                                                                                 |
|   |   |                                                                                                                                                                                                                    |

 

Netrealized capital losses on the valuation and settlement of derivativeinstruments totaled $71 million for the third quarter of 2008.  Gains from the risk reduction programs wererelated to declines in the fair value of S&P securities and losses wereexperienced in our income generation programs and from the accounting valuationchanges of embedded options in fixed income securities.  Net realized capital losses on the valuationand settlement of derivative instruments totaled $218 million for the firstnine months of 2008, primarily comprised $208 million of losses for theaccounting valuation of equity indexed notes and convertible fixed incomesecurities.

 

AtSeptember 30, 2008, our securities with embedded options totaled $1.14billion and decreased in fair value from December 31, 2007 by $365million, comprising realized capital losses related to the valuation ofembedded options of $208 million, net sales activity of $107 million inrealized capital losses, and unrealized net capital losses reported in othercomprehensive income (“OCI”) of $50 million for the host security.  Net unrealized capital losses were unchangeddue to amortization of $27 million and impairment write-downs of $27 million onthe host security.  The change in thefair value of embedded options is bifurcated from the host securities,separately valued and reported in realized capital gains and losses, while thechange in value of the host securities is reported in OCI.  Total amortized cost exceeded total fairvalue by $30 million at September 30, 2008.  Valuation gains and losses are converted intocash for securities with embedded options upon our election to sell thesesecurities.  In the event the economicvalue of the options is not realized, we will recover the par value if held tomaturity.  Total par value exceeded fairvalue by $90 million at September 30, 2008.

 

Lossesfrom the previously established risk reduction programs, primarily in ourduration management programs, were related to changing interest rates andcredit spreads as rates declined during the period.

 

Achanging interest rate environment will drive changes in our portfolio durationtargets at a tactical level.  A durationtarget and range is established with an economic view of liabilities relativeto a long-term portfolio view.  Tacticalduration management is accomplished through both cash market transactionsincluding new purchases and derivative activities that generate realized gainsand losses.  As a component of ourapproach to managing portfolio duration, realized gains and losses on certainderivative instruments are most appropriately considered in conjunction withthe unrealized gains and losses on the fixed income portfolio.  This approach mitigates the impacts ofgeneral interest rate changes to the overall financial condition of theCompany.

 

51

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The table below presents the realized capital gains and losses(pre-tax) on the valuation and settlement of derivative instruments shown byunderlying exposure and derivative strategy.

 
| ** **                                              | ** ** | **Nine  months ended September 30,** | ** ** | ** **      | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------|------------|-----------------|------------|
| ** **                                              | ** ** | **2008**                                  | ** ** | **2007**        | ** ** | **YTD  2008 Explanations** | ** ** |
| **($ in millions)**                                | ** ** | **Valuation**                             | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| **Risk  Reduction**                                     |       |                                      |       | ** **      |       |   |   |   |   |   |   |
| Duration  gap management                                |       | $                                         | (86        | )               | $          | 31 |   | $ | (55 | ) | $ | 14 |   | Interest rate caps, floors and swaps are used to  align interest-rate sensitivities of assets and liabilities.  The contracts settle based on differences  between current market rates and a contractually specified fixed rate through  expiration. The contracts can be terminated and settled at anytime with a  minimal additional cost. If a settlement is not paid on interest rate  changes, the maximum loss on caps and floors would be limited to the amount  of premium paid for the protection. The change in valuation reflects the  changing value of expected futures settlements from changing interest rates,  which may vary over the period of the contracts. The 2008 YTD losses,  resulting from decreasing interest rates, are offset in unrealized gains in  OCI to the extent it relates to changes in risk-free rates; however, the  impact of widening credit spreads more than offset this benefit. |   |
|                                                    |       |                                      |       |            |       |   |   |   |   |   |   |
| Anticipatory  hedging                                   |       | (1                                        | )          | 90              |       | 89 |   | (26 | ) | Futures are used to protect investment spread from  interest rate changes during mismatches in the timing of cash flows between  product sales and the related investment activity. The futures contracts are  exchange traded, daily cash settled and can be exited at any time for minimal  additional cost. If the cash flow mismatches are such that a positive net  investment position is being hedged, there is an offset for the related  investments unrealized loss in OCI. The 2008 YTD amounts reflect decreases in  risk–free interest rates on a net long position as liability issuances  exceeded asset acquisitions. |   |
|                                                    |       |                                      |       |            |       |   |   |   |   |   |   |
| Hedging of  interest rate exposure in annuity contracts |       | (3                                        | )          | (7              | )          | (10 | ) | (8 | ) | Interest rate caps are used to hedge the effect of  changing crediting rates that are indexed to changes in treasury rates on  certain annuity contracts. The change in valuation reflects the changing  value of expected future settlements including the underlying cost to hedge  the treasury-rate index feature. The offset to the product hedging cost is  reflected in the base crediting rates on the underlying annuity policies,  which is reported in credited interest. The value of expected future  settlements and the associated value of future credited interest, which is  reportable in future periods when incurred, decreased due to declining  interest rates. |   |
|                                                    |       |                                      |       |            |       |   |   |   |   |   |   |
| Hedging  unrealized gains on equity indexed notes       |       | —                                    |       | 4               |       | 4 |   | — |   |   |   |
|                                                    |       |                                      |       |            |       |   |   |   |   |   |   |
| Hedge  ineffectiveness                                  |       | (12                                       | )          | (1              | )          | (13 | ) | — |   | The hedge ineffectiveness of ($12 million) includes  $104 million in realized capital losses on swaps that were offset by $92  million in realized capital gains on the hedged risk. |   |
|                                                    |       |                                      |       |            |       |   |   |   |   |   |   |
| Foreign currency  contracts                             |       | —                                    |       | (2              | )          | (2 | ) | (3 | ) |   |   |
|                                                    |       |                                      |       |            |       |   |   |   |   |   |   |
| Credit  risk reduction                                  |       | 9                                         |       | (1              | )          | 8 |   | — |   | Credit default swaps are used for buying protection  to offset widening credit spreads in our fixed income portfolio. Credit  default swaps typically have five-year terms for which we pay periodic  premiums through expiration. Valuation gains or losses will reverse if  allowed to expire. The changes in valuation would only be converted to cash  upon disposition, which can be done at any time, or if the credit event  specified in the contract occurs. The change in valuation reflects the market’s  view of the potential for a credit event (default and ratings downgrade) to  occur which is reflected in the market place as widening credit spreads.  Valuation changes would only be converted to cash upon disposition which can  be done at any time, or if the credit event specified in the contract occurs.  Not withstanding any recovery on the protection covering an indebtedness  default, the maximum loss is limited to the amount of premiums paid for this  protection. We acquired additional credit default swaps in the third quarter  of 2008 as part of our macro-hedge program. The 2008 YTD valuation gain is  the result of widening credit spreads on referenced credit entities. As of  September 30, 2008, we had $711 million of notional outstanding. |   |
| **Total Risk****reduction**                             |       | $                                         | (93        | )               | $          | 114 |   | $ | 21 |   | $ | (23 | ) |   |   |
|                                                    |       |                                      |       |            |       |   |   |   |   |   |   |
| **Income  generation**                                  |       |                                      |       |            |       |   |   |   |   |   |   |
| Asset  replication – credit exposure               |       | $                                         | (39        | )               | $          | 8 |   | $ | (31 | ) | $ | — |   | Credit default swaps are used to replicate fixed  income securities and to complement the cash market when credit exposure to  certain issuers is not available or when the derivative alternative is less  expensive than the cash market alternative. The credit default swaps  typically have five-year terms for which we receive periodic premiums through  expiration. The change in valuation reflects the market’s view of the  potential for a credit event (default and ratings downgrade) to occur which  is reflected in the market place as widening credit spreads. Valuation  changes would only be converted to cash upon disposition which can be done at  any time, or if the credit event specified in the contract occurs. Not  withstanding any payment received for premiums for providing protection from  an indebtedness default, the maximum exposure is equal to the notional amount  of the credit derivative. In the event of a credit event specified in the  contract, we are obligated to pay the counterparty the notional amount of the  contract and receive in return the referenced defaulted security or similar  security. As of September 30, 2008 we had $1.1 billion of notional  outstanding. |   |

 

52

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| ** **               | ** ** | **Nine  months ended September 30,** | ** ** | ** **      | ** ** |
|--------------------------|------------|-------------------------------------------|------------|-----------------|------------|
| ** **               | ** ** | **2008**                                  | ** ** | **2007**        | ** ** | **YTD  2008 Explanations** | ** ** |
| **($ in millions)** | ** ** | **Valuation**                             | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| **Accounting**           |       |                                      |       |            |       |   |   |   |   |   |   |
| Equity  indexed notes    |       | $                                         | (174       | )               | $          | — |   | $ | (174 | ) | $ | 62 |   | Equity–indexed notes are fixed income securities that  contain embedded options. The changes in valuation of the embedded equity  indexed call options are reported in realized capital gains and losses. The results  generally track the performance of underlying equity indices. During the  third quarter 2008, one of the embedded options was valued at $0 due to the  counterparty’s bankruptcy. As a result, an additional $21 million of losses  was reported in realized capital gains and losses. Valuation gains and losses  are converted into cash upon sale or maturity. In the event the economic  value of the options is not realized, we will recover the par value of the  host fixed income security if held to maturity unless the issuer of the note  defaults. Par value exceeded fair value by $83 million at September 30,  2008. Equity-indexed notes are subject to our comprehensive portfolio  monitoring and watchlist processes to identify and evaluate when the carrying  value may be other-than-temporarily impaired. As a result of this process,  one issue was written-down during third quarter 2008 due to the issuer’s  bankruptcy. The following table compares the September 30, 2008 and  December 31, 2007 holdings respectively. |   |
|                          |            |                                           |            |                 |            |  |  |  |  |  |  |  |  |  |  |

 
|   |                                           |       |                         |       |       |       |                          |       |   |   |   |   |   |   |   |
|--------|------------------------------------------------|------------|------------------------------|------------|------------|------------|-------------------------------|------------|--------|--------|--------|--------|--------|--------|--------|
|   | **($ in millions)**                  | ** ** | **September 30,  2008** | ** ** | **Change** | ** ** | **December 31,****2007** | ** ** |
|   |                                           |       |                         |       |       |       |                          |       |
|   | Par value                                      |       | $                            | 800        |       | $          | —                        |       | $      | 800    |   |
|   | Amortized cost of  host contract               |       | $                            | 491        |       | $          | (6                            | )          | $      | 497    |   |
|   | Fair value of  equity–indexed call option |       | 248                          |       | (174       | )          | 422                           |       |
|   | Total amortized  cost                          |       | $                            | 739        |       | $          | (180                          | )          | $      | 919    |   |
|   | Total Fair value                               |       | $                            | 717        |       | $          | (207                          | )          | $      | 924    |   |
|   | Unrealized  gain/loss                          |       | $                            | (22        | )          | $          | (27                           | )          | $      | 5      |   |

 
|                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Conversion  options in fixed income securities |   |   | (34    | )      |   | — |   |   | (34    | )      |   | 28     |   | Convertible bonds are fixed income securities that  contain embedded options. Changes in valuation of the embedded option are  reported in realized capital gains and losses. The results generally track  the performance of underlying equities. Valuation gains and losses are  converted into cash upon our election to sell these securities. In the event  the economic value of the options is not realized, we will recover the par  value of the host fixed income security if held to maturity unless the issuer  of the note defaults. Par value exceeded fair value by $7 million at September 30,  2008. Convertible bonds are subject to our comprehensive portfolio monitoring  and watchlist processes to identify and evaluate when the carrying value may  be other-than-temporarily impaired. The following table compares the  September 30, 2008 and December 31, 2007 holdings respectively. |   |

 
|   |                             |       |                         |       |                       |       |                                   |       |                        |        |   |   |      |   |   |
|--------|----------------------------------|------------|------------------------------|------------|----------------------------|------------|----------------------------------------|------------|-----------------------------|-------------|--------|--------|-----------|--------|--------|
|   | **($ in millions)**         | ** ** | **September 30,  2008** | ** ** | **Change  in Fair  Value** | ** ** | **Change  due  to Net Sale  Activity** | ** ** | **December 31,  2007** | ** **  |
|   | Par value                        |       | $                            | 429        |                       | $          | —                                 |       | $                           | (130        | )      | $      | 559       |   |
|   | Amortized cost of  host contract |       | $                            | 286        |                       | $          | 6                                      |       | $                           | (107        | )      | $      | 387       |   |
|   | Fair value of  conversion option |       | 144                          |       | (34                        | )          | (12                                    | )          | 190                         |        |
|   | Total amortized  cost            |       | $                            | 430        |                       | $          | (28                                    | )          | $                           | (119        | )      | $      | 577       |   |
|   | Total Fair value       |       | $                            |  422  |                       | $          |  (51)                             |       | $                           |  (107) |   | $      |  580 |   |
|   | Unrealized  gain/loss            |       | $                            | (8         | )                          | $          | (23                                    | )          | $                           | 12          |   | $      | 3         |   |

 
| **Total  accounting** |   | $      | (208   | )      | $      | — |   | $      | (208   | )      | $      | 90 |   |   |   |
|-----------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|----|--------|--------|--------|
| ** **            |   |   |   |   |   |   |   |   |   |   |   |
| **Total**             |   | $      | (340   | )      | $      | 122    |   | $      | (218   | )      | $      | 67 |   |   |   |

 

53

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**APPLICATION OF CRITICAL ACCOUNTING ESTIMATES**

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America (“GAAP”) requires management to adopt accounting policies and makeestimates and assumptions that affect amounts reported in the consolidatedfinancial statements.

 

In applying policies, management makes subjectiveand complex judgments that frequently require estimates about matters that areinherently uncertain. Many of these policies, estimates and related judgmentsare common in the insurance and financial services industries; others are specificto our businesses and operations.  It isreasonably likely that changes in these estimates could occur from period toperiod and result in a material impact on our consolidated financialstatements.

 

Our critical accounting estimate for the fair valueof financial assets and financial liabilities follows.  For a description of critical accountingestimates not discussed below, see the Application of Critical AccountingEstimates section of MD&A found under Part II. Item 7. of the AllstateLife Insurance Company Annual Report on Form 10-K for 2007.

 

**Fair Value of Financial Assets and FinancialLiabilities**SFAS No. 157is effective for fiscal years beginning after November 15, 2007. Weadopted the provisions of SFAS No. 157 as of January 1, 2008 forfinancial assets and financial liabilities that are measured at fairvalue.  SFAS No. 157:

 

·                   Defines fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date, andestablishes a framework for measuring fair value;

 

·                   Establishes a three-level hierarchy for fairvalue measurements based upon the transparency of inputs to the valuation as ofthe measurement date;

 

·                   Expands disclosures about financialinstruments measured at fair value.

 

We categorize our financial assets and financialliabilities measured at fair value based on the priority of the inputs to thevaluation technique, into a three-level fair value hierarchy. The fair valuehierarchy gives the highest priority to quoted prices in active markets foridentical assets or liabilities which we can access (Level 1); the secondhighest priority for similar assets or liabilities in active markets, quotedprices for identical or similar assets or liabilities in non-active markets, orvaluation models whose inputs are observable (Level 2); and the lowest priorityto unobservable inputs (Level 3).  Todistinguish among the categories we consider the frequency of completedtransactions such as daily trading for equity securities.  If inputs used to measure a financialinstrument fall within different levels of the fair value hierarchy, thecategorization is based on the lowest level input that is significant to thefair value measurement of the entire instrument.  Certain financial assets are not carried atfair value on a recurring basis, including investments such as mortgage loans,limited partnership interests, bank loans and policy loans.  Accordingly, such investments are onlyincluded in the fair value hierarchy disclosure when the investment is subjectto remeasurement at fair value after initial recognition and the resultingmeasurement is reflected in the condensed consolidated financialstatements.  In addition, equity optionsembedded in fixed income securities are not disclosed in the hierarchy withfree-standing derivatives as the embedded derivatives are presented as combinedinstruments in fixed income securities.

 

The availability of market observable information isthe principal factor in determining the level that financial instruments areassigned in the three-level hierarchy. Observable inputs are those used bymarket participants in valuing financial instruments that are developed basedon market data obtained from independent sources. In the absence of sufficientobservable inputs, unobservable inputs reflect our estimates of the assumptionsmarket participants would use in valuing financial assets and financialliabilities and are developed based on the best information available in thecircumstances.  The degree of managementjudgment involved in determining fair values is inversely related to theavailability of market observable information.

 

Financial assets andfinancial liabilities recorded on the Condensed Consolidated Statements ofFinancial Position at fair value as of September 30, 2008 are categorizedbased on the reliability of inputs to the valuation techniques as follows:

 

*Level 1:***    **Financial assets and financial liabilities whose values are based onunadjusted quoted prices for identical assets or liabilities in an activemarket that we can access.

 

*Level 2:*****Financial assets and financial liabilitieswhose values are based on the following:

 

a)              Quoted prices for similar assets orliabilities in active markets;

 

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

 

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

 

*Level 3:****    ***Financial assets and financial liabilitieswhose values are based on prices or valuation techniques that require inputsthat are both unobservable and significant to the overall fair valuemeasurement. These inputs may reflect our estimates of the assumptions thatmarket participants would use in valuing the financial assets and financialliabilities.

 

We utilize a combination of third party valuationservice providers, brokers, and internal valuation models to determine fairvalue.  We gain assurance on the overallreasonableness and consistent application of valuation input assumptions,valuation methodologies, and compliance with accounting standards for fairvalue determination through the execution of various processes and controls designedto ensure that our financial assets and financial liabilities are appropriatelyvalued.  We monitor fair values receivedfrom third parties and those derived internally on an ongoing basis.

 

We are responsible for the determination of thevalue of the financial assets and financial liabilities carried at fair valueand the supporting assumptions and methodologies.  In certain situations, we employ independentthird-party valuation service providers to gather, analyze, and interpretmarket information and derive fair values based upon relevant assumptions andmethodologies for individual instruments. In situations where our valuation service providers are unable to obtainsufficient market observable information upon which to estimate the fair valuefor a particular security, fair value is determined either by requestingbrokers who are knowledgeable about these securities to provide a single quoteor by employing internal valuation models that are widely accepted in thefinancial services industry.  Changingmarket conditions are incorporated into valuation assumptions and reflected inthe fair values, which are validated by calibration and other analyticaltechniques to available market observable data.

 

Valuation service providers typically obtain dataabout market transactions and other key valuation model inputs from multiplesources and, through the use of proprietary algorithms, produce valuationinformation in the form of a single fair value for individual securities forwhich a fair value has been requested under the terms of our agreements.  For certain equity securities, valuationservice providers provide market quotations for completed transactions on themeasurement date.  For other securitytypes, fair values are derived from the valuation service providers’proprietary valuation models.  The inputsused by the valuation service providers include, but are not limited to, marketprices from recently completed transactions and transactions of comparablesecurities, interest rate yield curves, credit spreads, liquidity spread,currency rates, and other market-observable information, as applicable. Creditand liquidity spreads are typically implied from completed transactions andtransactions of comparable securities. Valuation service providers also use proprietary discounted cash flowmodels that are widely accepted in the financial services industry and similarto those used by other market participants to value the same financialinstruments.  The valuation models takeinto account, among other things, market observable information as of themeasurement date, as described above, as well as the specific attributes of thesecurity being valued including its term, interest rate, credit rating,industry sector, and where applicable, collateral quality and other issue orissuer specific information.  Executingvaluation models effectively requires seasoned professional judgment andexperience.  In cases where market transactionsor other market observable data is limited, the extent to which judgment isapplied varies inversely with the availability of market observableinformation.

 

For certain of our financialassets carried at fair value, where our valuation service providers cannotprovide fair value determinations, we obtain non-binding price quotes frombrokers familiar with the security who, similar to our valuation serviceproviders, may consider transactions or activity in similar securities, asapplicable, among other information.  Thebrokers providing price quotes are generally from the brokerage divisions ofleading financial institutions with market making, underwriting anddistribution expertise.

 

The fair value of financialassets and financial liabilities, including privately-placed securities,certain free-standing derivatives and certain derivatives embedded in certaincontractholder liabilities, where our valuation service providers or brokers donot provide fair value determinations, is determined using valuation methodsand models widely accepted in the financial services industry.  Internally developed valuation models, whichinclude inputs that may not be market observable and as such involve somedegree of judgment, are considered appropriate for each class of security towhich they are applied.

 

Our internal pricing methods are primarily based onmodels using discounted cash flow methodologies that determine a single bestestimate of fair value for individual financial instruments.  In addition, our models use internallyassigned credit ratings as inputs (which are generally consistent with anyexternal ratings and those we use to report our holdings by credit rating) andstochastically determined cash flows for certain derivatives embedded incertain contractholder liabilities, both of which are difficult toindependently observe and verify. Instrument specific 

 

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inputsused in our internal fair value determinations include: coupon rate, weightedaverage life, sector of the issuer, call provisions, and the contractualelements of derivatives embedded in certain contractholder liabilities.  Market related inputs used in these fairvalues, which we believe are representative of inputs other market participantswould use to determine fair value of the same instruments include: interestrate yield curves, quoted market prices of comparable securities, creditspreads, estimated liquidity premiums, and other applicable market dataincluding lapse and anticipated market return estimates for derivativesembedded in certain contractholder liabilities. Credit spreads are determined using those published by a commonly usedindustry specialist for comparable public securities.  A liquidity premium is also added to reflectspreads commonly required for the types of securities being valued and arecalibrated based on actual trades or other market data.  As a result of the significance of non-marketobservable inputs, including internally assigned credit ratings and stochasticcash flow estimates as described above, judgment is required in developingthese fair values. The fair value of these financial assets and financialliabilities may differ from the amount actually received to sell an asset orthe amount paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date. Moreover, the use of different valuation assumptions may have a materialeffect on the financial assets’ and financial liabilities’ fair values.

 

Fairvalue of our investments comprise an aggregation of numerous, single bestestimates for each security in the Condensed Consolidated Statements ofFinancial Position.  Because of thisdetailed approach, there is no single set of assumptions that determine ourfair value estimates at a consolidated level. Moreover, management does not compile a range of estimates for itemsreported at fair value at the consolidated level because we do not believe thata range would provide meaningful information. Level 1 and Level 2 measurements represent valuations where allsignificant inputs are market observable. Level 3 measurements have one or moresignificant inputs that are not market observable and as a result these fairvalue determinations have greater potential variability as it relates to theirsignificant inputs.  The Level 3principal components are privately placed securities valued using internalmodels, broker quoted securities, ABS RMBS, Alt-A, ARS backed by student loansand other CDO.  In general, the greaterthe reliance on significant inputs that are not market observable, the greaterpotential variability of the fair value determinations. Due to the reducedavailability of actual market prices or relevant observable inputs as a resultof the decrease in liquidity that has been experienced in the market, all ABSRMBS and Alt-A are categorized as Level 3. For broker quoted securities’ fair value determinations, we believe thebrokers providing the quotes may consider market observable transactions oractivity in similar securities, as applicable, and other information ascalibration points.  Privately placedsecurities’ fair value determinations, which were based on internal ratingsthat are not market observable, are calibrated to market observable informationin the form of external NAIC ratings and credit spreads.

 

Webelieve our most significant exposure to changes in fair value is due to marketrisk.  Our exposure to changes in marketconditions is discussed fully in the Market Risk section of the MD&Aincluded in our 2007 Form 10-K.

 

We employ specific control processes to determine thereasonableness of the fair values of our financial assets and financialliabilities.  Our processes are designedto ensure that the values received or internally estimated are accuratelyrecorded and that the data inputs and the valuation techniques utilized areappropriate, consistently applied, and that the assumptions are reasonable andconsistent with the objective of determining fair value.  For example, on a continuing basis, we assessthe reasonableness of individual security values received from valuationservice providers that exceed certain thresholds as compared to previous valuesreceived from those valuation service providers. In addition, we may validatethe reasonableness of fair values by comparing information obtained from ourvaluation service providers to other third party valuation sources for selectedfinancial assets. When fair value determinations are expected to be morevariable, we validate them through reviews by members of management who haverelevant expertise and who are independent of those charged with executinginvestment transactions.  We do not alterfair values provided by our valuation providers or brokers.

 

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The following table identifies investments as of September 30,2008 by source of value determination:

 
| ** **                                                                                                                                                         | ** ** | **Investments** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|
| **($ in millions)**                                                                                                                                      | ** ** | **Fair  Value** | ** ** | **Percent  to total** | ** ** |
| Fair value based on internal sources                                                                                                                               |       | $               | 11,929     |   | 18.4 | % |
| Fair value based on external sources (1)                                                                                                                           |       | 39,115          |       | 60.3 |   |
| Total fixed income, equity and certain  short-term securities                                                                                                      |       | 51,044          |       | 78.7 |   |
| Fair value of derivatives                                                                                                                                          |       | 100             |       | 0.2 |   |
| Mortgage loans, policy loans, bank loans  and certain limited partnership, short-term and other investments, valued at  cost, amortized cost and the equity method |       | 13,670          |       | 21.1 |   |
| Total                                                                                                                                                              |       | $               | 64,814     |   | 100.0 | % |

 

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(1)          Includes $901 million that are valued using broker quotes.

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Formore detailed information on our accounting policy for the fair value offinancial assets and financial liabilities and information on the financialassets and financial liabilities included in the levels promulgated by SFAS No. 157,see Note 4 to the Condensed Consolidated Financial Statements.

 

57

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The following table provides additional detailsregarding Level 1, 2 and 3 financial assets and financial liabilities by theirclassification in the Condensed Consolidated Statement of Financial Position atSeptember 30, 2008.

 
| ** **                                                 | ** ** | **Quoted prices  in active  markets for  identical  assets** | ** ** | **Significant  other  observable  inputs** | ** ** | **Significant  unobservable  inputs** | ** ** | **Other  valuations  and** | ** ** | **Balance as of  September 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------|------------|----------------------------|------------|-------------------------------------------------|------------|
| **($ in millions)**                              | ** ** | **(Level 1)**                                                          | ** ** | **(Level 2)**                         | ** ** | **(Level 3)**                    | ** ** | **netting**                | ** ** | **2008**                                        | ** ** |
| **Financial  assets**                                      |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| Fixed income securities:                                   |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| Corporate                                                  |       | $                                                                           | —     |                                       | $          | 12,555                                |       | $                          | 502        |                                            |       |   | $ | 13,057 |   |
| Corporate privately placed securities                      |       | —                                                                      |       | 3,637                                      |       | 10,363                                |       |                       |       | 14,000                                          |       |
| Municipal                                                  |       | —                                                                      |       | 3,150                                      |       | 1                                     |       |                       |       | 3,151                                           |       |
| Municipal – ARS                                       |       | —                                                                      |       | —                                     |       | 708                                   |       |                       |       | 708                                             |       |
| U.S. government and agencies                               |       | 654                                                                         |       | 2,958                                      |       | —                                |       |                       |       | 3,612                                           |       |
| ABS RMBS                                                   |       | —                                                                      |       | —                                     |       | 1,553                                 |       |                       |       | 1,553                                           |       |
| Alt-A                                                      |       | —                                                                      |       | —                                     |       | 364                                   |       |                       |       | 364                                             |       |
| Other CDO                                                  |       | —                                                                      |       | —                                     |       | 1,326                                 |       |                       |       | 1,326                                           |       |
| Other ABS                                                  |       | —                                                                      |       | —                                     |       | 477                                   |       |                       |       | 477                                             |       |
| ABS CDO                                                    |       | —                                                                      |       | —                                     |       | 8                                     |       |                       |       | 8                                               |       |
| CRE CDO                                                    |       | —                                                                      |       | —                                     |       | 115                                   |       |                       |       | 115                                             |       |
| CMBS                                                       |       | —                                                                      |       | 4,862                                      |       | 119                                   |       |                       |       | 4,981                                           |       |
| Preferred stock                                            |       | —                                                                      |       | 14                                         |       | 1                                     |       |                       |       | 15                                              |       |
| MBS                                                        |       | —                                                                      |       | 2,435                                      |       | 10                                    |       |                       |       | 2,445                                           |       |
| Foreign government                                         |       | —                                                                      |       | 1,964                                      |       | —                                |       |                       |       | 1,964                                           |       |
| ABS – Credit card, auto and student loans             |       | —                                                                      |       | 124                                        |       | 171                                   |       |                       |       | 295                                             |       |
| Total fixed income securities                              |       | 654                                                                         |       | 31,699                                     |       | 15,718                                |       |                       |       | 48,071                                          |       |
| Equity securities:                                         |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| U.S equities                                               |       | 11                                                                          |       | —                                     |       | 15                                    |       |                       |       | 26                                              |       |
| International equities                                     |       | 22                                                                          |       | —                                     |       | 13                                    |       |                       |       | 35                                              |       |
| Other                                                      |       | —                                                                      |       | 45                                         |       | 2                                     |       |                       |       | 47                                              |       |
| Total equity securities                                    |       | 33                                                                          |       | 45                                         |       | 30                                    |       |                       |       | 108                                             |       |
| Short-term investments:                                    |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| Commercial paper and other                                 |       | —                                                                      |       | 2,710                                      |       | —                                |       |                       |       | 2,710                                           |       |
| Money market funds                                         |       | 155                                                                         |       | —                                     |       | —                                |       |                       |       | 155                                             |       |
| Total short–term investments                          |       | 155                                                                         |       | 2,710                                      |       | —                                |       |                       |       | 2,865                                           |       |
| Other investments:                                         |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| Free–standing derivatives                             |       | —                                                                      |       | 403                                        |       | 34                                    |       |                       |       | 437                                             |       |
| Total other investments                                    |       | —                                                                      |       | 403                                        |       | 34                                    |       |                       |       | 437                                             |       |
| **Total recurring basis assets**                           |       | 842                                                                         |       | 34,857                                     |       | 15,782                                |       |                       |       | 51,481                                          |       |
| Non–recurring basis                                   |       | —                                                                      |       | —                                     |       | 225                                   |       |                       |       | 225                                             |       |
| Valued at cost, amortized cost or using the  equity method |       | —                                                                      |       | —                                     |       | —                                |       | $                          | 13,445     |                                            | 13,445     |   |
| Counterparty and cash collateral netting (1)               |       | —                                                                      |       | —                                     |       | —                                |       | (337                       | )          | (337                                            | )          |
| **Total investments**                                      | ** ** | **842**                                                                     | ** ** | **34,857**                                 | ** ** | **16,007**                            | ** ** | **13,108**                 | ** ** | **64,814**                                      | ** ** |
| Separate account assets                                    |       | 10,603                                                                      |       | —                                     |       | —                                |       | —                     |       | 10,603                                          |       |
| Other assets                                               |       | (3                                                                          | )          | —                                     |       | 2                                     |       | —                     |       | (1                                              | )          |
|                                                       |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| **Total  financial assets**                                | ** ** | **$**                                                                       | **11,442** | ** **                                 | **$**      | **34,857**                            | ** ** | **$**                      | **16,009** | ** **                                      | **$**      | **13,108** | ** ** | **$** | **75,416** | ** ** |
| % of total  financial assets                               |       | 15.2                                                                        | %          | 46.2                                       | %          | 21.2                                  | %          | 17.4                       | %          | 100.0                                           | %          |
| ** **                                                 |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| **Financial  liabilities**                                 |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| Contractholder funds:                                      |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| Derivatives embedded in annuity contracts                  |       | $                                                                           | —     |                                       | $          | (46                                   | )          | $                          | (42        | )                                               |       |   | $ | (88 | ) |
| Other liabilities:                                         |       |                                                                        |       |                                       |       |                                  |       |                       |       |                                            |       |
| Free–standing derivatives                             |       | —                                                                      |       | (399                                       | )          | (68                                   | )          |                       |       | (467                                            | )          |
| Non–recurring basis                                   |       | —                                                                      |       | —                                     |       | —                                |       |                       |       | —                                          |       |
| Counterparty and cash collateral netting (1)               |       | —                                                                      |       | —                                     |       | —                                |       | $                          | 222        |                                            | 222        |   |
| **Total  financial liabilities**                           | ** ** | **$**                                                                       | **—** | ** **                                 | **$**      | **(445**                              | **)**      | **$**                      | **(110**   | **)**                                           | **$**      | **222** | ** ** | **$** | **(333** | **)** |
| % of total  financial liabilities                          |       | —                                                                      | %          | 133.6                                      | %          | 33.0                                  | %          | (66.6                      | )%         | 100.0                                           | %          |

 

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(1) In accordance with *Financial Accounting Standards Board (“FASB”) StaffPosition No. FIN 39-1, Amendment of FASB Interpretation No. 39*,we net all fair value amounts recognized for derivative instruments and fairvalue amounts recognized for the right to reclaim cash collateral or theobligation to return cash collateral executed with the same counterparty undera master netting agreement.  At September 30, 2008, the right toreclaim cash collateral was offset by securities held, and the obligation toreturn collateral was $115 million.

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Thefollowing table provides a summary of changes in fair value during the three–monthperiod ended September 30, 2008 of Level 3 financial assets and financialliabilities held at fair value on a recurring basis at September 30, 2008.

 
| ** **                                        | ** ** | ** **                                           | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                                                          | ** ** | **Total  gains (losses)  included in  net income for** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in millions)**                     | ** ** | **Balance as of  June 30, 2008** | ** ** | **Net income**** (1)**                                                             | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases, sales,  issuances and  settlements,  net** | ** ** | **Net  transfers in  and/or (out)  of Level 3** | ** ** | **Balance as of  September 30,  2008**                      | ** ** | **instruments  still held at  September 30,  2008 ****(4)** | ** ** |
| **Financial assets**                              |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                       |       |   |   |
| Fixed income securities:                          |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                       |       |   |   |
| Corporate                                         |       | $                                                    | 569        |                                                                                         | $          | (22                                                     | )          | $                                                                 | (32        | )                                                                   | $          | (160                                                                       | )          | $ | 147 |   | $ | 502 |   | $ | (22 | ) |
| Corporate privately placed securities             |       | 10,775                                               |       | (67                                                                                          | )          | (434                                                    | )          | 87                                                                |       | 2                                                                   |       | 10,363                                                                     |       | (73 | ) |
| Municipal                                         |       | 59                                                   |       | —                                                                                       |       | (7                                                      | )          | 6                                                                 |       | (57                                                                 | )          | 1                                                                          |       | — |   |
| Municipal –ARS                               |       | 745                                                  |       | —                                                                                       |       | 1                                                       |       | (38                                                               | )          | —                                                              |       | 708                                                                        |       | — |   |
| ABS RMBS                                          |       | 1,798                                                |       | (64                                                                                          | )          | (44                                                     | )          | (137                                                              | )          | —                                                              |       | 1,553                                                                      |       | (51 | ) |
| Alt–A                                        |       | 468                                                  |       | (17                                                                                          | )          | (38                                                     | )          | (49                                                               | )          | —                                                              |       | 364                                                                        |       | (11 | ) |
| Other CDO                                         |       | 1,613                                                |       | (170                                                                                         | )          | (111                                                    | )          | (6                                                                | )          | —                                                              |       | 1,326                                                                      |       | (171 | ) |
| Other ABS                                         |       | 560                                                  |       | —                                                                                       |       | (17                                                     | )          | (55                                                               | )          | (11                                                                 | )          | 477                                                                        |       | — |   |
| ABS CDO                                           |       | 14                                                   |       | —                                                                                       |       | (4                                                      | )          | (2                                                                | )          | —                                                              |       | 8                                                                          |       | — |   |
| CRE CDO                                           |       | 375                                                  |       | (63                                                                                          | )          | 2                                                       |       | (199                                                              | )          | —                                                              |       | 115                                                                        |       | (53 | ) |
| CMBS                                              |       | 168                                                  |       | 11                                                                                           |       | (10                                                     | )          | (81                                                               | )          | 31                                                                  |       | 119                                                                        |       | 2 |   |
| Preferred stock                                   |       | —                                               |       | 1                                                                                            |       | —                                                  |       | —                                                            |       | —                                                              |       | 1                                                                          |       | — |   |
| MBS                                               |       | 12                                                   |       | —                                                                                       |       | (2                                                      | )          | —                                                            |       | —                                                              |       | 10                                                                         |       | — |   |
| Foreign government                                |       | —                                               |       | —                                                                                       |       | —                                                  |       | (5                                                                | )          | 5                                                                   |       | —                                                                     |       | — |   |
| ABS – Credit card, auto and student loans    |       | 204                                                  |       | (4                                                                                           | )          | (7                                                      | )          | (33                                                               | )          | 11                                                                  |       | 171                                                                        |       | (4 | ) |
| Total  fixed income securities                    |       | 17,360                                               |       | (395                                                                                         | )          | (703                                                    | )          | (672                                                              | )          | 128                                                                 |       | 15,718                                                                     |       | (383 | ) |
| Equity securities                                 |       | 27                                                   |       | (1                                                                                           | )          | (1                                                      | )          | 5                                                                 |       | —                                                              |       | 30                                                                         |       | (1 | ) |
| Other investments:                                |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                       |       |   |   |
| Free-standing derivatives, net                    |       | (25                                                  | )          | (34                                                                                          | )          | —                                                  |       | 25                                                                |       | —                                                              |       | (34                                                                        | )(2)       | (3 | ) |
| Total  other investments                          |       | (25                                                  | )          | (34                                                                                          | )          | —                                                  |       | 25                                                                |       | —                                                              |       | (34                                                                        | )          | (3 | ) |
| **Total investments**                             |       | 17,362                                               |       | (430                                                                                         | )          | (704                                                    | )          | (642                                                              | )          | 128                                                                 |       | 15,714                                                                     | (3)        | (387 | ) |
| Other assets                                      |       | 2                                                    |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                              |       | 2                                                                          |       | — |   |
| **Total recurring Level 3 financial assets**      |       | $                                                    | 17,364     |                                                                                         | $          | (430                                                    | )          | $                                                                 | (704       | )                                                                   | $          | (642                                                                       | )          | $ | 128 |   | $ | 15,716 |   | $ | (387 | ) |
|                                              |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                       |       |   |   |
| **Financial liabilities**                         |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                       |       |   |   |
| Contractholder funds:                             |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                       |       |   |   |
| Derivatives embedded in annuity contracts         |       | $                                                    | (20        | )                                                                                            | $          | (23                                                     | )          | $                                                                 | —     |                                                                | $          | 1                                                                          |       | $ | — |   | $ | (42 | ) | $ | (23 | ) |
| **Total recurring Level 3 financial liabilities** |       | $                                                    | (20        | )                                                                                            | $          | (23                                                     | )          | $                                                                 | —     |                                                                | $          | 1                                                                          |       | $ | — |   | $ | (42 | ) | $ | (23 | ) |

 

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(1) The amounts above total $(453) million andare reported in the Condensed Consolidated Statements of Operations as follows:$(461) million in realized capital gains and losses; $32 million in netinvestment income; $(1) million in interest credited to contractholderfunds; and $(23) million in contract benefits.

(2) Comprises $34 million of financial assetsand $(68) million of financial liabilities.

(3) Comprises $15.78 billion of investments and$(68) million of free–standing derivatives included in financial liabilities.

(4) The amounts above represent gains and lossesincluded in net income for the period of time that the financial asset orfinancial liability was determined to be in Level 3.  These gains and losses total $(410) millionand are reported in the Condensed Consolidated Statements of Operations asfollows: $(419) million in realized capital gains and losses; $32 million innet investment income; and $(23) million in contract benefits.

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Thefollowing table provides a summary of changes in fair value during the nine–monthperiod ended September 30, 2008 of Level 3 financial assets and financialliabilities held at fair value on a recurring basis at September 30, 2008.

 
| ** **                                        | ** ** | ** **                                         | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                                                          | ** ** | **Total  gains (losses)  included in  net income for** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| **($ in millions)**                     | ** ** | **Balance as of  January 1,  2008** | ** ** | **Net income**** (1)**                                                             | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases, sales,  issuances and  settlements,  net** | ** ** | **Net  transfers in  and/or (out)  of Level 3** | ** ** | **Balance as of  September 30,  2008**            | ** ** | **instruments  still held at  September 30,  2008 ****(4)** | ** ** |
| **Financial assets**                              |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                             |       |   |   |
| Fixed income securities:                          |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                             |       |   |   |
| Corporate                                         |       | $                                                  | 747        |                                                                                         | $          | (65                                                     | )          | $                                                                 | (39        | )                                                                   | $          | (156                                                             | )          | $ | 15 |   | $ | 502 |   | $ | (65 | ) |
| Corporate privately placed securities             |       | 11,098                                             |       | (78                                                                                          | )          | (634                                                    | )          | (262                                                              | )          | 239                                                                 |       | 10,363                                                           |       | (110 | ) |
| Municipal                                         |       | 68                                                 |       | —                                                                                       |       | (7                                                      | )          | 7                                                                 |       | (67                                                                 | )          | 1                                                                |       | — |   |
| Municipal – ARS                              |       | 163                                                |       | —                                                                                       |       | (20                                                     | )          | (50                                                               | )          | 615                                                                 |       | 708                                                              |       | — |   |
| ABS RMBS                                          |       | 2,382                                              |       | (345                                                                                         | )          | (176                                                    | )          | (308                                                              | )          | —                                                              |       | 1,553                                                            |       | (325 | ) |
| Alt–A                                        |       | 588                                                |       | (87                                                                                          | )          | (55                                                     | )          | (82                                                               | )          | —                                                              |       | 364                                                              |       | (65 | ) |
| Other CDO                                         |       | 1,961                                              |       | (168                                                                                         | )          | (424                                                    | )          | (23                                                               | )          | (20                                                                 | )          | 1,326                                                            |       | (142 | ) |
| Other ABS                                         |       | 720                                                |       | (15                                                                                          | )          | (62                                                     | )          | (219                                                              | )          | 53                                                                  |       | 477                                                              |       | (2 | ) |
| ABS CDO                                           |       | 36                                                 |       | (63                                                                                          | )          | 38                                                      |       | (3                                                                | )          | —                                                              |       | 8                                                                |       | (63 | ) |
| CRE CDO                                           |       | 566                                                |       | (374                                                                                         | )          | 160                                                     |       | (237                                                              | )          | —                                                              |       | 115                                                              |       | (230 | ) |
| CMBS                                              |       | 224                                                |       | (24                                                                                          | )          | (13                                                     | )          | (103                                                              | )          | 35                                                                  |       | 119                                                              |       | (6 | ) |
| Preferred stock                                   |       | —                                             |       | 1                                                                                            |       | —                                                  |       | —                                                            |       | —                                                              |       | 1                                                                |       | — |   |
| MBS                                               |       | 28                                                 |       | (1                                                                                           | )          | (2                                                      | )          | (15                                                               | )          | —                                                              |       | 10                                                               |       | — |   |
| Foreign government                                |       | —                                             |       | —                                                                                       |       | —                                                  |       | (5                                                                | )          | 5                                                                   |       | —                                                           |       | — |   |
| ABS – Credit card, auto and student loans    |       | 249                                                |       | (4                                                                                           | )          | (14                                                     | )          | (74                                                               | )          | 14                                                                  |       | 171                                                              |       | (4 | ) |
| Total fixed income securities                     |       | 18,830                                             |       | (1,223                                                                                       | )          | (1,248                                                  | )          | (1,530                                                            | )          | 889                                                                 |       | 15,718                                                           |       | (1,012 | ) |
| Equity securities                                 |       | 61                                                 |       | (3                                                                                           | )          | (7                                                      | )          | 18                                                                |       | (39                                                                 | )          | 30                                                               |       | (3 | ) |
| Other investments:                                |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                             |       |   |   |
| Free-standing derivatives, net                    |       | (6                                                 | )          | (65                                                                                          | )          | —                                                  |       | 37                                                                |       | —                                                              |       | (34                                                              | )(2)       | 18 |   |
| Total other investments                           |       | (6                                                 | )          | (65                                                                                          | )          | —                                                  |       | 37                                                                |       | —                                                              |       | (34                                                              | )          | 18 |   |
| **Total investments**                             |       | 18,885                                             |       | (1,291                                                                                       | )          | (1,255                                                  | )          | (1,475                                                            | )          | 850                                                                 |       | 15,714                                                           | (3)        | (997 | ) |
| Other assets                                      |       | 2                                                  |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                              |       | 2                                                                |       | — |   |
| **Total recurring Level 3 financial assets**      |       | $                                                  | 18,887     |                                                                                         | $          | (1,291                                                  | )          | $                                                                 | (1,255     | )                                                                   | $          | (1,475                                                           | )          | $ | 850 |   | $ | 15,716 |   | $ | (997 | ) |
|                                              |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                             |       |   |   |
| **Financial liabilities**                         |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                             |       |   |   |
| Contractholder funds:                             |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                             |       |   |   |
| Derivatives embedded in annuity contracts         |       | $                                                  | 4          |                                                                                         | $          | (47                                                     | )          | $                                                                 | —     |                                                                | $          | 1                                                                |       | $ | — |   | $ | (42 | ) | $ | (47 | ) |
| **Total recurring Level 3 financial liabilities** |       | $                                                  | 4          |                                                                                         | $          | (47                                                     | )          | $                                                                 | —     |                                                                | $          | 1                                                                |       | $ | — |   | $ | (42 | ) | $ | (47 | ) |

 

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(1) The amounts above total $(1.34) billion andare reported in the Condensed Consolidated Statements of Operations as follows:$(1.34) billion in realized capital gains and losses; $57 million in netinvestment income; $(5) million in interest credited to contractholderfunds; and $(47) million in contract benefits.

(2) Comprises $34 million of financial assetsand $(68) million of financial liabilities.

(3) Comprises $15.78 billion of investments and$(68) million of free–standing derivatives included in financial liabilities.

(4) The amounts above represent gains and lossesincluded in net income for the period of time that the financial asset orfinancial liability was determined to be in Level 3.  These gains and losses total $(1.04) billionand are reported in the Condensed Consolidated Statements of Operations asfollows: $(1.04) billion in realized capital gains and losses; $51 million innet investment income; $(1) million in interest credited to contractholderfunds; and $(47) million in contract benefits.

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Transfers into and out of Level 3 during the ninemonths ended September 30, 2008 are attributable to a change in theavailability of market observable information for individual securities withinthe respective categories.  Due to acontinued deterioration in liquidity for the segment of the ARS market backedby student loans, certain market observable data utilized for valuationpurposes became unavailable during the second quarter of 2008.  As of September 30, 2008, $708 millionor 100.0% of our total ARS holdings continued to be valued using a discountedcash flow model.  Certain inputs to thevaluation model that are significant to the overall valuation and not marketobservable included: estimates of future coupon rates if auction failurescontinue, maturity assumptions, and illiquidity premium.  As a result of the reliance on certainnon-market observable inputs, the ARS portfolio backed by student loans havebeen transferred to Level 3 for the quarters ended June 30, 2008 and September 30,2008. These same securities were classified as Level 2 measurements for theperiod ended March 31, 2008.

 

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The following table presents fair value as a percent of amortized costfor Level 3 investments at September 30, 2008.

 
| **($ in millions)**                  | ** ** | **Fair value** | ** ** | **Fair value as a  % of amortized  cost** | ** ** |
|------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------------------|------------|
| Fixed income securities:                       |       |                |       |                                                               |       |
| Corporate                                      |       | $                   | 502        |                                                               | 94.5       | % |
| Corporate - privately placed securities        |       | 10,363              |       | 95.8                                                               |       |
| Municipal                                      |       | 1                   |       | 100.0                                                              |       |
| Municipal - ARS                                |       | 708                 |       | 96.2                                                               |       |
| ABS RMBS                                       |       | 1,553               |       | 75.0                                                               |       |
| Alt-A                                          |       | 364                 |       | 81.6                                                               |       |
| Other CDO                                      |       | 1,326               |       | 66.3                                                               |       |
| Other ABS                                      |       | 477                 |       | 85.2                                                               |       |
| ABS CDO                                        |       | 8                   |       | 72.7                                                               |       |
| CRE CDO                                        |       | 115                 |       | 100.9                                                              |       |
| CMBS                                           |       | 119                 |       | 73.9                                                               |       |
| Preferred stock                                |       | 1                   |       | 100.0                                                              |       |
| MBS                                            |       | 10                  |       | 90.9                                                               |       |
| ABS – Credit card, auto and student loans |       | 171                 |       | 90.5                                                               |       |
| Total fixed income securities                  |       | 15,718              |       | 89.1                                                               |       |
| Equity securities:                             |       |                |       |                                                               |       |
| U.S. equities                                  |       | 15                  |       | 100.0                                                              |       |
| International equities                         |       | 13                  |       | 100.0                                                              |       |
| Other                                          |       | 2                   |       | 100.0                                                              |       |
| Total equity securities                        |       | 30                  |       | 100.0                                                              |       |
| Other investments:                             |       |                |       |                                                               |       |
| Free-standing derivatives                      |       | 34                  |       | N/A                                                                |       |
| Total other investments                        |       | 34                  |       | N/A                                                                |       |
| Sub-total recurring Level 3 investments        |       | 15,782              |       | 89.1                                                               |       |
| Non-recurring basis                            |       | 225                 |       | 100.0                                                              |       |
| **Total Level 3 investments**                  |       | $                   | 16,007     |                                                               | 89.2       |   |

 

Non-recurringinvestments include certain mortgage loans, limited partnership interests andother investments remeasured at fair value during the third quarter of 2008 dueto our change in intent write-downs and other-than-temporary impairments.

 

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**CAPITAL RESOURCES AND LIQUIDITY**

 

**Capital Resources** consist of shareholder’s equity and surplusnotes due to related parties, representing funds deployed or available to bedeployed to support business operations. The following table summarizes our capital resources.

 
| **($ in millions)**                                 | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Common stock, additional capital paid-in  and retained income |       | $                            | 4,569      |                        | $          | 4,847 |   |
| Accumulated other comprehensive loss                          |       | (787                         | )          | (84                         | )          |
| Total shareholder’s equity                               |       | 3,782                        |       | 4,763                       |       |
| Surplus notes due to related parties                          |       | 650                          |       | 200                         |       |
| Total capital resources                                       |       | $                            | 4,432      |                        | $          | 4,963 |   |

 

*Shareholder’s equity* decreased in the first nine months of 2008due primarily to higher unrealized net capital losses on investments as of September 30,2008 compared to December 31, 2007 and a net loss for the first ninemonths of 2008, partially offset by capital contributions from AllstateInsurance Company (“AIC”).

 

In the second quarter of 2008, the Company received a capitalcontribution from its parent AIC of $349 million, which was recorded asadditional capital paid-in on the Condensed Consolidated Statements ofFinancial Position.  The capitalcontribution included fixed income securities with a fair value of $337million, accrued investment income of $5 million and cash of $7 million.  Additionally, in the first quarter of 2008, anon-cash capital contribution was recorded in connection with a reinsurancetransaction with AHL.

 

*Surplus notes due to related parties* increased $450 million in the first ninemonths of 2008 due to the issuance of a $400 million surplus note to AIC andthe issuance and transfer of a $50 million surplus note to an unconsolidatedaffiliate.

 

On August 29, 2008, the Company issued a surplus note to AIC witha principal sum of $400 million in exchange for cash.  This surplus note accrues interest at a rateof 7.50% annually, which is due on the first day of April and October ineach year beginning 2009 until maturity on August 29, 2028.  The payment of interest and principal issubject to prior written approval from the Director of Insurance of the Stateof Illinois and can only be paid out of the Company’s statutory-basis surplusthat is in excess of certain amounts specified in the surplus note.  This surplus note is included as a componentof surplus notes due to related parties on the Condensed ConsolidatedStatements of Financial Position.

 

Under an existing agreement with Kennett Capital, Inc. (“Kennett”),an unconsolidated affiliate of the Company, the Company sold Kennett on June30, 2008 a $50 million redeemable surplus note issued on May 28, 2008 by ALICReinsurance Company (“ALIC Re”), a wholly owned subsidiary of the Company.  The surplus note is due June 1, 2038with an initial rate of 5.93% that will reset every ten years to the thencurrent ten year Constant Maturity Treasury yield (“CMT”), plus 2.09%.  As payment, Kennett issued on June 30, 2008 afull recourse note due June 1, 2038 to the Company for the same amountwith an initial interest rate of 5.73% that will reset every ten years to thethen current ten year CMT, plus 1.89%. The note due from Kennett is classified as other investments and therelated surplus note is classified as surplus notes due to related parties inthe Condensed Consolidated Statements of Financial Position.

 

**Financial Ratings and Strength **Our ratings are influenced by many factors including our operating andfinancial performance, asset quality, liquidity, asset/liability management,overall portfolio mix, financial leverage (i.e., debt), exposure to risks, thecurrent level of operating leverage, AIC’s ratings and other factors.  In October 2008, A.M. Best affirmedour A+ financial strength rating.  Theoutlook for this rating is stable. S&P affirmed our rating of AA but revised its outlook from stable tonegative.  Moody’s downgraded ourinsurance financial strength rating to Aa3 from Aa2 with a negative outlook.

 

EffectiveMay 8, 2008, the Company, AIC and The Allstate Corporation (the “Corporation”)entered into a one-year Amended and Restated Intercompany Liquidity Agreement (“LiquidityAgreement”) replacing the Intercompany Liquidity Agreement between the Companyand AIC, dated January 1, 2008.  Theagreement allows for short-term advances of funds to be made between partiesfor liquidity and other general corporate purposes.  It shall be automatically renewed forsubsequent one-year terms unless terminated by the parties.  The Liquidity Agreement does not establish acommitment to advance funds on the part of either party.  The Company and AIC each serve as a lenderand borrower and the Corporation serves only as a lender. See Note 2 to theCondensed Consolidated Financial Statements for further details.

 

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Additionally,the Company has a Capital Support Agreement with AIC under which AIC iscommitted to provide capital to the Company to allow for profitable growthwhile maintaining financial strength ratings at or above those of AIC.  See Note 2 to the Condensed ConsolidatedFinancial Statements for further details.

 

**Liquidity Sources and Uses**  We actively manage our liquidity levels in light of changing market,economic, and business conditions and we believe our liquidity levels are morethan adequate to cover our exposures, including any potential shortfallsidentified in our cash flow stress testing. In anticipation of continued illiquidity in the financial markets, wecontinue to take a number of additional actions to enhance our liquidityposition pending a return to normal capital market conditions.  These actions include:

 

·                  Accumulating higher cash and short-terminvestment positions easily convertible to cash from asset sales, principal andinterest receipts, calls, maturities and other cash inflows from our investmentportfolio.

 

·                  Reducing our securities lending program to$1.14 billion as of September 30, 2008 from $3.39 billion as of December 31,2007.  We expect to reduce the securitieslending portfolio further in the fourth quarter of 2008. By reducing thesecurities lending program, we gain additional direct access to our liquidinvestments.

 

·                  Proactively selling securities we think willbecome less liquid.

 

Webelieve that these actions will provide us with a greater level of flexibilitynecessary to operate in the current market environment.  If market conditions warrant, we may takeadditional actions to enhance our liquidity position including:

 

·                  Continued retention of portfolio cash flowsincluding approximately $3.33 billion of expected inflows from upcomingmaturities, calls and interest receipts on investments over the next sixmonths.

 

·                  The sale of fixed income (government,municipals and investment grade corporate bonds) and equity securities withunrealized capital gains at September 30, 2008.

 

Sourcesof liquidity include cash and short-term positions easily convertible to cash,and certain other liquid investments as presented in the following table.

 
| **($ in millions)**                                                         | ** ** | **As of  September 30,  2008** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| Cash and short-term positions easily  convertible to cash available same day/next day |       | $                                        | 1,816      |   |
| Other highly liquid investments (1)                                                   |       | 4,758                                    |       |
| Other liquid investments (2)                                                          |       | 8,656                                    |       |
| Total liquid                                                                          |       | $                                        | 15,230     |   |

 

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(1)     Otherhighly liquid investments are defined as assets that are generally saleablewithin one week, and primarily include common equity securities of $29 million,U.S. government and agencies bonds of $2.66 billion, agency pass throughsecurities of $929 million, municipal bonds of $68 million, commercial paperand money market funds of $373 million and other investments of $700million.   The amounts shown in the tableabove represents the amount of our holdings in these assets, excluding anyholdings with restrictions.

(2)     Otherliquid investments are defined as assets that are saleable within one quarter,and primarily includes municipal bonds of $888 million, agency pass through securitiesof $3.95 billion, investment grade corporate bonds of $1.34 billion, short-terminvestments of $586 million and U.S. government and agencies bonds of $1.32billion, and other investments of $569 million. The amounts shown in the table above represent the amount that webelieve could be sold during the fourth quarter of 2008, excluding any holdingswith restrictions.

----

 

Theabove analysis identifies our access to internal sources of liquidity.  We believe we have sufficient liquidity toaddress current planned needs from investments other than those for which wehave asserted the intent to hold until recovery.

 

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*Allstate Parent Company Capital Capacity*****The Allstate Corporation and consolidated subsidiaries has at theparent holding company level investments totaling $5.02 billion as of September 30,2008 that could be used to support the Company and other of the Corporation’soperating subsidiaries through capital contributions or intercompany borrowingarrangements and for general corporate purposes such as dividends, debtservicing and share repurchases.  Theseassets include highly liquid securities that are generally saleable within oneweek totaling $2.68 billion, additional liquid investments that are saleablewithin one quarter totaling $1.06 billion, and $1.28 billion of investmentsthat trade in illiquid markets.

 

OnOctober 15, 2008, the Corporation’s Board of Directors approved a capitalcontribution of up to $1.25 billion in the form of investments or cash to bemade from time to time to AIC from the Corporation on or before April 30,2009.  On October 28, 2008, theCorporation completed a capital contribution of $1.00 billion of less liquidinvested assets to AIC.  In addition tothese transactions, approval was also received for AIC to make up to $1.25billion of funds available to the Company by making one or more capitalcontributions, by providing a guaranty or guaranties, or by purchasing one ormore surplus notes or other securities by April 30, 2009.  Subject to approval by regulatoryauthorities, the Corporation intends for AIC to purchase surplus notes from theCompany and contribute capital to the Company in an aggregate amount of $1.00billion in the fourth quarter of 2008.

 

Forthe remainder of 2008, management intends that no dividends will be paid by theCompany to AIC or by AIC to the Corporation. The payment of dividends by AIC and the Company is dependent on businessconditions, income, cash requirements and other relevant factors.  The payment of dividends by AIC and theCompany without prior approval from regulatory authorities is limited toformula amounts based on net income and capital and surplus, determined inconformity with statutory accounting practices, as well as the timing andamount of dividends paid in the preceding twelve months.  In 2009, we anticipate that AIC will paydividends to the Corporation and will have the capacity to pay dividendscurrently estimated at $1.39 billion without prior regulatory approval.  We do not anticipate that the Company willpay dividends to AIC in 2009.

 

TheCorporation is well capitalized. Moreover, in addition to historic externalsources of capital including the debt and equity capital markets and theCorporation’s $1.00 billion credit facility, access to funding from additionalsources, including participation in programs offered by the U.S. Treasury andother governmental organizations, are potentially available to the Corporationand its operating subsidiaries for capital and liquidity needs.

 

*2009 Capital Outlook *Should theCompany subsequently require the remaining approved funding of $250 millionfrom AIC, the Corporation may contribute rated municipal bonds to AIC, which isconsistent with AIC’s enterprise-wide asset allocation strategy to offset theimpact to AIC’s capital.  The Corporation’snet remaining investments would amount to $3.77 billion after this funding andare sufficient to meet quarterly fixed charges of approximately $275 millionand $750 million of maturing debt in December 2009, if not refinanced,before considering receipt of AIC’s 2009 estimated potential dividends of $1.39billion that can be paid without prior regulatory approval, which wouldincrease the Corporation’s deployable assets to $3.03 billion in 2009.  These assets would be available to supportthe Company’s and other of the Corporation’s operating subsidiaries capital andborrowing needs and for general corporate purposes as discussedpreviously.  The Corporation’s AllstateProtection segment anticipates continuing to produce strong underwritingresults in its standard auto operations while its on-going focus on homeownerscatastrophe management actions serves to reduce exposure to adverse catastrophedevelopments.  The Company will continueto be exposed to adverse developments in its investment portfolio and topressures on its risk based capital ratio. The Company’s risk based capital ratio following the $1.00 billioncapital infusion will improve to its targeted range.

 

In addition to the Capital Support Agreement andLiquidity Agreement, which provide a maximum amount of potential funding undereach agreement of $1.00 billion, the Company also has access to additionalborrowing to support liquidity through the Corporation as follows:

 

·                  A commercial paper program with a borrowinglimit of $1.00 billion to cover short-term cash needs.  As of September 30, 2008, there were nobalances outstanding and therefore the remaining borrowing capacity was $1.00billion; however, the outstanding balance can fluctuate daily.

 

·                  A primary credit facility that coversshort-term liquidity requirements. Barclays Capital has agreed to assume the Lehman Brothers Bank, FSBcommitment in the Corporation’s $1.00 billion unsecured revolving creditfacility which has an initial term of five years expiring in 2012 with twooptional one-year extensions that can be exercised at the end of any of theremaining four years of the facility upon approval of existing or replacementlenders providing more than two thirds of the commitments to lend.  No other lenders have withdrawn from theCorporation’s $1.00 billion unsecured revolving credit facility.  The lender group is diversified among 13lenders with varying commitments, with the two largest commitments both being $145million.  The 

 

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commitments of the lenders are several and no lenderis responsible for any other lender’s commitment if such lender fails to make aloan under the facility.  None of theborrowing capacity under this credit facility has been utilized.  Thisfacility contains an increase provision that would allow up to an additional$500 million of borrowing provided the increased portion could be fullysyndicated at a later date among existing or new lenders.  This facility has a financial covenantrequiring that the Corporation not exceed a 37.5% debt to capital resourcesratio as defined in the agreement.  Thisratio at September 30, 2008 was 19.2%. Although the right to borrow under the facility is not subject to aminimum rating requirement, the costs of maintaining the facility and borrowingunder it are based on the ratings of our senior, unsecured, nonguaranteedlong-term debt.  There were no borrowingsunder this line of credit during the first nine months of 2008. The totalamount outstanding at any point in time under the combination of the commercialpaper program and the credit facility cannot exceed the amount that can beborrowed under the credit facility.

 

·                  A universal shelf registration statement wasfiled by the Corporation with the Securities and Exchange Commission in May 2006.  The Corporation can use it to issue anunspecified amount of debt securities, common stock (including 364 millionshares of treasury stock as of September 30, 2008), preferred stock,depositary shares, warrants, stock purchase contracts, stock purchase units andsecurities of subsidiaries.  The specificterms of any securities the Corporation issues under this registrationstatement will be provided in the applicable prospectus supplements.

 

*Liquidity Exposure*** **Contractholder funds as of September 30, 2008 were $57.79billion.  The following table summarizescontractholder funds by their contractual withdrawal provisions at September 30,2008.

 
| **($ in millions)**                                | ** ** | ** ** | ** ** | **% to  Total** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|----------------------|------------|
| Not subject to discretionary withdrawal                      |       | $          | 13,296     |                 | 23.0       | % |
| Subject to discretionary withdrawal with  adjustments:       |       |       |       |                 |       |
| Specified surrender charges (1)                              |       | 25,630     |       | 44.4                 |       |
| Market value adjustments (2)                                 |       | 9,778      |       | 16.9                 |       |
| Subject to discretionary withdrawal without  adjustments (3) |       | 9,086      |       | 15.7                 |       |
| Total contractholder funds (4)                               |       | $          | 57,790     |                 | 100.0      | % |

 

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(1)                    Includes approximately $10.89 billion ofliabilities with a contractual surrender charge of less than 5% of the accountbalance.

(2)                    Approximately $8.96 billion of the contractswith market value adjusted surrenders have a 30-45 day period during whichthere is no surrender charge or market value adjustment.

(3)                    Includes extendible funding agreements backingmedium-term notes outstanding with a par value of $1.34 billion that have beennon-extended and are due in the next 12 months and $830 million with acontractually specified final maturity date in 2013 that were extended by thecontractholders at the most recent election date in September 2008.  The next extension election for thesecontracts will occur in December 2008.

(4)                    Includes approximately $1.14 billion ofcontractholder funds on variable annuities reinsured to Prudential effective June 1,2006.

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Retaillife and annuity products may be surrendered by customers for a variety ofreasons.  Reasons unique to individualcustomers include a current or unexpected need for cash or a change in lifeinsurance coverage needs.  Other keyfactors that may impact the likelihood of customer surrender include the levelof the contract surrender charge, the length of time the contract has been inforce, distribution channel, market interest rates, equity market conditionsand potential tax implications.  Inaddition, the propensity for retail life insurance policies to lapse is lowerthan it is for fixed annuities because of the need for the insured to bere-underwritten upon policy replacement. Surrenders and partial withdrawals for our retail annuities have decreased21.7% and 10.7% in the third quarter and first nine months of 2008,respectively, compared to the same periods of 2007.  The annualized surrender and partialwithdrawal rate on deferred annuities and interest-sensitive life insuranceproducts, based on the beginning of period contractholder funds, was 9.8% and10.9% for the first nine months of 2008 and 2007, respectively.  Although generally paid promptly followingreceipt of requests for cash surrenders, the Company generally has up to sixmonths in most states to pay contractholder cash surrender requests.

 

Ourinstitutional products are primarily funding agreements backing medium-termnotes.  As of September 30, 2008,total institutional products outstanding were $9.98 billion, of which $830million are subject to an acceleration of maturity with a ten month noticerequirement.  The remainder is notsubject to an acceleration of maturity. The 

 

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followingtable presents the scheduled maturities for our institutional productsoutstanding as of September 30, 2008.

 
| **($ in millions)** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| Fourth quarter of 2008        |       | $          | 970        |   |
| 2009 (1)                      |       | 3,249      |       |
| 2010                          |       | 3,128      |       |
| 2011                          |       | 760        |       |
| 2012                          |       | 40         |       |
| 2013                          |       | 1,750      |       |
| 2016                          |       | 85         |       |
|                          |       | $          | 9,982      |   |

 

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(1)     Included in 2009 are extendible fundingagreements backing medium-term notes outstanding of $1.45 billion that include$830 million with a contractually specified final maturity date in 2013 thatwere extended by the contractholders at the most recent election date in September 2008.  The next extension election for these contractswill occur in December 2008.

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Ourasset-liability management practices limit the differences between the cashflows generated by our investment portfolio and the expected cash flowrequirements of our life insurance, annuity and institutional productobligations.

 

Weperformed a sensitivity analysis on OTC derivative collateral requirements byassuming a hypothetical reduction in our S&P’s insurance financial strengthratings from AA to A and a 100 basis point decline in interest rates.  The analysis indicated that we would have topost an estimated $238 million in additional collateral.  The selection of these hypothetical scenariosshould not be construed as our prediction of future events, but only as an illustrationof the estimated potential effect of such events.  We also actively manage our counterpartycredit risk exposure by monitoring the level of collateral posted by ourcounterparties with respect to our receivable positions.

 

*Cash Flows*  As reflected in our CondensedConsolidated Statements of Cash Flows,****loweroperating cash flows in the first nine months of 2008, compared to the firstnine months of 2007, were primarily related to a decrease in investment income,higher contract benefit payments and lower premiums, partially offset by incometax refunds in the first nine months of 2008 compared to income tax payments inthe first nine months of 2007.

 

Cashflows provided by investing activities in the first nine months of 2008compared to cash flows used in investing activities in the first nine months of2007 was primarily due to the sale of assets to fund liability settlements.

 

# **Highercash flows used in financing activities in the first nine months of 2008compared to the first nine months of 2007 were primarily due to higher contractholderfund withdrawals partially offset by higher contractholder fund deposits.  For quantification of the changes incontractholder funds, see the Operations section of the MD&A.**

# ** **

Inthe first nine months of 2008, we retired $4.64 billion of institutional marketdeposits for which investors had elected to non-extend their maturity datethrough a combination of maturities, calls, and acquisitions in the secondarymarket.  Total outstanding non-extendedinstitutional market deposits were $1.34 billion as of September 30, 2008,all of which become due before the end of the third quarter of 2009.  We have accumulated, and expect to maintain,short-term and other maturing investments to fund the retirement of theseobligations.

 

*Federal Income Tax Carryback andCarryforward*As of January 1,2008, we had the ability to carryback capital losses of $92 million as a resultof capital gains recognized in prior years. While the majority of our GAAPrealized capital losses relate to securities that have not yet been sold, wehave disposed of assets with tax losses in excess of prior years’ gains,resulting in a capital loss carryforward of $50 million.  The Corporation has $2.13 billion of grossunrealized gains which are available to offset the capital loss carryforwardand future capital losses. Our capital gain and loss strategies take intoconsideration our ability to offset gains and losses in future periods andcapital loss carryforward opportunities to apply against future capital gainsover the next five years.

 

As of September 30, 2008, we recorded a netdeferred tax asset of $285 million, which included $1.60 billion relating tounrealized and realized net capital losses that have not yet been recognizedfor tax purposes.  Although realizationis not assured, management believes it is more likely than not that thedeferred tax asset will be realized based on our assessment that the deductionsultimately recognized for tax purposes will be fully utilized.

 

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**Item 4. Controls and Procedures**

** **

*Evaluation of Disclosure Controls and Procedures. *We maintain disclosure controls and procedures as defined in Rule 13a-15(e) and15(d)-15(e) under the Securities Exchange Act of 1934.  Under the supervision and with the participationof our management, including our principal executive officer and principalfinancial officer, we conducted an evaluation of the effectiveness of ourdisclosure controls and procedures as of the end of the period covered by thisreport.  Based upon this evaluation, theprincipal executive officer and the principal financial officer concluded thatour disclosure controls and procedures are effective in providing reasonableassurance that material information required to be disclosed in our reports filedwith or submitted to the Securities and Exchange Commission under theSecurities Exchange Act is made known to management, including the principalexecutive officer and the principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

*Changes in Internal Control over Financial Reporting. *During the fiscal quarter ended September 30, 2008, there havebeen no changes in our internal control over financial reporting that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II.  OTHERINFORMATION**

 

**Item 1.    LegalProceedings**

 

Information required for this Part II, Item 1 is incorporated byreference to the discussion under the heading “Regulation” and under theheading “Legal and regulatory proceedings and inquiries” in Note 6 of theCondensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.

 

**Item1A.  Risk Factors**

 

Thisdocument contains “forward-looking statements” that anticipate results based onour estimates, 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 thesestatements are based on reasonable estimates, assumptions and plans. However,if the estimates, assumptions or plans underlying the forward-lookingstatements prove inaccurate or if other risks or uncertainties arise, actualresults could differ materially from those communicated in theseforward-looking statements.  Risk factorswhich could cause actual results to differ materially from those suggested bysuch forward-looking statements include but are not limited to those discussedor identified in this document (including the risks described below), in ourpublic filings with the Securities and Exchange Commission, and those incorporatedby reference in Part I, Item 1A of Allstate Life Insurance Company AnnualReport on Form 10-K for 2007.

 

**The impact of our investment strategies may be adverselyaffected by developments in the investment markets**

 

Theimpact of our investment portfolio risk mitigation and return optimizationprograms may be adversely affected by unexpected developments in the investmentmarkets.  For example, derivativecontracts, when entered into, may result in coverage that is not as effectiveas intended.

 

**Our capital position and our liquidity levels may beadversely affected by developments in the investment markets**

 

Ourcapital position and our liquidity levels may be adversely affected byunexpected developments in the investment markets, such as disruptions,uncertainty or volatility in the capital and credit markets, and result inrealized and unrealized capital losses that may significantly reduce ourfinancial position and may limit our access to capital required to operate ourbusiness.

 

**Reducing our concentration in fixed annuities and fundingagreements may adversely affect reported results**

 

Dueto the current capital market conditions, we are evaluating strategies toreduce our concentration in fixed annuities and funding agreements.  Lower new sales of these products, as well asour ongoing risk mitigation and return optimization programs, may lead to lowerlevels of income which could negatively impact DAC amortization and insurancereserves deficiency testing.

 

**The realization of deferred tax assets is subject touncertainty**

 

The realization of our deferred tax assets is based on our assumptionthat we will be able to fully utilize the deductions that are ultimatelyrecognized for tax purposes.  However,actual results may differ from our assumptions if adequate levels of taxableincome are not attained.

 

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**Item5.  Other Information**

 

On September 25, 2008, Deloitte & ToucheLLP (“Deloitte”) advised The Allstate Corporation (the “Corporation”) AuditCommittee (the “Allstate Audit Committee”) that it had become aware that aformer Deloitte advisory partner (the “Former Advisory Partner”) traded in theCorporation’s securities on two occasions in 2006.  Allstate Life Insurance Company (“ALIC”) is aconsolidated subsidiary of the Corporation, and Deloitte is our registeredpublic accounting firm, and performs our audits, in addition to those of theCorporation.  Deloitte concluded thatthese securities transactions violated the SEC’s independence rules.  Deloitte had conducted an internal review andconcluded that the Former Advisory Partner’s actions did not impair Deloitte’simpartiality or objectivity or that of the engagement team that has conductedboth the Corporation’s and our audits. Deloitte’s audit engagement team consisted of a lead client servicepartner, who had responsibility for all substantive issues with respect to theplanning, scope and conduct of the audit, an additional audit partner, aconcurring review partner, a senior manager, additional professional staff, aswell as the Former Advisory Partner, who functioned primarily in a clientrelationship and assessment role and had no substantive or technical role inthe audit.  The Former Advisory Partnerattended many, but not all, of the Allstate Audit Committee meetings.  He has not attended any meetings of the Boardof Directors or of the Audit Committee of ALIC. His primary role at the Corporation level was to function in a clientservice role, including conducting Deloitte’s annual client serviceassessments, and he did not review any substantive audit matters with theAllstate Audit Committee at any of these meetings.  Deloitte provided a draft letter on September25 to the Allstate Audit Committee concluding the actions of its FormerAdvisory Partner did not impair Deloitte’s past or continuing independence. 

 

The Allstate Audit Committee thereafterinitiated its own review with the assistance of external counsel.  The Allstate Audit Committee and its externalcounsel held meetings with Deloitte and had frequent contacts with Deloitte andits counsel.  The Allstate AuditCommittee held meetings concerning the progress of its review on September 29,October 8, 17, and 30, 2008.  The reviewincluded an examination of the Corporation’s relationship to the FormerAdvisory Partner and his role on the engagement.  Over the course of the review, the AllstateAudit Committee’s counsel examined a substantial number of documents andcommunications from the Corporation’s files and Deloitte’s, including theFormer Advisory Partner’s annual goals and assessments, his communication withthe audit engagement team and with the Corporation’s management and AllstateAudit Committee members, his independence certifications, and email and otherdocuments relating to the audit engagement. The Allstate Audit Committee’s external counsel’s review establishedthat the Former Advisory Partner had functioned in a client service role andhad not been involved in the substantive audit or influenced any substantiveportion of any audit or review of the Corporation’s financial statements.  The Allstate Audit Committee membersconfirmed that this was their view of the role of the Former AdvisoryPartner.  The Allstate Audit Committeeand its external counsel also met with the Corporation’s financial managementteam as well as with senior management of Deloitte, including the current andformer lead client service partners.  TheAllstate Audit Committee’s review confirmed Deloitte’s findings that the FormerAdvisory Partner met with the Allstate Audit Committee as well as seniormanagement of the Corporation, for the purpose of enhancing Deloitte’s clientservice to the Corporation rather than participating in the audit orreview.  

 

The Allstate Audit Committee concurred withDeloitte’s conclusion, reconfirmed in its letter to the Allstate AuditCommittee issued October 31, 2008, that Deloitte’s impartiality or objectivityrelated to its audits of the Corporation had not been compromised andtherefore, notwithstanding the violation of the independence rules, Deloitte’sindependence was not impaired.  Inreaching this conclusion, the Allstate Audit Committee took into considerationthe following: (i) the Former Advisory Partner is no longer a partner orotherwise affiliated with Deloitte; (ii) it appears that the trades in theCorporation’s securities were isolated incidents; (iii) the Former AdvisoryPartner did not disclose his investments to Deloitte, in contravention ofDeloitte’s independence policies; (iv) the problem was corrected as promptly aspossible; (v) the Former Advisory Partner had no responsibility for, and wasnot involved in, the conduct of the audit of the Corporation; (vi) it appearsthat the Former Advisory Partner did not exercise any influence over theconduct of the audit or Deloitte’s conclusions with respect to the audit oraccounting consultations related to the audit; (vii) there is no indication ofindependence issues with respect to other members of the engagement team; and(viii) Deloitte has in place a quality control system that meets therequirements of the SEC and the Public Company Accounting Oversight Board, andprovides reasonable assurance that the accounting firm and its employees do notlack independence.  The Allstate AuditCommittee and Deloitte separately reported their conclusions to the SEC Staff.

 

On November 11, 2008, after the AllstateAudit Committee and Deloitte had reported their conclusions to the SEC Staff,the ALIC Audit Committee met.  Duringthat meeting, the ALIC Audit Committee reviewed the Allstate Audit Committee’sconclusion that Deloitte’s impartiality or objectivity related to its audits ofthe Corporation had not been compromised and that Deloitte’s independence wasnot impaired.  Following that review, theALIC Audit Committee concurred with Deloitte’s conclusion, reconfirmed in itsletter to the Allstate Audit Committee issued October 31, 2008, that Deloitte’simpartiality or objectivity related to its audits of the Corporation, includingALIC as a consolidated subsidiary, had not been compromised and therefore,notwithstanding the violation of the independence rules, Deloitte’sindependence was not impaired with regard to ALIC.

** **

**Item6.  Exhibits**

 

(a)                                  Exhibits

 

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

 

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**SIGNATURE**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                    | Allstate  Life Insurance Company    |
|-------------------------|-------------------------------------|
|                    | (Registrant)                        |
|                    |                                |
|                    |                                |
| November 11,  2008 |                                |
|                    |                                |
|                    | By                                  | /s/  Samuel H. Pilch |
|                    | Samuel  H. Pilch                    |
|                    | (chief  accounting officer and duly |
|                    | authorized  officer of Registrant)  |

 

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                     |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                |
| 10.1                 |       | Surplus  Note between Allstate Life Insurance Company and Allstate Insurance Company  dated August 29, 2008, incorporated herein by reference to  Exhibit 10.1 to Allstate Life Insurance Company’s Current Report on  Form 8-K filed September 5, 2008.                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |
| 10.2                 |       | Sale  Agreement between Allstate Insurance Company and Allstate Life Insurance  Company effective September 10, 2008 for those securities listed on  attached Exhibit A, incorporated herein by reference to Exhibit 10.1  to Allstate Life Insurance Company’s Current Report on Form 8-K filed  September 16, 2008. |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |
| 10.3                 |       | Sale  Agreement between Allstate Insurance Company and Allstate Life Insurance  Company effective September 10, 2008 for those mortgages listed on  attached Exhibit A, incorporated herein by reference to  Exhibit 10.2 to Allstate Life Insurance Company’s Current Report on  Form 8-K filed September 16, 2008.  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |
| 10.4                 |       | Reinsurance  Agreement effective October 1, 2008 between American Heritage Life  Insurance Company and Allstate Life Insurance Company, incorporated herein by  reference to Exhibit 10.1 to Allstate Life Insurance Company’s Current  Report on Form 8-K filed October 28, 2008.                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |
| 15                   |       | Acknowledgment  of awareness from Deloitte & Touche LLP, datedNovember 10, 2008, 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                                                                                                                                                                                                                                                                                                                   |

 

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