** **

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**TheRegistrant meets the conditions set forth in General Instruction H (1)(a) and(b) of Form 10-Q and is therefore filing this Form with thereduced disclosure format.**

 

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

**THESECURITIES EXCHANGE ACT OF 1934**

**FOR THE QUARTERLY PERIOD ENDEDSEPTEMBER 30, 2009**

 

**OR**

 

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

**THESECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from             to            **

 

**Commission file number: 000-31248**

 

**ALLSTATE LIFE INSURANCE COMPANY**

(Exact name of registrant as specified in itscharter)

 

| ** ** | **Illinois**             | ** ** | **36-2554642**                       |   |
|------------|--------------------------|------------|--------------------------------------|--------|
|       | (State of Incorporation) |       | (I.R.S. Employer Identification No.) |   |

 

**3100Sanders Road, Northbrook, Illinois** **60062**

(Address of principal executive offices)  (Zip code)

 

**(847)402-5000**

**(Registrant’s telephone number, including area code)**

 

**Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities 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 has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (****§****232.405of this chapter) during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).**

 

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

 

**Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act.**

 

| **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 a shell company (asdefined in Rule 12b-2 of the Exchange Act).**

 

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

 

**As of November 10, 2009, 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, 2009**

 
| **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, 2009 and 2008 (unaudited) |       | 1          |
|             |       |                                                                                                                                            |       |       |
|             |       | Condensed Consolidated  Statements of Financial Position as of September 30, 2009 (unaudited)  and December 31, 2008                  |       | 2          |
|             |       |                                                                                                                                            |       |       |
|             |       | Condensed Consolidated  Statements of Cash Flows for the Nine-Month Periods Ended September 30,  2009 and 2008 (unaudited)                 |       | 3          |
|             |       |                                                                                                                                            |       |       |
|             |       | Notes to Condensed  Consolidated Financial Statements (unaudited)                                                                               |       | 4          |
|             |       |                                                                                                                                            |       |       |
|             |       | Report of Independent  Registered Public Accounting Firm                                                                                        |       | 39         |
|             |       |                                                                                                                                            |       |       |
| Item 2.          |       | Management’s Discussion  and Analysis of Financial Condition and Results of Operations                                                     |       | 40         |
|             |       |                                                                                                                                            |       |       |
| Item 4.          |       | Controls and Procedures                                                                                                                         |       | 72         |
|             |       |                                                                                                                                            |       |       |
| **PART II** | ** ** | **OTHER INFORMATION**                                                                                                                           | ** ** | ** ** |
|             |       |                                                                                                                                            |       |       |
| Item 1.          |       | Legal Proceedings                                                                                                                               |       | 73         |
|             |       |                                                                                                                                            |       |       |
| Item 1A.         |       | Risk Factors                                                                                                                                    |       | 73         |
|             |       |                                                                                                                                            |       |       |
| Item 6.          |       | Exhibits                                                                                                                                        |       | 74         |

 

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##### ** **

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

##### ** **

**ITEM 1. FINANCIAL STATEMENTS**

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| **($ in millions)**                                          | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                        | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                        | ** ** | **(Unaudited)**                                  | ** ** | **(Unaudited)**                                 | ** ** |
| **Revenues**                                                      |       |                                             |       |                                            |       |   |   |   |   |
| Premiums                                                          | $          | 134                                              | $          | 138                                             | $          | 440 | $ | 425 |   |
| Contract charges                                                  |       | 241                                              |       | 228                                             |       | 706 |   | 665 |   |
| Net investment income                                             |       | 722                                              |       | 912                                             |       | 2,260 |   | 2,826 |   |
| Realized capital gains and losses:                                |       |                                             |       |                                            |       |   |   |   |   |
| Total other-than-temporary impairment losses                      |       | (404                                             | )          | (616                                            | )          | (1,120 | ) | (1,773 | ) |
| Portion of loss recognized in other comprehensive income          |       | 125                                              |       | —                                          |       | 229 |   | — |   |
| Net other-than-temporary impairment losses recognized in earnings |       | (279                                             | )          | (616                                            | )          | (891 | ) | (1,773 | ) |
| Sales and other realized capital gains and losses                 |       | 47                                               |       | 48                                              |       | 743 |   | (155 | ) |
| Total realized capital gains and losses                           |       | (232                                             | )          | (568                                            | )          | (148 | ) | (1,928 | ) |
|                                                              |       | 865                                              |       | 710                                             |       | 3,258 |   | 1,988 |   |
|                                                              |       |                                             |       |                                            |       |   |   |   |   |
| **Costs and expenses**                                            |       |                                             |       |                                            |       |   |   |   |   |
| Contract benefits                                                 |       | 327                                              |       | 361                                             |       | 1,018 |   | 1,045 |   |
| Interest credited to contractholder funds                         |       | 485                                              |       | 573                                             |       | 1,598 |   | 1,732 |   |
| Amortization of deferred policy acquisition costs                 |       | 61                                               |       | (26                                             | )          | 758 |   | (32 | ) |
| Operating costs and expenses                                      |       | 74                                               |       | 100                                             |       | 244 |   | 285 |   |
| Restructuring and related charges                                 |       | 4                                                |       | —                                          |       | 23 |   | — |   |
| Interest expense                                                  |       | 11                                               |       | 6                                               |       | 32 |   | 12 |   |
|                                                              |       | 962                                              |       | 1,014                                           |       | 3,673 |   | 3,042 |   |
| Gain (loss) on disposition of operations                          |       | 2                                                |       | 2                                               |       | 6 |   | (7 | ) |
|                                                              |       |                                             |       |                                            |       |   |   |   |   |
| **Loss from operations before income tax benefit**                |       | (95                                              | )          | (302                                            | )          | (409 | ) | (1,061 | ) |
|                                                              |       |                                             |       |                                            |       |   |   |   |   |
| Income tax benefit                                                |       | (38                                              | )          | (118                                            | )          | (16 | ) | (394 | ) |
|                                                              |       |                                             |       |                                            |       |   |   |   |   |
| **Net loss**                                                      | $          | (57                                              | )          | $                                               | (184       | ) | $ | (393 | ) | $ | (667 | ) |
|                                                                   |            |                                                  |            |                                                 |            |  |  |  |  |  |  |  |

 

Seenotes to condensed consolidated financial statements.

 

1

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION**

** **
| **($ in millions, except par value data)**                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                        | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                        | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                        |       |                   |       |                  |       |
| Investments                                                                                       |       |                   |       |                  |       |
| Fixed income  securities, at fair value (amortized cost $49,063 and $49,136)                      | $          | 46,321                 | $          | 42,446                |       |
| Mortgage loans                                                                                    |       | 8,674                  |       | 10,012                |       |
| Equity  securities, at fair value (cost $167 and $106)                                            |       | 188                    |       | 82                    |       |
| Limited  partnership interests                                                                    |       | 1,017                  |       | 1,187                 |       |
| Short-term, at  fair value (amortized cost $1,731 and $3,855)                                     |       | 1,731                  |       | 3,858                 |       |
| Policy loans                                                                                      |       | 816                    |       | 813                   |       |
| Other                                                                                             |       | 1,179                  |       | 1,374                 |       |
| Total  investments                                                                                |       | 59,926                 |       | 59,772                |       |
| Cash                                                                                              |       | 263                    |       | 93                    |       |
| Deferred policy  acquisition costs                                                                |       | 5,082                  |       | 6,701                 |       |
| Reinsurance  recoverables                                                                         |       | 4,113                  |       | 3,923                 |       |
| Accrued  investment income                                                                        |       | 554                    |       | 542                   |       |
| Deferred income  taxes                                                                            |       | —                 |       | 1,382                 |       |
| Other assets                                                                                      |       | 1,191                  |       | 1,294                 |       |
| Separate  Accounts                                                                                |       | 9,026                  |       | 8,239                 |       |
| **Total  assets**                                                                                 | $          | 80,155                 | $          | 81,946                |       |
|                                                                                              |       |                   |       |                  |       |
| **Liabilities**                                                                                   |       |                   |       |                  |       |
| Contractholder  funds                                                                             | $          | 51,625                 | $          | 56,780                |       |
| Reserve for  life-contingent contract benefits                                                    |       | 12,209                 |       | 12,256                |       |
| Unearned  premiums                                                                                |       | 30                     |       | 32                    |       |
| Payable to  affiliates, net                                                                       |       | 95                     |       | 142                   |       |
| Other  liabilities and accrued expenses                                                           |       | 1,614                  |       | 1,638                 |       |
| Deferred income  taxes                                                                            |       | 45                     |       | —                |       |
| Surplus notes  due to related parties                                                             |       | 650                    |       | 650                   |       |
| Separate  Accounts                                                                                |       | 9,026                  |       | 8,239                 |       |
| **Total  liabilities**                                                                            |       | 75,294                 |       | 79,737                |       |
|                                                                                              |       |                   |       |                  |       |
| **Commitments  and Contingent Liabilities (Note 8)**                                              |       |                   |       |                  |       |
|                                                                                              |       |                   |       |                  |       |
| **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                                                                       |       | 2,742                  |       | 2,475                 |       |
| Retained income                                                                                   |       | 2,159                  |       | 2,066                 |       |
| Accumulated  other comprehensive income:                                                          |       |                   |       |                  |       |
| Unrealized net  capital gains and losses:                                                         |       |                   |       |                  |       |
| Unrealized net  capital losses on fixed income securities with OTTI                               |       | (283                   | )          | —                |       |
| Other unrealized  net capital gains and losses                                                    |       | (1,503                 | )          | (4,362                | )          |
| Unrealized  adjustment to DAC, DSI and insurance reserves                                         |       | 1,741                  |       | 2,025                 |       |
| Total unrealized  net capital gains and losses                                                    |       | (45                    | )          | (2,337                | )          |
| Total accumulated other comprehensive loss                                                        |       | (45                    | )          | (2,337                | )          |
| Total shareholder’s equity                                                                   |       | 4,861                  |       | 2,209                 |       |
| **Total  liabilities and shareholder’s equity**                                              | $          | 80,155                 | $          | 81,946                |       |

 

Seenotes to condensed consolidated financial statements.****

 

2

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| **($ in millions)**                                                         | ** ** | **Nine months ended**  | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                       | ** ** | **September 30,** | ** ** |
| ** **                                                                       | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                                                                       | ** ** | **(Unaudited)**        | ** ** |
| **Cash  flows from operating activities**                                        | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net loss                                                                         | $          | (393                   | )          | $ | (667 | ) |
| Adjustments to reconcile net loss to net cash provided by operating  activities: |       |                   |       |   |   |
| Amortization and other non-cash items                                            |       | (219                   | )          | (313 | ) |
| Realized capital gains and losses                                                |       | 148                    |       | 1,928 |   |
| (Gain) loss on disposition of operations                                         |       | (6                     | )          | 7 |   |
| Interest credited to contractholder funds                                        |       | 1,598                  |       | 1,732 |   |
| Changes in:                                                                      |       |                   |       |   |   |
| Policy benefits and other insurance reserves                                     |       | (268                   | )          | (435 | ) |
| Unearned premiums                                                                |       | (2                     | )          | (2 | ) |
| Deferred policy acquisition costs                                                |       | 471                    |       | (486 | ) |
| Reinsurance recoverables, net                                                    |       | (241                   | )          | (59 | ) |
| Income taxes                                                                     |       | 360                    |       | (277 | ) |
| Other operating assets and liabilities                                           |       | 134                    |       | 30 |   |
| Net cash provided by operating activities                                        |       | 1,582                  |       | 1,458 |   |
|                                                                             |       |                   |       |   |   |
| **Cash flows from investing activities**                                         |       |                   |       |   |   |
| Proceeds from sales:                                                             |       |                   |       |   |   |
| Fixed income securities                                                          |       | 10,111                 |       | 8,617 |   |
| Equity securities                                                                |       | 28                     |       | 120 |   |
| Limited partnership interests                                                    |       | 58                     |       | 76 |   |
| Mortgage loans                                                                   |       | 138                    |       | 205 |   |
| Other investments                                                                |       | 401                    |       | 131 |   |
| Investment collections:                                                          |       |                   |       |   |   |
| Fixed income securities                                                          |       | 2,572                  |       | 1,814 |   |
| Mortgage loans                                                                   |       | 1,049                  |       | 575 |   |
| Other investments                                                                |       | 88                     |       | 77 |   |
| Investment purchases:                                                            |       |                   |       |   |   |
| Fixed income securities                                                          |       | (11,593                | )          | (5,112 | ) |
| Equity securities                                                                |       | (101                   | )          | (130 | ) |
| Limited partnership interests                                                    |       | (149                   | )          | (322 | ) |
| Mortgage loans                                                                   |       | (15                    | )          | (1,112 | ) |
| Other investments                                                                |       | (18                    | )          | (102 | ) |
| Change in short-term investments, net                                            |       | 2,091                  |       | (2,878 | ) |
| Change in other investments, net                                                 |       | (223                   | )          | (295 | ) |
| Net cash provided by investing activities                                        |       | 4,437                  |       | 1,664 |   |
|                                                                             |       |                   |       |   |   |
| **Cash flows from financing activities**                                         |       |                   |       |   |   |
| Capital contribution                                                             |       | 250                    |       | — |   |
| Issuance of surplus notes to related parties                                     |       | —                 |       | 400 |   |
| Contractholder fund deposits                                                     |       | 2,621                  |       | 8,249 |   |
| Contractholder fund withdrawals                                                  |       | (8,720                 | )          | (11,843 | ) |
| Net cash used in financing activities                                            |       | (5,849                 | )          | (3,194 | ) |
| **Net increase (decrease) in cash**                                              |       | 170                    |       | (72 | ) |
| **Cash at beginning of the period**                                              |       | 93                     |       | 185 |   |
| **Cash at end of period**                                                        | $          | 263                    | $          | 113 |   |
|                                                                                  |            |                        |            |  |  |  |

 

Seenotes to condensed consolidated financial statements.

 

3

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.   General**

 

**Basis of presentation**

 

The accompanying condensed consolidated financial statements includethe accounts of Allstate Life Insurance Company (“ALIC”) and its wholly ownedsubsidiaries (collectively referred to as the “Company”).  ALIC is wholly owned by Allstate InsuranceCompany (“AIC”), which is wholly owned by Allstate Insurance Holdings, LLC, awholly owned subsidiary of The Allstate Corporation (the “Corporation”).

 

The condensedconsolidated financial statements and notes as of September 30, 2009, andfor the three-month and nine-month periods ended September 30, 2009 and2008 are unaudited.  The condensedconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring accruals), which are, in the opinion of management, necessaryfor the fair presentation of the financial position, results of operations andcash flows for the interim periods.  Thesecondensed consolidated financial statements and notes should be read inconjunction with the consolidated financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the year ended December 31,2008.  The results of operations for theinterim periods should not be considered indicative of results to be expectedfor the full year.

 

To conform to the 2009 presentation, certain amounts in the prior yearcondensed consolidated financial statements and notes have been reclassified.

 

Subsequent events were evaluated through November 10,2009, the date the consolidated financial statements were issued.

 

**Premiums and Contract Charges**

 

The following table summarizes premiums and contract charges byproduct.

 
| **($ in millions)**                     | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|----------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                   | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Premiums**                                 |       |                   |       |                   |       |   |   |   |   |
| Traditional  life insurance                  | $          | 96                     | $          | 90                     | $          | 289 | $ | 271 |   |
| Immediate  annuities with life contingencies |       | 15                     |       | 25                     |       | 83 |   | 91 |   |
| Accident,  health and other                  |       | 23                     |       | 23                     |       | 68 |   | 63 |   |
| Total  premiums                              |       | 134                    |       | 138                    |       | 440 |   | 425 |   |
|                                         |       |                   |       |                   |       |   |   |   |   |
| **Contract charges**                         |       |                   |       |                   |       |   |   |   |   |
| Interest-sensitive  life insurance           |       | 229                    |       | 215                    |       | 671 |   | 625 |   |
| Fixed  annuities                             |       | 11                     |       | 13                     |       | 34 |   | 39 |   |
| Variable  annuities                          |       | 1                      |       | —                 |       | 1 |   | 1 |   |
| Total  contract charges                      |       | 241                    |       | 228                    |       | 706 |   | 665 |   |
| Total  premiums and contract charges         | $          | 375                    | $          | 366                    | $          | 1,146 | $ | 1,090 |   |

 

**Adopted accounting standards**

 

*Recognition and Presentation ofOther-Than-Temporary Impairments*

 

In April 2009, the FASB issued newaccounting guidance for the recognition of other-than-temporary impairments (“OTTI”)of debt securities.  If the fair value ofa debt security is less than its amortized cost basis at the reporting date, anentity shall assess whether the impairment is an OTTI.  When an entity intends to sell an impaired securityor more likely than not will be required to sell an impaired security beforerecovery of its amortized cost basis, an OTTI is recognized in earnings.  If the entity does not expect to recover theentire amortized cost basis of an impaired debt security, even if it does notintend to sell the security and it is not more likely than not that it would berequired to sell the security before recovery of its amortized cost basis, theentity must consider, based upon an estimate of the present value of cash flowsexpected to be collected on the debt security as compared to its amortized costbasis, whether a credit loss exists.  Theportion of the total OTTI related to a credit loss shall be recognized inearnings while the portion of the total OTTI related to factors other thancredit shall be recognized in 

 

4

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other comprehensive income (“OCI”).  The statement of operations is required topresent the total OTTI with an offset for the amount of the total OTTI that isrecognized in OCI.  The statementdisclosing accumulated other comprehensive income (“AOCI”) is required toseparately present amounts recognized for debt securities for which a portionof an OTTI has been recognized in earnings.

 

The new guidance expands disclosurerequirements for both debt and equity securities and requires a more detailed,risk-oriented breakdown of security types and related information, and requiresthat the annual disclosures be made for interim periods.  In addition, new disclosures are requiredabout significant inputs used in determining credit losses as well as arollforward of credit losses each period. The disclosures are not required for earlier periods presented forcomparative purposes.  The new guidanceapplies to existing and new investments held as of the beginning of the interimperiod of adoption.

 

The Company adopted the provisions of the new guidanceas of April 1, 2009.  The adoptionresulted in the reclassification of $733 million of previously recorded OTTIwrite-downs from retained income to unrealized capital losses.  The cumulative effect of adoption, net ofrelated deferred policy acquisition costs (“DAC”), deferred sales inducements (“DSI”)and tax adjustments, was an increase in retained income of $481 million and adecrease in unrealized net capital gains and losses of $339 million, with a netbenefit to equity of $142 million.  Thebenefit to equity resulted from a decrease in the deferred tax asset valuationallowance.  The adoption did not have animpact on the Company’s Condensed Consolidated Statement of Operations.   The effect of the adoption on net income forinterim periods after adoption is not determinable.  The accounting standard incorporatesmanagement’s intent as a critical component to the determination of the amountrecorded and this assessment process was changed as of April 1, 2009 to anintent to sell model from an intent to hold model.

 

*DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are Not Orderly*

 

In April 2009, the FASB issued newaccounting guidance relating to fair value measurement to provide additionalguidance for estimating fair value when the volume and level of activity for anasset or liability have significantly decreased.  Guidance on identifying circumstances thatindicate a transaction is not orderly is also provided.  If it is concluded that there has been asignificant decrease in the volume and level of market activity for an asset orliability in relation to normal market activity, transaction or quoted pricesmay not be determinative of fair value and further analysis of transaction orquoted prices may be necessary.  A significantadjustment to transaction or quoted prices may be necessary to estimate fairvalue under the current market conditions. Determination of whether a transaction is orderly is based on the weightof relevant evidence.

 

The disclosure requirements are expanded toinclude the inputs and valuation techniques used to measure fair value and adiscussion of changes in valuation techniques and related inputs during thequarterly reporting period.  Disclosuresof assets and liabilities measured at fair value are to be presented by majorsecurity type.  Disclosures are notrequired for earlier periods presented for comparative purposes.  Revisions resulting from a change invaluation technique or its application shall be accounted for as a change inaccounting estimate and disclosed, along with the total effect of the change invaluation technique and related inputs, if practicable, by major category.  The Company adopted the provisions of the newguidance as of April 1, 2009.  Theadoption had no effect on the Company’s results of operations or financialposition.

 

*Interim Disclosures about FairValue of Financial Instruments*

 

In April 2009, the FASB issued newaccounting guidance to require disclosures about fair value of financialinstruments for interim reporting periods as well as in annual financialstatements.  The disclosures are notrequired for earlier periods presented for comparative purposes.  The Company adopted the provisions of the newguidance as of June 30, 2009.  Thenew guidance affects disclosures only and therefore the adoption had no impacton the Company’s results of operations or financial position.

 

*Noncontrolling Interests inConsolidated Financial Statements*

 

In December 2007, the FASB issued newaccounting guidance which clarifies that a noncontrolling interest in a subsidiaryis that portion of the subsidiary’s equity that is attributable to owners ofthe subsidiary other than its parent or parent’s affiliates.  Noncontrolling interests are required to bereported as equity in the consolidated financial statements and as such, netincome will include amounts attributable to both the parent and the 

 

5

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noncontrolling interest with disclosure ofthe amounts attributable to each on the face of the consolidated statements ofoperations, if material.  All changes ina parent’s ownership interest in a subsidiary when control of the subsidiary isretained should be accounted for as equity transactions.  In contrast, when control over a subsidiaryis relinquished and the subsidiary is deconsolidated, a parent is required torecognize a gain or loss in net income as well as provide certain associatedexpanded disclosures.  The new guidancerequires prospective application as of the beginning of the fiscal year inwhich the standard is initially applied, except for the presentation anddisclosure requirements which are to be applied retrospectively for all periodspresented.  The adoption did not have aneffect on the Company’s results of operations or financial position.

 

*Disclosuresabout Derivative Instruments and Hedging Activities*

 

In March 2008, the FASB issued newaccounting guidance, which amends and expands the disclosure requirements forderivatives.  The new disclosures aredesigned to enhance the understanding of how and why an entity uses derivativeinstruments and how derivative instruments affect an entity’s financialposition, results of operations, and cash flows.  The standard requires, on a quarterly basis,quantitative disclosures about the potential cash outflows associated with thetriggering of credit-risk-contingent features, if any; tabular disclosuresabout the classification and fair value amounts of derivative instrumentsreported in the statement of financial position; disclosure of the location andamount of gains and losses on derivative instruments reported in the statementof operations; and qualitative information about how and why an entity usesderivative instruments and how derivative instruments and related hedged itemsaffect the entity’s financial statements. Disclosures are not required for earlier periods presented forcomparative purposes.  The new guidanceaffects disclosures only and therefore the adoption as of March 31, 2009had no impact on the Company’s results of operations or financial position.

 

**Pending accounting standards**

 

*Consolidation of Variable InterestEntities*

 

In June 2009, the FASB issued newaccounting guidance which requires an entity to perform a qualitative analysisto determine whether it holds a controlling financial interest (i.e., primarybeneficiary (“PB”)) in a variable interest entity (“VIE”).  The analysis identifies the PB of a VIE asthe entity that has both the power to direct the activities of the VIE thatmost significantly impact the economic performance of the VIE and theobligation to absorb losses, or the right to receive benefits, that couldpotentially be significant to the VIE. Additional amendments include the requirement to perform ongoingreassessments to determine whether the entity is the PB of a VIE and theelimination of the quantitative approach for determining the PB of a VIE.  The new guidance is effective for fiscalyears beginning after November 15, 2009. The Company is in the process of evaluating the impact of adoption onthe Company’s results of operations or financial position.

 

*Investmentsin Certain Entities That Calculate Net Asset Value per Share (or ItsEquivalent)*

 

In September 2009,the FASB issued new accounting guidance relating to investments that arerequired or permitted to be measured or disclosed at fair value when theinvestment does not have a readily determinable fair value and is accounted forunder the measurement principles pertaining to investment companies. As apractical expedient, this guidance allows a reporting entity to measure thefair value of these investments on the basis of the net asset value per shareof the investment (or its equivalent). The amendments include additional disclosure requirements. The newguidance is effective for years ending after December 15, 2009.  The new guidance will affect the Company’sdisclosures and the impact of adoption is not expected to be material to theCompany’s results of operations or financial position.

 

**2.    Related Party Transactions**

 

**Capitalcontributions**

 

In March 2009,the Company received a capital contribution from AIC of $250 million, which waspaid in cash and recorded as additional capital paid-in on the CondensedConsolidated Statements of Financial Position.

 

**Postretirementbenefit plans**

 

Effective September 30, 2009, the Corporationbecame the sponsor of a group medical plan and a group life insurance plan toprovide covered benefits to certain retired employees (“postretirement benefits”).  Prior to September 30, 2009, AIC was thesponsor of the plans that provided group medical and life insurance benefits to

 

6

----

 

eligible retired employees.  In connection with the change in thesponsorship, amounts payable by the Company to the previous plan sponsor, AIC,totaling $22 million were forgiven.  Theforgiveness of this liability was recorded as an increase in additional capitalpaid-in of $17 million and an increase to retained income of $5 million.

 

**3.    Supplemental Cash Flow Information**

 

Non-cash investment exchanges, includingmodifications of certain fixed income securities, mortgage loans and otherinvestments, as well as mergers completed with equity securities and limitedpartnerships, totaled $277 million and $9 million for the nine-month periodsended September 30, 2009 and 2008, respectively.

 

Liabilities for collateral received inconjunction with the Company’s securities lending and over-the-counter (“OTC”)derivatives and for funds received from the Company’s security repurchasebusiness activities are reported in other liabilities and accrued expenses orother investments in the Condensed Consolidated Statements of FinancialPosition.  The accompanying cash flowsare included in cash flows from operating activities in the CondensedConsolidated Statements of Cash Flows along with the activities resulting frommanagement of the proceeds, which are as follows:

 
| **($ in millions)**                                               | ** ** | ** ** | **Nine months ended**  | ** ** |
|------------------------------------------------------------------------|------------|------------|------------------------|------------|
| ** **                                                             | ** ** | ** ** | **September 30,** | ** ** |
| ** **                                                             | ** ** | ** ** | **2009**               | ** ** | ** ** | **2008** | ** ** |
| **Net change in proceeds managed**                                     | ** ** | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** |
| Net  change in fixed income securities                                 |       | $          | —                 |       | $ | 314 |   |
| Net  change in short-term investments                                  |       |       | (155                   | )          |   | 274 |   |
| Operating  cash flow (used) provided                                   |       | $          | (155                   | )          | $ | 588 |   |
|                                                                   |       |       |                   |       |   |   |   |
| **Net change in liabilities**                                          |       |       |                   |       |   |   |   |
| Liabilities  for collateral and security repurchase, beginning of year |       | $          | (340                   | )          | $ | (1,817 | ) |
| Liabilities  for collateral and security repurchase, end of period     |       |       | (495                   | )          |   | (1,229 | ) |
| Operating  cash flow provided (used)                                   |       | $          | 155                    |       | $ | (588 | ) |

 

7

----

 

**4.  Investments**

 

**Fairvalues**

** **

Theamortized cost, gross unrealized gains and losses and fair value for fixedincome securities are as follows:

 
| **($ in millions)**                                   | ** ** | ** ** | **Amortized** | ** ** | ** ** | **Gross unrealized** | ** ** | ** ** | **Fair**   | ** ** |
|------------------------------------------------------------|------------|------------|---------------|------------|------------|----------------------|------------|------------|------------|------------|
| ** **                                                 | ** ** | ** ** | **cost**      | ** ** | ** ** | **Gains**            | ** ** | ** ** | **Losses** | ** ** | ** ** | **value** | ** ** |
| **At September 30, 2009**                             |       |       |          |       |       |                 |       |       |       |       |   |   |   |
| U.S.  government and agencies                              |       | $          | 4,716         |       | $          | 192                  |       | $          | (2         | )          | $ | 4,906 |   |
| Municipal                                                  |       |       | 4,981         |       |       | 125                  |       |       | (428       | )          |   | 4,678 |   |
| Corporate                                                  |       |       | 26,013        |       |       | 1,069                |       |       | (975       | )          |   | 26,107 |   |
| Foreign  government                                        |       |       | 1,531         |       |       | 277                  |       |       | (1         | )          |   | 1,807 |   |
| Residential  mortgage-backed securities (“RMBS”) |       |       | 5,681         |       |       | 93                   |       |       | (1,221     | )          |   | 4,553 |   |
| Commercial  mortgage-backed securities (“CMBS”)  |       |       | 3,635         |       |       | 27                   |       |       | (1,181     | )          |   | 2,481 |   |
| Asset-backed  securities (“ABS”)                 |       |       | 2,490         |       |       | 22                   |       |       | (738       | )          |   | 1,774 |   |
| Redeemable  preferred stock                                |       |       | 16            |       |       | —               |       |       | (1         | )          |   | 15 |   |
| Total  fixed income securities                             |       | $          | 49,063        |       | $          | 1,805                |       | $          | (4,547     | )          | $ | 46,321 |   |
|                                                       |       |       |          |       |       |                 |       |       |       |       |   |   |   |
| **At December 31, 2008**                              |       |       |          |       |       |                 |       |       |       |       |   |   |   |
| U.S.  government and agencies                              |       | $          | 2,792         |       | $          | 895                  |       | $          | —     |       | $ | 3,687 |   |
| Municipal                                                  |       |       | 3,976         |       |       | 28                   |       |       | (696       | )          |   | 3,308 |   |
| Corporate                                                  |       |       | 27,416        |       |       | 408                  |       |       | (3,555     | )          |   | 24,269 |   |
| Foreign  government                                        |       |       | 1,652         |       |       | 513                  |       |       | (65        | )          |   | 2,100 |   |
| RMBS                                                       |       |       | 4,933         |       |       | 62                   |       |       | (1,022     | )          |   | 3,973 |   |
| CMBS                                                       |       |       | 5,712         |       |       | 10                   |       |       | (1,992     | )          |   | 3,730 |   |
| ABS                                                        |       |       | 2,639         |       |       | 5                    |       |       | (1,275     | )          |   | 1,369 |   |
| Redeemable  preferred stock                                |       |       | 16            |       |       | —               |       |       | (6         | )          |   | 10 |   |
| Total  fixed income securities                             |       | $          | 49,136        |       | $          | 1,921                |       | $          | (8,611     | )          | $ | 42,446 |   |

 

**Scheduledmaturities**

** **

Thescheduled maturities for fixed income securities are as follows at September 30,2009:

 
| **($ in millions)**                          | ** ** | **Amortized** | ** ** | **Fair**  |   |
|---------------------------------------------------|------------|---------------|------------|-----------|--------|
| ** **                                        | ** ** | **cost**      | ** ** | **value** |   |
| Due in one year or less                           | $          | 1,814         | $          | 1,815     |   |
| Due after one year through five years             |       | 13,902        |       | 14,196    |   |
| Due after five years through ten years            |       | 9,771         |       | 10,085    |   |
| Due after ten years                               |       | 15,405        |       | 13,898    |   |
|                                              |       | 40,892        |       | 39,994    |   |
| Residential mortgage- and asset-backed securities |       | 8,171         |       | 6,327     |   |
| Total                                             | $          | 49,063        | $          | 46,321    |   |

 

Actual maturities may differ from thosescheduled as a result of prepayments by the issuers.  Because of the potential for prepayment onresidential mortgage and asset-backed securities, they are not categorized bycontractual maturity.  The commercialmortgage-backed securities are categorized by contractual maturity because theygenerally are not subject to prepayment risk.

 

8

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**Netinvestment income**

 

Netinvestment income is as follows:

 
| **($ in millions)**          | ** ** | **Three months ended****September ****30,** | ** ** | **Nine**** months ended****September ****30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                                   | ** ** | **2008**                                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Fixed income securities           | $          |                                                       | 635        | $                                                             |       | 772 | $ |   | 1,955 | $ |   | 2,370 |   |
| Mortgage loans                    |       | 118                                                        |       | 143                                                           |       | 381 |   | 434 |   |
| Equity securities                 |       | 2                                                          |       | 2                                                             |       | 4 |   | 6 |   |
| Limited partnership interests     |       | 2                                                          |       | (4                                                            | )          | 6 |   | 33 |   |
| Short-term                        |       | 2                                                          |       | 31                                                            |       | 12 |   | 79 |   |
| Other                             |       | (12                                                        | )          | (2                                                            | )          | (28 | ) | 11 |   |
| Investment income, before expense |       | 747                                                        |       | 942                                                           |       | 2,330 |   | 2,933 |   |
| Investment expense                |       | (25                                                        | )          | (30                                                           | )          | (70 | ) | (107 | ) |
| Net investment income             | $          |                                                       | 722        | $                                                             |       | 912 | $ |   | 2,260 | $ |   | 2,826 |   |

 

**Realized capital gains and losses**

 

Realizedcapital gains and losses by security type are as follows:

 
| **($ in millions)**          | ** ** | **Three months ended****September ****30,** | ** ** | **Nine**** months ended****September ****30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                                   | ** ** | **2008**                                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Fixed income securities           | $          |                                                       | (62        | )                                                             | $          |   | (459 | ) | $ | 86 | $ | (1,566 | ) |
| Mortgage loans                    |       | (65                                                        | )          | (10                                                           | )          | (113 | ) | (46 | ) |
| Equity securities                 |       | 1                                                          |       | (2                                                            | )          | (23 | ) | (25 | ) |
| Limited partnership interests     |       | (33                                                        | )          | (27                                                           | )          | (257 | ) | (30 | ) |
| Derivatives                       |       | (56                                                        | )          | (70                                                           | )          | 234 |   | (246 | ) |
| Other                             |       | (17                                                        | )          | —                                                        |       | (75 | ) | (15 | ) |
| Realized capital gains and losses | $          |                                                       | (232       | )                                                             | $          |   | (568 | ) | $ | (148 | ) | $ | (1,928 | ) |
|                                   |            |                                                            |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |

 

Realizedcapital gains and losses by transaction type are as follows:

 
| **($ in millions)**               | ** ** | **Three months ended********September ****30,** | ** ** | **Nine**** months ended********September ****30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                             | ** ** | **2009**                                                       | ** ** | **2008**                                                          | ** ** | **2009** | ** ** | **2008** | ** ** |
| Impairment write-downs (1)             | $          | (278                                                           | )          | $                                                                 |       | (354 | ) | $ | (833 | ) | $ | (757 | ) |
| Change in intent write-downs (2)       |       | (1                                                             | )          | (262                                                              | )          | (58 | ) | (1,016 | ) |
| Net OTTI losses recognized in earnings |       | (279                                                           | )          | (616                                                              | )          | (891 | ) | (1,773 | ) |
| Sales                                  |       | 106                                                            |       | 119                                                               |       | 627 |   | 63 |   |
| Valuation of derivative instruments    |       | (60                                                            | )          | (146                                                              | )          | 202 |   | (340 | ) |
| Settlements of derivative instruments  |       | 7                                                              |       | 75                                                                |       | 30 |   | 122 |   |
| EMA  LP income (3)                     |       | (6                                                             | )          | —                                                            |       | (116 | ) | — |   |
| Realized capital gains and losses      | $          | (232                                                           | )          | $                                                                 |       | (568 | ) | $ | (148 | ) | $ | (1,928 | ) |
|                                        |            |                                                                |            |                                                                   |            |  |  |  |  |  |  |  |  |  |  |

 

----

| (1)    | Beginning  April 1, 2009 for fixed income securities, impairment write-downs  reflect the credit loss component of issue specific other-than-temporary  declines in fair value where the amortized cost basis is not expected to be  entirely recovered. For periods prior to April 1, 2009 for fixed income  securities and all periods for equity securities, impairment write-downs  reflect issue specific other-than-temporary declines in fair value, including  instances where the Company could not reasonably assert that the recovery  period would be temporary. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (2)    | Beginning  April 1, 2009 for fixed income securities, change in intent write-downs  reflect instances where the Company has made a decision to sell the security  or it is more likely than not the Company will be required to sell the security  before recovery of its amortized cost basis. For periods prior to  April 1, 2009 for fixed income securities and all periods for equity  securities, change in intent write-downs reflect instances where the Company  could not assert a positive intent to hold until recovery.                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (3)    | Beginning  in the fourth quarter of 2008, income from limited partnership interests  accounted for utilizing the equity method of accounting (“EMA LP”) is  reported in realized capital gains and losses. EMA LP income for periods prior  to the fourth quarter of 2008 is reported in net investment income.                                                                                                                                                                                                                                                              |

 

9

----

 

Grossgains of $250 million and $186 million and gross losses of $101 million and $76million were realized on sales of fixed income securities during the threemonths ended September 30, 2009 and 2008, respectively.  Gross gains of $879 million and $363 millionand gross losses of $216 million and $285 million were realized on sales offixed income securities during the nine months ended September 30, 2009and 2008, respectively.

 

Other-than-temporaryimpairment losses by asset type are as follows:

 
| **($ in millions)**                | ** ** | **Three months ended****September ****30, 2009** | ** ** | **Nine**** months ended****September ****30, 2009** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **Total**                                                            | ** ** | **Included  in OCI**                                               | ** ** | **Net** | ** ** | **Total** | ** ** | **Included  in OCI** | ** ** | **Net** | ** ** |
| Fixed income securities:                |       |                                                                 |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Municipal                               | $          | —                                                               | $          | —                                                                  | $          | — | $ | (16 | ) | $ | — | $ | (16 | ) |
| Corporate                               |       | (110                                                                 | )          | —                                                                  |       | (110 | ) | (180 | ) | (9 | ) | (189 | ) |
| Foreign  government                     |       | —                                                               |       | —                                                                  |       | — |   | (17 | ) | — |   | (17 | ) |
| RMBS                                    |       | (139                                                                 | )          | 96                                                                      |       | (43 | ) | (307 | ) | 200 |   | (107 | ) |
| CMBS                                    |       | (89                                                                  | )          | 61                                                                      |       | (28 | ) | (142 | ) | 61 |   | (81 | ) |
| ABS                                     |       | (8                                                                   | )          | (32                                                                     | )          | (40 | ) | (175 | ) | (23 | ) | (198 | ) |
| Total fixed income securities           |       | (346                                                                 | )          | 125                                                                     |       | (221 | ) | (837 | ) | 229 |   | (608 | ) |
| Mortgage loans                          |       | (30                                                                  | )          | —                                                                  |       | (30 | ) | (79 | ) | — |   | (79 | ) |
| Equity securities                       |       | —                                                               |       | —                                                                  |       | — |   | (26 | ) | — |   | (26 | ) |
| Limited partnership interests           |       | (27                                                                  | )          | —                                                                  |       | (27 | ) | (142 | ) | — |   | (142 | ) |
| Other                                   |       | (1                                                                   | )          | —                                                                  |       | (1 | ) | (36 | ) | — |   | (36 | ) |
| Other-than-temporary impairment  losses | $          | (404                                                                 | )          | $                                                                       | 125        | $ | (279 | ) | $ | (1,120 | ) | $ | 229 | $ | (891 | ) |
|                                         |            |                                                                      |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

The total amount of other-than-temporary impairment losses included inaccumulated other comprehensive income for fixed income securities at September 30,2009, which were not included in earnings, are presented in the followingtable.  The amount excludes $92 millionof net unrealized gains related to changes in valuation of the fixed income securitiessubsequent to the impairment measurement date.

 
| **($ in millions)** | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| Corporate                | $          | (40        | )          |
| RMBS                     |       | (309       | )          |
| CMBS                     |       | (86        | )          |
| ABS                      |       | (93        | )          |
| Total                    | $          | (528       | )          |

 

10

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Rollforwardsof the amount recognized in earnings related to credit losses for fixed incomesecurities are presented in the following tables.

 
| **($ in millions)**                                                                                                                                  | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| Balance  at June 30, 2009                                                                                                                            | $          | (1,193     | )          |
| Additional  credit loss for securities previously other-than-temporarily impaired                                                                         |       | (72        | )          |
| Additional  credit loss for securities not previously other-than-temporarily impaired                                                                     |       | (149       | )          |
| Reduction  in credit loss for securities disposed or collected                                                                                            |       | 365        |       |
| Reduction  in credit loss for securities other-than-temporarily impaired to fair value                                                                    |       | —     |       |
| Change  in credit loss due to accretion of increase in cash flows and time value of  cash flows for securities previously other-than-temporarily impaired |       | —     |       |
| Ending  balance at September 30, 2009                                                                                                                | $          | (1,049     | )          |
| ** **                                                                                                                                                |       |       |       |
| Beginning  balance of cumulative credit loss for securities held at April 1, 2009                                                                    | $          | (1,059     | )          |
| Additional  credit loss for securities previously other-than-temporarily impaired                                                                         |       | (101       | )          |
| Additional  credit loss for securities not previously other-than-temporarily impaired                                                                     |       | (278       | )          |
| Reduction  in credit loss for securities disposed or collected                                                                                            |       | 389        |       |
| Reduction  in credit loss for securities other-than-temporarily impaired to fair value                                                                    |       | —     |       |
| Change  in credit loss due to accretion of increase in cash flows and time value of  cash flows for securities previously other-than-temporarily impaired |       | —     |       |
| Ending  balance at September 30, 2009                                                                                                                | $          | (1,049     | )          |

 

TheCompany uses its best estimate of future cash flows expected to be collectedfrom the fixed income security discounted at the security’s original or currenteffective rate, as appropriate, to calculate a recovery value and determinewhether a credit loss exists.  Thedetermination of cash flow estimates is inherently subjective and methodologiesmay vary depending on facts and circumstances specific to the security.  All reasonably available information relevantto the collectability of the security, including past events, current conditions, and reasonableand supportable assumptions and forecasts, are considered when developing theestimate of cash flows expected to be collected.  That information generally includes, but isnot limited to, the remaining payment terms of the security, prepayment speeds,foreign exchange rates, the financial condition of the issue or issuer(s),expected defaults, expected recoveries, the value of underlying collateral andcurrent subordination levels, vintage, geographic concentration, availablereserves or escrows, third party guarantees and other credit enhancements.  Additionally, other information, such asindustry analyst reports and forecasts, sector credit ratings, financialcondition of the bond insurer for insured fixed income securities, and othermarket data relevant to the realizability of contractual cash flows, may alsobe considered.  The estimated fair valueof collateral may be used to estimate recovery value if the Company determinesthat the security is dependent on the liquidation of collateral for ultimatesettlement.  If the estimated recoveryvalue is less than the amortized cost of the security, a credit loss exists andan other-than-temporary impairment for the difference between the estimatedrecovery value and amortized cost is recorded in earnings.  The unrealized loss deemed to be related tofactors other than credit remains classified in OCI.  If the Company determines that the fixedincome security does not have sufficient cash flow or other information todetermine a recovery value for the security, the Company may conclude that theentire decline in fair value is deemed to be credit related and is recorded inearnings.

 

11

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**Unrealized net capital gains and losses**

 

Unrealizednet capital gains and losses included in accumulated other comprehensive incomeare as follows:

 
| **($ in millions)**                            | ** ** | **Fair**   | ** ** | **Gross unrealized** | ** ** | **Unrealized net** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------------------|------------|--------------------|------------|
| ** **                                          | ** ** | **value**  | ** ** | **Gains**            | ** ** | **Losses**         | ** ** | **gains (losses)** | ** ** |
| **At September 30, 2009**                      | ** ** | ** ** | ** ** | ** **           | ** ** | ** **         | ** ** | ** ** | ** ** |
| Fixed  income securities (1)                        | $          | 46,321     | $          | 1,805                | $          | (4,547             | )          | $ | (2,742 | ) |
| Equity  securities                                  |       | 188        |       | 29                   |       | (8                 | )          | 21 |   |
| Short-term  investments                             |       | 1,731      |       | —               |       | —             |       | — |   |
| Derivative  instruments (2)                         |       | (21        | )          | 2                    |       | (21                | )          | (19 | ) |
| Unrealized  net capital gains and losses, pre-tax   |       |       |       |                 |       |               |       | (2,740 | ) |
| Amounts  recognized for:                            |       |       |       |                 |       |               |       |   |   |
| Insurance  reserves (3)                             |       |       |       |                 |       |               |       | — |   |
| DAC  and DSI (4)                                    |       |       |       |                 |       |               |       | 2,679 |   |
| Amounts  recognized                                 |       |       |       |                 |       |               |       | 2,679 |   |
| Deferred  income taxes                              |       |       |       |                 |       |               |       | 16 |   |
| Unrealized  net capital gains and losses, after-tax |       |       |       |                 |       |               | $          | (45 | ) |
|                                                     |            |            |            |                      |            |                    |            |  |  |  |

 

----

| (1)    | Unrealized  net capital gains and losses for fixed income securities comprise $(436)  million related to unrealized net capital losses on fixed income securities  with OTTI and $(2,306) million related to other unrealized net capital gains  and losses.                                                                                                                                                                                                                                                                                                                                                            |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (2)    | Included  in the fair value of derivative securities are $(4) million classified  as assets and $17 million classified as liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (3)    | The  insurance reserves adjustment represents the amount by which the reserve  balance would increase if the net unrealized gains in the applicable product  portfolios were realized and reinvested at current lower interest rates,  resulting in a premium deficiency. Although the Company evaluates premium  deficiencies on the combined performance of our life insurance and immediate  annuities with life contingencies, the adjustment primarily relates to  structured settlement annuities with life contingencies, in addition to  annuity buy-outs and certain payout annuities with life contingencies. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (4)    | The  DAC and DSI adjustment represents the amount by which the amortization of DAC  and DSI would increase or decrease if the unrealized gains or losses in the  respective product portfolios were realized.                                                                                                                                                                                                                                                                                                                                                                                                           |

 
| ** **                                          | ** ** | **Fair**  | ** ** | **Gross unrealized** | ** ** | **Unrealized net** | ** ** |
|-----------------------------------------------------|------------|-----------|------------|----------------------|------------|--------------------|------------|
| ** **                                          | ** ** | **value** | ** ** | **Gains**            | ** ** | **Losses**         | ** ** | **gains (losses)** | ** ** |
| **At December 31, 2008**                       |       |      |       |                 |       |               |       |   |   |
| Fixed  income securities                            | $          | 42,446    | $          | 1,921                | $          | (8,611             | )          | $ | (6,690 | ) |
| Equity  securities                                  |       | 82        |       | 1                    |       | (25                | )          | (24 | ) |
| Short-term  investments                             |       | 3,858     |       | 4                    |       | (1                 | )          | 3 |   |
| Derivative  instruments (1)                         |       | 16        |       | 23                   |       | (9                 | )          | 14 |   |
| Unrealized  net capital gains and losses, pre-tax   |       |      |       |                 |       |               |       | (6,697 | ) |
| Amounts  recognized for:                            |       |      |       |                 |       |               |       |   |   |
| Insurance  reserves                                 |       |      |       |                 |       |               |       | (378 | ) |
| DAC  and DSI                                        |       |      |       |                 |       |               |       | 3,493 |   |
| Amounts  recognized                                 |       |      |       |                 |       |               |       | 3,115 |   |
| Deferred  income taxes                              |       |      |       |                 |       |               |       | 1,245 |   |
| Unrealized  net capital gains and losses, after-tax |       |      |       |                 |       |               | $          | (2,337 | ) |
|                                                     |            |           |            |                      |            |                    |            |  |  |  |

 

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| (1) | Included  in the fair value of derivative securities are $4 million classified as  assets and $(12) million classified as liabilities. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------|

 

12

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**Change in unrealized net capital gains and losses**

 

Thechange in unrealized net capital gains and losses for the nine months ended September 30,2009 is as follows:

 
| **($ in millions)**                             | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| ** **                                           | ** ** | ** ** | ** ** |
| Fixed income securities                              | $          | 3,948      |       |
| Equity securities                                    |       | 45         |       |
| Short-term investments                               |       | (3         | )          |
| Derivative instruments                               |       | (33        | )          |
| Total                                                |       | 3,957      |       |
| Amounts recognized for:                              |       |       |       |
| Insurance reserves                                   |       | 378        |       |
| DAC and DSI                                          |       | (814       | )          |
| Decrease in amounts recognized                       |       | (436       | )          |
| Deferred income taxes                                |       | (1,229     | )          |
| Increase in unrealized net capital gains and  losses | $          | 2,292      |       |

 

**Portfolio monitoring**

 

The Company has acomprehensive portfolio monitoring process to identify and evaluate each fixedincome and equity security whose carrying value may be other-than-temporarilyimpaired*.*

 

For each fixed incomesecurity in an unrealized loss position, the Company assesses whethermanagement with the appropriate authority**has made adecision to sell or whether it is more likely than not the Company will berequired to sell the security before recovery of the amortized cost basis forreasons such as liquidity, contractual or regulatory purposes.  If a security meets either of these criteria,the security’s decline in fair value is deemed other than temporary and isrecorded in earnings.

 

If the Company has notmade the decision to sell the fixed income security and it is not more likelythan not the Company will be required to sell the fixed income security beforerecovery of its amortized cost basis, the Company evaluates if it expects toreceive cash flows sufficient to recover the entire amortized cost basis of thesecurity by comparing the estimated recovery value calculated by discountingthe best estimate of future cash flows at the security’s original or currenteffective rate, as appropriate, with the amortized cost of the security.  If the Company does not expect to receivecash flows sufficient to recover the entire amortized cost basis of the fixedincome security, the credit loss component of the impairment is recorded inearnings, with the remaining amount of the unrealized loss deemed to be relatedto other factors and recognized in OCI.

 

For equity securities,the Company considers various factors, including whether the Company has theintent and ability to hold the equity security for a period of time sufficientto recover its cost basis.  Where theCompany lacks the intent and ability to hold to recovery, or believes therecovery period is extended, the equity security’s decline in fair value isconsidered other than temporary and is recorded in earnings.

 

Our portfolio monitoringprocess includes a quarterly review of all securities through a screeningprocess which identifies instances where the fair value compared to amortizedcost for fixed income securities and cost for equity securities is belowestablished thresholds, and also includes the monitoring of other criteria suchas ratings, ratings downgrades or payment defaults.  The securities identified, in addition toother securities for which the Company may have a concern, are evaluated forpotential other-than-temporary impairment using all reasonably availableinformation relevant to the collectability or recovery of the security.  Inherent in the Company’s evaluation ofother-than-temporary impairment for these fixed income and equity securitiesare assumptions and estimates about the financial condition of the issue orissuer and its future earnings potential. Some of the factors considered in evaluating whether a decline in fairvalue is other than temporary are: 1) the length of time and extent to whichthe fair value has been less than amortized cost for fixed income securities,or cost for equity securities; 2) the financial condition, near-term andlong-term prospects of the issue or issuer, including relevant industry specificmarket conditions and trends, geographic location and implications of ratingagency actions and offering prices; and 3) the specific reasons that a securityis in a significant unrealized loss position, including overall marketconditions which could affect liquidity.

 

13

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

 
| **($ in millions)**                      | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**      | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                    | ** ** | **Number**              | ** ** | **Fair**              | ** ** | **Unrealized** | ** ** | **Number** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **unrealized** | ** ** |
| ** **                                    | ** ** | **of issues**           | ** ** | **value**             | ** ** | **losses**     | ** ** | **of issues** | ** ** | **value** | ** ** | **losses** | ** ** | **losses** | ** ** |
| **At September 30, 2009**                |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |
| Fixed income securities                       |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |
| U.S. government and agencies                  |       | 2                       | $          | 450                   | $          | (2             | )          | — | $ | — | $ | — |   | $ | (2 | ) |
| Municipal                                     |       | 98                      |       | 839                   |       | (52            | )          | 237 |   | 1,524 |   | (376 | ) |   | (428 | ) |
| Corporate                                     |       | 167                     |       | 2,339                 |       | (181           | )          | 492 |   | 5,794 |   | (794 | ) |   | (975 | ) |
| Foreign government                            |       | 2                       |       | 21                    |       | —         |       | 3 |   | 7 |   | (1 | ) |   | (1 | ) |
| RMBS                                          |       | 62                      |       | 92                    |       | (42            | )          | 319 |   | 1,769 |   | (1,179 | ) |   | (1,221 | ) |
| CMBS                                          |       | 9                       |       | 59                    |       | —         |       | 289 |   | 2,164 |   | (1,181 | ) |   | (1,181 | ) |
| ABS                                           |       | 12                      |       | 126                   |       | (9             | )          | 179 |   | 1,329 |   | (729 | ) |   | (738 | ) |
| Redeemable preferred stock                    |       | 2                       |       | —                |       | —         |       | 1 |   | 13 |   | (1 | ) |   | (1 | ) |
| Total fixed income securities (1)             |       | 354                     |       | 3,926                 |       | (286           | )          | 1,520 |   | 12,600 |   | (4,261 | ) |   | (4,547 | ) |
| Equity securities                             |       | 8                       |       | 12                    |       | (4             | )          | 3 |   | 17 |   | (4 | ) |   | (8 | ) |
| Total fixed income and equitysecurities       |       | 362                     | $          | 3,938                 | $          | (290           | )          | 1,523 | $ | 12,617 | $ | (4,265 | ) | $ | (4,555 | ) |
|                                          |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |   |
| Investment grade fixed incomesecurities       |       | 305                     | $          | 3,635                 | $          | (193           | )          | 1,174 | $ | 10,660 | $ | (2,690 | ) | $ | (2,883 | ) |
| Below investment grade fixed incomesecurities |       | 49                      |       | 291                   |       | (93            | )          | 346 |   | 1,940 |   | (1,571 | ) |   | (1,664 | ) |
| Total fixed income securities                 |       | 354                     | $          | 3,926                 | $          | (286           | )          | 1,520 | $ | 12,600 | $ | (4,261 | ) | $ | (4,547 | ) |
|                                          |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |   |
| **At December 31, 2008**                 |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |   |
| Fixed income securities                       |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |   |
| Municipal                                     |       | 400                     | $          | 2,460                 | $          | (653           | )          | 26 | $ | 199 | $ | (43 | ) | $ | (696 | ) |
| Corporate                                     |       | 1,282                   |       | 12,781                |       | (1,779         | )          | 446 |   | 4,344 |   | (1,776 | ) |   | (3,555 | ) |
| Foreign government                            |       | 43                      |       | 304                   |       | (53            | )          | 2 |   | 13 |   | (12 | ) |   | (65 | ) |
| RMBS                                          |       | 209                     |       | 1,154                 |       | (293           | )          | 226 |   | 973 |   | (729 | ) |   | (1,022 | ) |
| CMBS                                          |       | 289                     |       | 2,646                 |       | (786           | )          | 176 |   | 901 |   | (1,206 | ) |   | (1,992 | ) |
| ABS                                           |       | 61                      |       | 348                   |       | (100           | )          | 166 |   | 926 |   | (1,175 | ) |   | (1,275 | ) |
| Redeemable preferred stock                    |       | 3                       |       | 9                     |       | (6             | )          | — |   | — |   | — |   |   | (6 | ) |
| Total fixed income securities                 |       | 2,287                   |       | 19,702                |       | (3,670         | )          | 1,042 |   | 7,356 |   | (4,941 | ) |   | (8,611 | ) |
| Equity securities                             |       | 39                      |       | 55                    |       | (25            | )          | — |   | — |   | — |   |   | (25 | ) |
| Total fixed income and equitysecurities       |       | 2,326                   | $          | 19,757                | $          | (3,695         | )          | 1,042 | $ | 7,356 | $ | (4,941 | ) | $ | (8,636 | ) |
|                                          |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |   |
| Investment grade fixed incomesecurities       |       | 2,104                   | $          | 18,791                | $          | (3,343         | )          | 906 | $ | 6,757 | $ | (4,481 | ) | $ | (7,824 | ) |
| Below investment grade fixed incomesecurities |       | 183                     |       | 911                   |       | (327           | )          | 136 |   | 599 |   | (460 | ) |   | (787 | ) |
| Total fixed income securities                 |       | 2,287                   | $          | 19,702                | $          | (3,670         | )          | 1,042 | $ | 7,356 | $ | (4,941 | ) | $ | (8,611 | ) |

 

----

| (1) | Gross  unrealized losses resulting from factors other than credit on fixed income  securities with other-than-temporary impairments for which the Company has  recorded a credit loss in earnings total $43 million for the less than 12  month category and $423 million for the 12 months or greater category. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

As of September 30, 2009, $894 millionof unrealized losses are related to securities with an unrealized loss positionless than 20% of cost or amortized cost, the degree of which suggests that thesesecurities do not pose a high risk of being other-than-temporarilyimpaired.  Of the $894 million, $819million are related to unrealized losses on investment grade fixed incomesecurities.  Investment grade is definedas a security having a rating from the National Association of InsuranceCommissioners (“NAIC”) of 1 or 2; a rating of Aaa, Aa, A or Baa from Moody’s, arating of AAA, AA, A or BBB from Standard & Poor’s (“S&P”), Fitchor Dominion, or aaa, aa, a or bbb from A.M. Best; or a comparable internalrating if an externally provided rating is not available.  Unrealized losses on investment gradesecurities are principally related to rising interest rates or changes incredit spreads since the securities were acquired.

 

As of September 30, 2009, the remaining$3.66 billion of unrealized losses are related to securities in unrealized losspositions greater than or equal to 20% of cost or amortized cost.  Investment grade securities comprising the$2.06 billion of unrealized losses were evaluated based on factors such as thefinancial condition and near-term and long-term prospects of the issue orissuer and were determined to have adequate resources to fulfill contractual 

 

14

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obligations, such as recent financings orbank loans, cash flows from operations, collateral or the position of asubsidiary with respect to its parent’s bankruptcy.  Of the $3.66 billion, $1.59 billion arerelated to below investment grade fixed income securities and $7 million arerelated to equity securities.  Of theseamounts, $1.26 billion of the below investment grade fixed income securitieshad been in an unrealized loss position for a period of twelve or moreconsecutive months as of September 30, 2009.  Unrealized losses on below investment gradesecurities are principally related to RMBS, CMBS and ABS and were the result ofwider credit spreads since the time of initial purchase which was largely dueto the impact of macroeconomic conditions and credit market deterioration onreal estate valuations.  Unrealized losses were evaluated basedon credit ratings, as well as the performance of the underlying collateralrelative to the securities’ positions in the securities’ respective capitalstructure. The unrealized losses on RMBS and ABS were evaluated with creditenhancements from bond insurers where applicable.  The unrealized losses on municipal bonds wereevaluated based on the quality of the underlying security, as well as withcredit enhancements from bond insurers, where applicable.  Unrealized losses on equity securities areprimarily related to equity market fluctuations.

 

As of September 30, 2009, the Companyhas not made a decision to sell and it is not more likely than not the Companywill be required to sell fixed income securities with unrealized losses beforerecovery of the amortized cost basis.  Asof September 30, 2009, the Company had the intent and ability to hold theequity securities with unrealized losses for a period of time sufficient forthem to recover.

 

**Limited partnership impairment**

 

As of September 30, 2009 and December 31,2008, equity-method limited partnership interests totaled $512 million and $627million, respectively.  The Companyrecognizes a loss in value for equity-method investments when evidencedemonstrates that it is other-than-temporarily impaired.  Evidence of a loss in value that is otherthan temporary may include the absence of an ability to recover the carryingamount of the investment or the inability of the investee to sustain an earningscapacity that would justify the carrying amount of the investment.  The Company did not have any write-downs forthe three months ended September 30, 2009 related to equity-method limitedpartnership interests.  The Company hadwrite-downs of $1 million for the three months ended September 30, 2008,and write-downs of $5 million and $1 million for the nine months ended September 30,2009 and 2008, respectively, related to equity-method limited partnershipinterests.

 

As of September 30, 2009 and December 31,2008, the carrying value for cost-method limited partnership interests was $505million and $560 million, respectively, which primarily included limitedpartnership interests in fund investments. The fair value for cost-method investments is estimated to be equivalent to the reported netasset value of the underlying funds.  Todetermine if an other-than-temporary impairment has occurred, the Companyevaluates whether an impairment indicator has occurred in the period that mayhave a significant adverse effect on the carrying value of the investment.  Impairment indicators may include: actualrecent cash flows received being significantly less than expected cash flows;reduced valuations based on financing completed at a lower value; completed saleof a material underlying investment at a price significantly lower thanexpected; significantly reduced valuations of the investments held by limitedpartnerships; or any other adverse events since the last financial statementsreceived that might affect the fair value of the investee’s capital.  Additionally, the Company uses a screeningprocess to identify those investments whose net asset value is belowestablished thresholds for certain periods of time, and investments that areperforming below expectations for consideration for inclusion on its watch-list. The Company had write-downs of $27 million and $26 million for the threemonths ended September 30, 2009 and 2008, respectively, and write-downs of$137 million and $33 million for the nine months ended September 30, 2009and 2008, respectively, related to cost method investments that wereother-than-temporarily impaired.

 

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**5. Fair Value of Assets and Liabilities**

 

The hierarchy forinputs used in determining fair value maximizes the use of observable inputsand minimizes the use of unobservable inputs by requiring that observableinputs be used when available. Assets and liabilities recorded on the CondensedConsolidated Statements of Financial Position at fair value are categorized inthe fair value hierarchy based on the observability of inputs to the valuationtechniques as follows:

 

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

 

*Level 2:***    **Assets and liabilities whose values are based on thefollowing:

 

a) Quotedprices for similar assets or liabilities in active markets;

b) Quotedprices for identical or similar assets or liabilities in markets that are notactive; or

c) Valuationmodels whose inputs are observable, directly or indirectly, for substantiallythe full term of the asset or liability.

 

*Level 3:**    *Assets and liabilities whose values are based onprices or valuation techniques that require inputs that are both unobservableand significant to the overall fair value measurement. Unobservable inputsreflect the Company’s estimates of the assumptions that market participantswould use in valuing the assets and liabilities.

 

The availability ofobservable inputs varies by instrument. In situations where fair value is basedon internally developed pricing models or inputs that are unobservable in themarket, the determination of fair value requires more judgment. The degree ofjudgment exercised by the Company in determining fair value is typicallygreatest for instruments categorized in Level 3. In many instances, valuationinputs used to measure fair value fall into different levels of the fairvalue hierarchy.  The category level in the fair value hierarchy isdetermined based on the lowest level input that is significant to the fairvalue measurement in its entirety. The Company uses prices and inputs thatare current as of the measurement date, including during periods of marketdisruption. In periods of market disruption, the ability to observe prices andinputs may be reduced for many instruments. This condition could cause aninstrument to be reclassified from Level 1 to Level 2, or from Level 2 to Level3.

 

Certain assets are notcarried at fair value on a recurring basis, including investments such asmortgage loans, limited partnership interests, bank loans and policy loans. Accordingly,such investments are only included in the fair value hierarchy disclosure whenthe investment is subject to remeasurement at fair value after initialrecognition and the resulting remeasurement is reflected in the condensedconsolidated financial statements. In addition, equity options embedded infixed income securities are not disclosed in the hierarchy with free-standingderivatives as the embedded derivatives are presented with the host contract infixed income securities. As of September 30, 2009, 72.3% of total assetsare measured at fair value and 1.1% of total liabilities are measured at fairvalue.

 

*Summaryof significant valuation techniques for assets and liabilities measured at fairvalue on a recurring basis*

 

Level 1 measurements

 

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

 

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

 

·                  Short-term: Comprise actively traded money marketfunds that have daily quoted net asset values for identical assets that theCompany can access.

 

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

 

16

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Level 2 measurements

 

·                  Fixed income securities:

 

*U.S.government and agencies:* Valued based on inputs including quoted prices for identical or similarassets in markets that are not active.

 

*Municipal:* Externally rated municipals are valuedbased on inputs including quoted prices for identical or similar assets inmarkets that are not active. Included in municipals are auction rate securities(“ARS”) other than those backed by student loans. ARS backed by student loansare included in Level 3.

 

*Corporate,including privately placed:* Valued based on inputs including quoted prices foridentical or similar assets in markets that are not active. Also includesprivately placed securities which have market-observable external ratings fromindependent third party rating agencies.

 

*Foreigngovernment; RMBS - U.S. government sponsored entities (“U.S. Agency”), Primeresidential mortgage-backed securities (“Prime”) and Alt-A residentialmortgage-backed securities (“Alt-A”); ABS -credit card, auto and student loans;Redeemable preferred stock:* Valued based on inputs including quoted prices foridentical 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.

 

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

 

·                  Short-term: Commercial paper and other short-terminvestments are valued based on quoted prices for identical or similar assetsin markets that are not active or amortized cost.

 

·                  Other investments: Free-standing exchange listedderivatives that are not actively traded are valued based on quoted prices foridentical instruments in markets that are not active.

 

OTC derivatives,including interest rate swaps, foreign currency swaps, foreign exchange forwardcontracts and certain credit default swaps, are valued using models that relyon inputs such as interest rate yield curves, currency rates and adjustment forcounterparty credit risks that are observable for substantially the full termof the contract. The valuation techniques underlying the models are widelyaccepted in the financial services industry and do not involve significantjudgment.

 

·                  Contractholder funds: 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. Thevaluation techniques are widely accepted in the financial services industry anddo not include significant judgment.

 

Level 3 measurements

 

·                  Fixed income securities:

 

*Municipal:*ARS primarilybacked by student loans that have become illiquid due to failures in theauction market and municipal bonds that are not rated by third party creditrating agencies but are generally rated by the NAIC are included in Level 3. ARSbacked by student loans are valued based on a discounted cash flow model withcertain inputs to the valuation model that are significant to the valuation,but are not market observable, including estimates of future coupon rates ifauction failures continue, maturity assumptions, and illiquidity premium. Non-ratedmunicipal bonds are valued based on valuation models that are widely acceptedin the financial services industry and are categorized as Level 3 as a resultof the significance of non-market observable inputs, which may includeprojections of future cash flows.

 

*Corporate:* Valued based on non-binding brokerquotes.

 

*Corporateprivately placed:*Valued based on non-binding broker quotes and models that are widely accepted in the financialservices industry and use internally assigned credit ratings as inputs andinstrument specific inputs. Instrument specific inputs used in internalfair value determinations include coupon rate, coupon type, weighted averagelife, sector of the issuer and call provisions. Privately placed

 

17

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securities arecategorized as Level 3 as a result ofthe significance of non-marketobservable inputs. The internally modeled securities are valued based oninternal ratings, which are not observable in the market. Multiple internalratings comprise an NAIC ratingcategory and when used in the internal model provide a more refineddetermination of fair value. The Company’s internal ratings are primarily consistentwith the NAIC ratings which are generally updated annually.

 

*RMBS -Subprime residential mortgage-backed securities (“Subprime”) and Alt-A:* Subprime and certain Alt-A areprincipally valued based on inputs including quoted prices for identical or similarassets in markets that exhibit less liquidity relative to those marketssupporting Level 2 fair value measurements. Certain Subprime and Alt-A arevalued based on non-binding broker quotes. Due to the reduced availability ofactual market prices or relevant observable inputs as a result of the decreasein liquidity that has been experienced in the market for these securities,Subprime and certain Alt-A are categorized as Level 3.

 

*CMBS:* Valued based on non-binding brokerquotes or based on inputs including quoted prices for identical or similarassets in markets that exhibit less liquidity relative to those marketssupporting Level 2 fair value measurements. Due to the reduced availability ofactual market prices or relevant observable inputs as a result of the decreasein liquidity that has been experienced in the market for these securities,certain CMBS are categorized as Level 3.

 

*ABS -Collateralized debt obligations (“CDO”):*Valued based on non-binding broker quotes receivedfrom brokers who are familiar with the investments. 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 for thesesecurities, all CDO are categorized as Level 3.

 

*ABS -student loans and other:* Valued based on inputs including quoted prices for identical orsimilar assets in markets that are not active. Due to the reduced availabilityof actual market prices or relevant observable inputs as a result of thedecrease in liquidity that has been experienced in the market for thesesecurities, certain ABS are categorized as Level 3.

 

·                  Other investments: Certain free-standing OTC derivatives,such as interest rate caps and floors, certain credit default swaps and OTCoptions (including swaptions), are valued using valuation models that arewidely accepted in the financial services industry. Non-market observableinputs such as volatility assumptions may be significant to the valuation ofthe instruments.

 

·                  Contractholder funds: Derivatives embedded in certain 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 models use stochastically determined cash flowsbased on the contractual elements of embedded derivatives and other applicablemarket data. These are categorized as Level 3 as a result of the significance of non-market observable inputs.

 

*Assetsand liabilities measured at fair value on a non-recurring basis*

 

Mortgage loans and otherinvestments written-down to fair value in connection with recognizingother-than-temporary impairments are valued using valuation models that arewidely accepted in the financial services industry. Inputs to the valuationmodels include non-market observable inputs such as credit spreads. Limitedpartnership interests written-down to fair value in connection with recognizingother-than-temporary impairments are valued using net asset values and othersources.

 

18

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Thefollowing table summarizes the Company’s assets and liabilities measured atfair value on a recurring and non-recurring basis as of September 30,2009:

 
| **($ in millions)**                  | ** ** | **Quoted prices  in active  markets for  identical assets** | ** ** | **Significant  other  observable  inputs** | ** ** | ** ** | **Significant  unobservable  inputs** | ** ** | ** ** | **Counterparty  and cash  collateral** | ** ** | ** ** | **Balance as of  September 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------|---------------------------------------|------------|------------|---------------------------------------------|------------|------------|-------------------------------------------------|------------|
| ** **                                | ** ** | **(Level 1)**                                                              | ** ** | **(Level 2)**                         | ** ** | ** ** | **(Level 3)**                    | ** ** | ** ** | **netting**                                 | ** ** | ** ** | **2009**                                        | ** ** |
| **Assets:**                               |       |                                                                            |       |                                       |       |       |                                  |       |       |                                        |       |       |                                            |       |   |
| Fixed income securities:                  |       |                                                                            |       |                                       |       |       |                                  |       |       |                                        |       |       |                                            |       |   |
| U.S. government and agencies              | $          | 3,059                                                                           |       | $                                          | 1,847      |       | $                                     | —     |       |                                        |       |       | $                                               | 4,906      |   |
| Municipal                                 |       | —                                                                          |       |                                       | 3,991      |       |                                  | 687        |       |                                        |       |       |                                            | 4,678      |   |
| Corporate                                 |       | —                                                                          |       |                                       | 16,644     |       |                                  | 9,463      |       |                                        |       |       |                                            | 26,107     |   |
| Foreign government                        |       | —                                                                          |       |                                       | 1,797      |       |                                  | 10         |       |                                        |       |       |                                            | 1,807      |   |
| RMBS                                      |       | —                                                                          |       |                                       | 3,496      |       |                                  | 1,057      |       |                                        |       |       |                                            | 4,553      |   |
| CMBS                                      |       | —                                                                          |       |                                       | 1,155      |       |                                  | 1,326      |       |                                        |       |       |                                            | 2,481      |   |
| ABS                                       |       | —                                                                          |       |                                       | 275        |       |                                  | 1,499      |       |                                        |       |       |                                            | 1,774      |   |
| Redeemable preferred stock                |       | —                                                                          |       |                                       | 14         |       |                                  | 1          |       |                                        |       |       |                                            | 15         |   |
| Total fixed income securities             |       | 3,059                                                                           |       |                                       | 29,219     |       |                                  | 14,043     |       |                                        |       |       |                                            | 46,321     |   |
| Equity securities                         |       | 133                                                                             |       |                                       | 28         |       |                                  | 27         |       |                                        |       |       |                                            | 188        |   |
| Short-term investments                    |       | 164                                                                             |       |                                       | 1,567      |       |                                  | —     |       |                                        |       |       |                                            | 1,731      |   |
| Other investments:                        |       |                                                                            |       |                                       |       |       |                                  |       |       |                                        |       |       |                                            |       |   |
| Free-standing derivatives                 |       | —                                                                          |       |                                       | 773        |       |                                  | 25         |       | $                                           | (338       | )          |                                            | 460        |   |
| Separate account assets                   |       | 9,026                                                                           |       |                                       | —     |       |                                  | —     |       |                                        |       |       |                                            | 9,026      |   |
| Other assets                              |       | —                                                                          |       |                                       | —     |       |                                  | 2          |       |                                        |       |       |                                            | 2          |   |
| **Total recurring basis assets**          |       | 12,382                                                                          |       |                                       | 31,587     |       |                                  | 14,097     |       |                                        | (338       | )          |                                            | 57,728     |   |
| Non-recurring basis (1)                   |       | —                                                                          |       |                                       | —     |       |                                  | 217        |       |                                        |       |       |                                            | 217        |   |
| **Total assets at fair value**            | $          | 12,382                                                                          |       | $                                          | 31,587     |       | $                                     | 14,314     |       | $                                           | (338       | )          | $                                               | 57,945     |   |
| % of total assets at fair value           |       | 21.4                                                                            | %          |                                       | 54.5       | %          |                                  | 24.7       | %          |                                        | (0.6       | )%         |                                            | 100.0      | % |
| ** **                                |       |                                                                            |       |                                       |       |       |                                  |       |       |                                        |       |       |                                            |       |   |
| **Liabilities:**                          |       |                                                                            |       |                                       |       |       |                                  |       |       |                                        |       |       |                                            |       |   |
| Contractholder funds:                     |       |                                                                            |       |                                       |       |       |                                  |       |       |                                        |       |       |                                            |       |   |
| Derivatives embedded in annuity contracts | $          | —                                                                          |       | $                                          | (221       | )          | $                                     | (120       | )          |                                        |       |       | $                                               | (341       | ) |
| Other liabilities:                        |       |                                                                            |       |                                       |       |       |                                  |       |       |                                        |       |       |                                            |       |   |
| Free-standing derivatives                 |       | —                                                                          |       |                                       | (687       | )          |                                  | (100       | )          | $                                           | 285        |       |                                            | (502       | ) |
| **Total liabilities at fair value**       | $          | —                                                                          |       | $                                          | (908       | )          | $                                     | (220       | )          | $                                           | 285        |       | $                                               | (843       | ) |
| % of total liabilities at fair value      |       | —                                                                          | %          |                                       | 107.7      | %          |                                  | 26.1       | %          |                                        | (33.8      | )%         |                                            | 100.0      | % |

 

----

| (1) | Includes  $167 million of mortgage loans, $48 million of limited partnership interests  and $2 million of other investments written-down to fair value in connection  with recognizing other-than-temporary impairments. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

19

----

 

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

 
| **($ in millions)**                  | ** ** | **Quoted prices  in active  markets for  identical assets** | ** ** | ** ** | **Significant  other  observable  inputs** | ** ** | ** ** | **Significant  unobservable  inputs** | ** ** | ** ** | **Counterparty  and cash  collateral** | ** ** | ** ** | **Balance as of********December 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------------------------------|------------|------------|--------------------------------------------|------------|------------|---------------------------------------|------------|------------|---------------------------------------------|------------|------------|------------------------------------------------------|------------|
| ** **                                | ** ** | **(Level 1)**                                                              | ** ** | ** ** | **(Level 2)**                         | ** ** | ** ** | **(Level 3)**                    | ** ** | ** ** | **netting**                                 | ** ** | ** ** | **2008**                                             | ** ** |
| **Assets**                                | ** ** | ** **                                                                      | ** ** | ** ** | ** **                                 | ** ** | ** ** | ** **                            | ** ** | ** ** | ** **                                  | ** ** | ** ** | ** **                                           | ** ** |
| Fixed income securities:                  |       |                                                                            |       |       |                                       |       |       |                                  |       |       |                                        |       |       |                                                 |       |
| U.S. government and agencies              | $          | 276                                                                             |       | $          | 3,411                                      |       | $          | —                                |       |       |                                        |       | $          | 3,687                                                |       |
| Municipal                                 |       | —                                                                          |       |       | 2,605                                      |       |       | 703                                   |       |       |                                        |       |       | 3,308                                                |       |
| Corporate                                 |       | —                                                                          |       |       | 14,402                                     |       |       | 9,867                                 |       |       |                                        |       |       | 24,269                                               |       |
| Foreign government                        |       | —                                                                          |       |       | 2,100                                      |       |       | —                                |       |       |                                        |       |       | 2,100                                                |       |
| RMBS                                      |       | —                                                                          |       |       | 2,162                                      |       |       | 1,811                                 |       |       |                                        |       |       | 3,973                                                |       |
| CMBS                                      |       | —                                                                          |       |       | 3,320                                      |       |       | 410                                   |       |       |                                        |       |       | 3,730                                                |       |
| ABS                                       |       | —                                                                          |       |       | 28                                         |       |       | 1,341                                 |       |       |                                        |       |       | 1,369                                                |       |
| Redeemable preferred stock                |       | —                                                                          |       |       | 9                                          |       |       | 1                                     |       |       |                                        |       |       | 10                                                   |       |
| Total fixed income securities             |       | 276                                                                             |       |       | 28,037                                     |       |       | 14,133                                |       |       |                                        |       |       | 42,446                                               |       |
| Equity securities                         |       | 1                                                                               |       |       | 54                                         |       |       | 27                                    |       |       |                                        |       |       | 82                                                   |       |
| Short-term investments                    |       | 342                                                                             |       |       | 3,516                                      |       |       | —                                |       |       |                                        |       |       | 3,858                                                |       |
| Other investments:                        |       |                                                                            |       |       |                                       |       |       |                                  |       |       |                                        |       |       |                                                 |       |
| Free-standing derivatives                 |       | —                                                                          |       |       | 605                                        |       |       | 13                                    |       | $          | (480                                        | )          |       | 138                                                  |       |
| Separate account assets                   |       | 8,239                                                                           |       |       | —                                     |       |       | —                                |       |       |                                        |       |       | 8,239                                                |       |
| Other assets                              |       | (1                                                                              | )          |       | —                                     |       |       | 1                                     |       |       |                                        |       |       | —                                               |       |
| **Total recurring basis assets**          |       | 8,857                                                                           |       |       | 32,212                                     |       |       | 14,174                                |       |       | (480                                        | )          |       | 54,763                                               |       |
| Non-recurring basis (1)                   |       | —                                                                          |       |       | —                                     |       |       | 244                                   |       |       |                                        |       |       | 244                                                  |       |
| **Total assets at fair value**            | $          | 8,857                                                                           |       | $          | 32,212                                     |       | $          | 14,418                                |       | $          | (480                                        | )          | $          | 55,007                                               |       |
| % of total assets at fair value           |       | 16.1                                                                            | %          |       | 58.6                                       | %          |       | 26.2                                  | %          |       | (0.9                                        | )%         |       | 100.0                                                | %          |
| ** **                                |       |                                                                            |       |       |                                       |       |       |                                  |       |       |                                        |       |       |                                                 |       |
| **Liabilities**                           |       |                                                                            |       |       |                                       |       |       |                                  |       |       |                                        |       |       |                                                 |       |
| Contractholder funds:                     |       |                                                                            |       |       |                                       |       |       |                                  |       |       |                                        |       |       |                                                 |       |
| Derivatives embedded in annuity contracts | $          | —                                                                          |       | $          | (37                                        | )          | $          | (265                                  | )          |       |                                        |       | $          | (302                                                 | )          |
| Other liabilities:                        |       |                                                                            |       |       |                                       |       |       |                                  |       |       |                                        |       |       |                                                 |       |
| Free-standing derivatives                 |       | —                                                                          |       |       | (1,118                                     | )          |       | (106                                  | )          | $          | 460                                         |       |       | (764                                                 | )          |
| **Total liabilities at fair value**       | $          | —                                                                          |       | $          | (1,155                                     | )          | $          | (371                                  | )          | $          | 460                                         |       | $          | (1,066                                               | )          |
| % of total liabilities at fair value      |       | —                                                                          | %          |       | 108.4                                      | %          |       | 34.8                                  | %          |       | (43.2                                       | )%         |       | 100.0                                                | %          |

 

----

| (1) | Includes  $164 million of mortgage loans, $70 million of limited partnership interests  and $10 million of other investments written-down to fair value in connection  with recognizing other-than-temporary impairments. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

When the inputs used tomeasure fair value fall into different levels of the fair value hierarchy, thecategorization is based on the lowest level input that is significant to thefair value measurement in its entirety. Thus, a Level 3 fair value measurementmay include inputs that are observable (Level 1 or Level 2) and unobservable(Level 3).

 

20

----

 

The following tableprovides a summary of changes in fair value during the three-month period endedSeptember 30, 2009 of Level 3 assets and liabilities held at fair value ona recurring basis. Net transfers in and/or out of Level 3 are reported ashaving occurred at the beginning of the quarter the transfer occurred;therefore, for all transfers into Level 3, all realized and changes inunrealized gains and losses in the quarter of transfer are reflected in thetable below.

 
| **($ in  millions)**                  | ** ** | ** **                                           | ** ** | **Total  realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                                                          | ** ** | **Total  gains (losses)  included in net  income for  financial** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Balance as of  June 30, 2009** | ** ** | **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,  2009**             | ** ** | **instruments  still held at  September 30,  2009 ****(3)** | ** ** |
| **Assets**                                 |       |                                                 |       |                                                            |       |                                                    |       |                                                              |       |                                                                |       |                                                              |       |   |   |
| Fixed  income securities:                  |       |                                                 |       |                                                            |       |                                                    |       |                                                              |       |                                                                |       |                                                              |       |   |   |   |   |   |   |   |
| Municipal                                  | $          | 687                                                  |       | $                                                               | (1         | )                                                       | $          | 21                                                                | $          | (14                                                                 | )          | $                                                                 | (6         | ) | $ | 687 |   | $ | — |   |
| Corporate                                  |       | 9,504                                                |       |                                                            | 48         |                                                    |       | 495                                                               |       | (533                                                                | )          |                                                              | (51        | ) |   | 9,463 |   |   | 34 |   |
| Foreign  government                        |       | —                                               |       |                                                            | —     |                                                    |       | —                                                            |       | 10                                                                  |       |                                                              | —     |   |   | 10 |   |   | — |   |
| RMBS                                       |       | 1,411                                                |       |                                                            | (35        | )                                                       |       | 176                                                               |       | (80                                                                 | )          |                                                              | (415       | ) |   | 1,057 |   |   | (37 | ) |
| CMBS                                       |       | 887                                                  |       |                                                            | (58        | )                                                       |       | 418                                                               |       | (57                                                                 | )          |                                                              | 136        |   |   | 1,326 |   |   | (17 | ) |
| ABS                                        |       | 1,257                                                |       |                                                            | (9         | )                                                       |       | 371                                                               |       | 3                                                                   |       |                                                              | (123       | ) |   | 1,499 |   |   | (39 | ) |
| Redeemable  preferred stock                |       | 1                                                    |       |                                                            | —     |                                                    |       | —                                                            |       | —                                                              |       |                                                              | —     |   |   | 1 |   |   | — |   |
| Total  fixed income securities             |       | 13,747                                               |       |                                                            | (55        | )                                                       |       | 1,481                                                             |       | (671                                                                | )          |                                                              | (459       | ) |   | 14,043 |   |   | (59 | ) |
| Equity  securities                         |       | 26                                                   |       |                                                            | —     |                                                    |       | 1                                                                 |       | —                                                              |       |                                                              | —     |   |   | 27 |   |   | — |   |
| Other  investments:                        |       |                                                 |       |                                                            |       |                                                    |       |                                                              |       |                                                                |       |                                                              |       |   |   |   |   |   |   |   |
| Free-standing  derivatives, net            |       | (99                                                  | )          |                                                            | 17         |                                                    |       | —                                                            |       | 7                                                                   |       |                                                              | —     |   |   | (75 | )(2) |   | 24 |   |
| Other  assets                              |       | 2                                                    |       |                                                            | —     |                                                    |       | —                                                            |       | —                                                              |       |                                                              | —     |   |   | 2 |   |   | — |   |
| **Total recurring Level 3****assets**      | $          | 13,676                                               |       | $                                                               | (38        | )                                                       | $          | 1,482                                                             | $          | (664                                                                | )          | $                                                                 | (459       | ) | $ | 13,997 |   | $ | (35 | ) |
|                                       |       |                                                 |       |                                                            |       |                                                    |       |                                                              |       |                                                                |       |                                                              |       |   |   |   |   |   |   |   |
| **Liabilities**                            |       |                                                 |       |                                                            |       |                                                    |       |                                                              |       |                                                                |       |                                                              |       |   |   |   |   |   |   |   |
| Contractholder  funds:                     |       |                                                 |       |                                                            |       |                                                    |       |                                                              |       |                                                                |       |                                                              |       |   |   |   |   |   |   |   |
| Derivatives  embedded in annuity contracts | $          | (155                                                 | )          | $                                                               | 36         |                                                    | $          | —                                                            | $          | (1                                                                  | )          | $                                                                 | —     |   | $ | (120 | ) | $ | 36 |   |
| **Total recurring Level 3****liabilities** | $          | (155                                                 | )          | $                                                               | 36         |                                                    | $          | —                                                            | $          | (1                                                                  | )          | $                                                                 | —     |   | $ | (120 | ) | $ | 36 |   |

 

----

| (1)    | The  effect to net income totals $(2) million and is reported in the  Condensed Consolidated Statements of Operations as follows: $(50) million in  realized capital gains and losses, $11 million in net investment  income, $(1) million in interest credited to contractholder funds and  $(36) million in contract benefits.                                                                                                                                             |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (2)    | Comprises  $25 million of assets and $(100) million of liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (3)    | The amounts represent gains and losses  included in net income for the period of time that the asset or liability was  determined to be in Level 3. These gains and losses total $1 million and are  reported in the Condensed Consolidated Statements of Operations as follows:  $(47) million in realized  capital gains and losses, $10 million in net investment income,  $(2) million in interest credited to contractholder funds, and $(36)  million in contract benefits. |

 

21

----

 

The following tableprovides a summary of changes in fair value during the nine-month period ended September 30,2009 of Level 3 assets and liabilities held at fair value on a recurring basis.

 
| **($ in millions)**                                                | ** ** | ** **                                           | ** ** | ** ** | **Total realized and unrealized gains  (losses) included in:** | ** ** | ** ** | ** **                                              | ** ** | ** ** | ** **                                                        | ** ** | ** ** | ** **                                                          | ** ** | ** ** | **Total**

**gains (losses)  included in net  income for  financial** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------|----------------------------------------------------------------------------------------------|------------|------------|---------------------------------------------------------|------------|------------|-------------------------------------------------------------------|------------|------------|---------------------------------------------------------------------|------------|------------|-------------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **Balance as of  December 31,  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,  2009**                                     | ** ** | ** ** | **instruments  still held at  September 30,  2009**** (3)** | ** ** |
| **Assets**                                                                   |       |                                                 |       |       |                                                                                         |       |       |                                                    |       |       |                                                              |       |       |                                                                |       |       |                                                                                      |       |   |   |   |
| Fixed  income securities:                                                    |       |                                                 |       |       |                                                                                         |       |       |                                                    |       |       |                                                              |       |       |                                                                |       |       |                                                                                      |       |   |   |   |
| Municipal                                                                    | $          | 703                                                  |       | $          | (1                                                                                           | )          | $          | 28                                                      |       | $          | (27                                                               | )          | $          | (16                                                                 | )          | $          | 687                                                                                       |       | $ | — |   |
| Corporate                                                                    |       | 9,867                                                |       |       | (9                                                                                           | )          |       | 1,119                                                   |       |       | (1,405                                                            | )          |       | (109                                                                | )          |       | 9,463                                                                                     |       |   | (5 | ) |
| Foreign  government                                                          |       | —                                               |       |       | —                                                                                       |       |       | —                                                  |       |       | 10                                                                |       |       | —                                                              |       |       | 10                                                                                        |       |   | — |   |
| RMBS                                                                         |       | 1,811                                                |       |       | (69                                                                                          | )          |       | 54                                                      |       |       | (162                                                              | )          |       | (577                                                                | )          |       | 1,057                                                                                     |       |   | (67 | ) |
| CMBS                                                                         |       | 410                                                  |       |       | (162                                                                                         | )          |       | 591                                                     |       |       | (74                                                               | )          |       | 561                                                                 |       |       | 1,326                                                                                     |       |   | (131 | ) |
| ABS                                                                          |       | 1,341                                                |       |       | (164                                                                                         | )          |       | 617                                                     |       |       | (126                                                              | )          |       | (169                                                                | )          |       | 1,499                                                                                     |       |   | (169 | ) |
| Redeemable  preferred stock                                                  |       | 1                                                    |       |       | —                                                                                       |       |       | —                                                  |       |       | —                                                            |       |       | —                                                              |       |       | 1                                                                                         |       |   | — |   |
| Total  fixed income securities                                               |       | 14,133                                               |       |       | (405                                                                                         | )          |       | 2,409                                                   |       |       | (1,784                                                            | )          |       | (310                                                                | )          |       | 14,043                                                                                    |       |   | (372 | ) |
| Equity  securities                                                           |       | 27                                                   |       |       | —                                                                                       |       |       | —                                                  |       |       | —                                                            |       |       | —                                                              |       |       | 27                                                                                        |       |   | — |   |
| Other  investments:                                                          |       |                                                 |       |       |                                                                                         |       |       |                                                    |       |       |                                                              |       |       |                                                                |       |       |                                                                                      |       |   |   |   |
| Free-standing  derivatives, net                                              |       | (93                                                  | )          |       | 55                                                                                           |       |       | —                                                  |       |       | (37                                                               | )          |       | —                                                              |       |       | (75                                                                                       | )(2)       |   | 68 |   |
| Other  assets                                                                |       | 1                                                    |       |       | 1                                                                                            |       |       | —                                                  |       |       | —                                                            |       |       | —                                                              |       |       | 2                                                                                         |       |   | 1 |   |
| **Total recurring Level 3 assets**                                           | $          | 14,068                                               |       | $          | (349                                                                                         | )          | $          | 2,409                                                   |       | $          | (1,821                                                            | )          | $          | (310                                                                | )          | $          | 13,997                                                                                    |       | $ | (303 | ) |
|                                                                         |       |                                                 |       |       |                                                                                         |       |       |                                                    |       |       |                                                              |       |       |                                                                |       |       |                                                                                      |       |   |   |   |
| **Liabilities**                                                              |       |                                                 |       |       |                                                                                         |       |       |                                                    |       |       |                                                              |       |       |                                                                |       |       |                                                                                      |       |   |   |   |
| Contractholder  funds:                                                       |       |                                                 |       |       |                                                                                         |       |       |                                                    |       |       |                                                              |       |       |                                                                |       |       |                                                                                      |       |   |   |   |
| Derivatives  embedded in annuity contracts                                   | $          | (265                                                 | )          | $          | 141                                                                                          |       | $          | —                                                  |       | $          | 4                                                                 |       | $          | —                                                              |       | $          | (120                                                                                      | )          | $ | 141 |   |
| **Total recurring Level 3****liabilities**                                   | $          | (265                                                 | )          | $          | 141                                                                                          |       | $          | —                                                  |       | $          | 4                                                                 |       | $          | —                                                              |       | $          | (120                                                                                      | )          | $ | 141 |   |
| **            ** |       |                                                 |       |       |                                                                                         |       |       |                                                    |       |       |                                                              |       |       |                                                                |       |       |                                                                                      |       |   |   |   |

----

| (1)    | The  effect to net income totals $(208) million and is reported in the Condensed  Consolidated Statements of Operations as follows: $(409) million in realized  capital gains and losses, $60 million in net investment income, and  $(141) million in contract benefits.                                                                                                                                                                                                                        |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (2)    | Comprises  $25 million of assets and $(100) million of liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (3)    | The amounts represent gains and losses included in  net income for the period of time that the asset or liability was determined  to be in Level 3. These gains and losses total $(162) million and are  reported in the Condensed Consolidated Statements of Operations as follows:  $(357) million in realized capital gains and losses, $51 million in net  investment income, $(3) million in interest credited to contractholder  funds, and $(141) million in contract benefits. |

 

22

----

 

The following table provides a summary of changes in fair value duringthe three-month period ended September 30, 2008 of Level 3 assets and liabilitiesheld at fair value on a recurring basis.

 
| **($ in millions)**                   | ** ** | ** **                                           | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** **                       | ** ** | ** ** | ** **                                              | ** ** | ** ** | ** **                                                        | **Total**

**gains (losses)  included in net  income for  financial** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|----------------------------------|------------|------------|---------------------------------------------------------|------------|------------|-------------------------------------------------------------------|-------------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **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 ****(3)** | ** ** |
| **Assets**                                 |       |                                                 |       |                                                                                         |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| Fixed  income securities:                  |       |                                                 |       |                                                                                         |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| Municipal                                  | $          | 804                                                  |       | $                                                                                            | —                           |       | $          | (6                                                      | )          | $          | (32                                                               | )                                                                                         | $          | (57 | ) | $ | 709 |   | $ | — |   |
| Corporate                                  |       | 11,344                                               |       |                                                                                         | (89                              | )          |       | (466                                                    | )          |       | (73                                                               | )                                                                                         |       | 149 |   |   | 10,865 |   |   | (95 | ) |
| Foreign  government                        |       | —                                               |       |                                                                                         | —                           |       |       | —                                                  |       |       | (5                                                                | )                                                                                         |       | 5 |   |   | — |   |   | — |   |
| RMBS                                       |       | 2,292                                                |       |                                                                                         | (81                              | )          |       | (88                                                     | )          |       | (188                                                              | )                                                                                         |       | — |   |   | 1,935 |   |   | (62 | ) |
| CMBS                                       |       | 543                                                  |       |                                                                                         | (52                              | )          |       | (8                                                      | )          |       | (280                                                              | )                                                                                         |       | 31 |   |   | 234 |   |   | (51 | ) |
| ABS                                        |       | 2,377                                                |       |                                                                                         | (174                             | )          |       | (135                                                    | )          |       | (94                                                               | )                                                                                         |       | — |   |   | 1,974 |   |   | (175 | ) |
| Redeemable  preferred stock                |       | —                                               |       |                                                                                         | 1                                |       |       | —                                                  |       |       | —                                                            |                                                                                      |       | — |   |   | 1 |   |   | — |   |
| 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 | ) |
| Other  assets                              |       | 2                                                    |       |                                                                                         | —                           |       |       | —                                                  |       |       | —                                                            |                                                                                      |       | — |   |   | 2 |   |   | — |   |
| **Total recurring Level 3****assets**      | $          | 17,364                                               |       | $                                                                                            | (430                             | )          | $          | (704                                                    | )          | $          | (642                                                              | )                                                                                         | $          | 128 |   | $ | 15,716 |   | $ | (387 | ) |
|                                       |       |                                                 |       |                                                                                         |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| **Liabilities**                            |       |                                                 |       |                                                                                         |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| Contractholder  funds:                     |       |                                                 |       |                                                                                         |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| Derivatives  embedded in annuity contracts | $          | (20                                                  | )          | $                                                                                            | (23                              | )          | $          | —                                                  |       | $          | 1                                                                 |                                                                                      | $          | — |   | $ | (42 | ) | $ | (23 | ) |
| **Total recurring Level 3****liabilities** | $          | (20                                                  | )          | $                                                                                            | (23                              | )          | $          | —                                                  |       | $          | 1                                                                 |                                                                                      | $          | — |   | $ | (42 | ) | $ | (23 | ) |

 

----

| (1)    | The  effect to net income totals $(453) million and is reported in the Condensed  Consolidated Statements of Operations as follows: $(461) million in realized  capital gains and losses, $32 million in net investment income, $1 million in  interest credited to contractholder funds, and $23 million in contract  benefits.                                                                                        |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (2)    | Comprises  $34 million of assets and $(68) million of liabilities.                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (3)    | The amounts represent gains and losses included  in net income for the period of time that the asset or liability was  determined to be in Level 3. These gains and losses total $(410) million and  are reported in the Condensed Consolidated Statements of Operations as  follows: $(419) million in realized capital gains and losses, $32 million in net investment  income, and $23 million in contract benefits. |

 

23

----

 

The following table provides a summary of changes in fair value duringthe nine-month period ended September 30, 2008 of Level 3 assets andliabilities held at fair value on a recurring basis.

 
| **($ in millions)**                   | ** ** | ** **                                         | ** ** | **Total realized and unrealized gains  (losses) included in:** | ** **                       | ** ** | ** ** | ** **                                              | ** ** | ** ** | ** **                                                        | **Total**

**gains (losses)  included in net  income for  financial** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------------|----------------------------------|------------|------------|---------------------------------------------------------|------------|------------|-------------------------------------------------------------------|-------------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **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**** (3)** | ** ** |
| **Assets**                                 |       |                                               |       |                                                           |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| Fixed  income securities:                  |       |                                               |       |                                                           |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| Municipal                                  | $          | 231                                                |       | $                                                              | —                           |       | $          | (27                                                     | )          | $          | (43                                                               | )                                                                                         | $          | 548 |   | $ | 709 |   | $ | — |   |
| Corporate                                  |       | 11,845                                             |       |                                                           | (143                             | )          |       | (673                                                    | )          |       | (418                                                              | )                                                                                         |       | 254 |   |   | 10,865 |   |   | (175 | ) |
| Foreign  government                        |       | —                                             |       |                                                           | —                           |       |       | —                                                  |       |       | (5                                                                | )                                                                                         |       | 5 |   |   | — |   |   | — |   |
| RMBS                                       |       | 3,034                                              |       |                                                           | (496                             | )          |       | (195                                                    | )          |       | (408                                                              | )                                                                                         |       | — |   |   | 1,935 |   |   | (453 | ) |
| CMBS                                       |       | 790                                                |       |                                                           | (398                             | )          |       | 147                                                     |       |       | (340                                                              | )                                                                                         |       | 35 |   |   | 234 |   |   | (236 | ) |
| ABS                                        |       | 2,930                                              |       |                                                           | (187                             | )          |       | (500                                                    | )          |       | (316                                                              | )                                                                                         |       | 47 |   |   | 1,974 |   |   | (148 | ) |
| Redeemable  preferred stock                |       | —                                             |       |                                                           | 1                                |       |       | —                                                  |       |       | —                                                            |                                                                                      |       | — |   |   | 1 |   |   | — |   |
| 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 |   |
| Other  assets                              |       | 2                                                  |       |                                                           | —                           |       |       | —                                                  |       |       | —                                                            |                                                                                      |       | — |   |   | 2 |   |   | — |   |
| **Total recurring Level 3 assets**         | $          | 18,887                                             |       | $                                                              | (1,291                           | )          | $          | (1,255                                                  | )          | $          | (1,475                                                            | )                                                                                         | $          | 850 |   | $ | 15,716 |   | $ | (997 | ) |
|                                       |       |                                               |       |                                                           |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| **Liabilities**                            |       |                                               |       |                                                           |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| Contractholder  funds:                     |       |                                               |       |                                                           |                             |       |       |                                                    |       |       |                                                              |                                                                                      |       |   |   |   |   |   |   |   |   |
| Derivatives  embedded in annuity contracts | $          | 4                                                  |       | $                                                              | (47                              | )          | $          | —                                                  |       | $          | 1                                                                 |                                                                                      | $          | — |   | $ | (42 | ) | $ | (47 | ) |
| **Total recurring Level 3 liabilities**    | $          | 4                                                  |       | $                                                              | (47                              | )          | $          | —                                                  |       | $          | 1                                                                 |                                                                                      | $          | — |   | $ | (42 | ) | $ | (47 | ) |

 

----

| (1)    | The  effect to net income totals $(1.34) billion and is reported in the  Condensed Consolidated Statements of Operations as follows:  $(1.34) billion in realized capital gains and losses,  $57 million in net investment income, $5 million in interest  credited to contractholder funds, and $47 million in contract benefits.                                                                                                                                                 |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (2)    | Comprises  $34 million of assets and $(68) million of liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (3)    | The amounts represent gains and losses included in  net income for the period of time that the asset or liability was determined  to be in Level 3. These gains and losses total $(1.04) billion and are  reported in the Condensed Consolidated Statements of Operations as follows:  $(1.04) billion in realized capital gains and losses, $51 million  in net investment income, $1 million in interest credited to  contractholder funds and $47 million in contract benefits. |

 

Presented below are the carrying values andfair value estimates of financial instruments not carried at fair value as of September 30,2009.

 

**Financial assets**

 
| **($ in millions)**                   | ** ** | **September ****30, 2009** | ** ** | **December 31, 2008** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|----------------------------|------------|
| ** **                                 | ** ** | **Carrying  value**             | ** ** | **Fair  value**            | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** |
| Mortgage loans                             | $          | 8,674                           | $          | 7,229                      | $          | 10,012 | $ | 8,700 |   |
| Limited partnership interests - cost basis |       | 505                             |       | 417                        |       | 560 |   | 541 |   |
| Bank loans                                 |       | 444                             |       | 403                        |       | 981 |   | 675 |   |
| Intercompany notes                         |       | 250                             |       | 216                        |       | 250 |   | 185 |   |

 

The fair value of mortgage loans is based ondiscounted contractual cash flows or if the loans are impaired due to creditreasons, the lower of discounted contractual cash flows or fair value ofcollateral less costs to sell.  Riskadjusted discount rates are selected using current rates at which similar loanswould be made to borrowers with similar characteristics, using similar types ofproperties as collateral.  The fair valueof limited partnership interests accounted for on the cost basis is determinedusing reported net asset values of the underlying funds.  The fair value of bank loans, which arereported in other investments on the Condensed Consolidated Statements ofFinancial Position, are valued based on broker quotes from brokers familiarwith the loans and current market conditions. The 

 

24

----

 

fair value of intercompany notes is based ondiscounted cash flow calculations using current interest rates for instrumentswith comparable terms.

 

**Financial liabilities**

 
| **($ in millions)**                     | ** ** | **September ****30, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **Carrying  value**                  | ** ** | **Fair  value**                 | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** |
| Contractholder funds on investment contracts | $          | 40,620                               | $          | 39,340                          | $          | 45,989 | $ | 42,484 |   |
| Surplus notes due to related parties         |       | 650                                  |       | 617                             |       | 650 |   | 566 |   |
| Liability for collateral                     |       | 495                                  |       | 495                             |       | 340 |   | 340 |   |

 

The fair value of contractholder funds oninvestment contracts is based on the terms of the underlying contractsutilizing prevailing market rates for similar contracts adjusted for creditrisk.  Deferred annuities included incontractholder funds are valued using discounted cash flow models whichincorporate market value margins, which are based on the cost of holdingeconomic capital, and the Company’s own credit risk.  Immediate annuities without lifecontingencies and fixed rate funding agreements are valued at the present valueof future benefits using market implied interest rates which include theCompany’s own credit risk.

 

The fair value of surplus notes due torelated parties is based on discounted cash flow calculations using currentinterest rates for instruments with comparable terms and considers the Company’sown credit risk.  The liability forcollateral is valued at carrying value due to its short-term nature.

 

**6.  DerivativeFinancial Instruments**

 

The Company primarily uses derivatives for riskmanagement and asset replication.  Inaddition, the Company has derivatives embedded in non-derivative “host”contracts, which are required to be separated from the host contracts andaccounted for at fair value as derivative instruments.  With the exception of non-hedge derivativesused for asset replication and non-hedge embedded derivatives, all of theCompany’s derivatives are evaluated for their ongoing effectiveness as eitheraccounting hedge or non-hedge derivative financial instruments on at least aquarterly basis.  The Company does notuse derivatives for trading purposes. Non-hedge accounting is generally used for “portfolio” level hedgingstrategies where the terms of the individual hedged items do not meet thestrict homogeneity requirements to permit the application of hedge accounting.

 

The Company uses derivatives to partiallymitigate potential adverse impacts from changes in credit spreads.  Credit default swaps are typically used tomitigate the credit risk within the Company’s fixed income portfolios.  The Company uses foreign currency swapsprimarily to reduce the foreign currency risk associated with issuing foreigncurrency denominated funding agreements and holding foreign currency denominatedinvestments.

 

Asset-liability management is a risk management strategy thatis principally employed to balance the respective interest-rate sensitivitiesof the Company’s assets and liabilities. Depending upon the attributes of the assets acquired and liabilitiesissued, derivative instruments such as interest rate swaps, caps, floors andfutures are acquired to change the interest rate characteristics of existingassets and liabilities to ensure the relationship is maintained withinspecified ranges and to reduce exposure to rising or falling interestrates.  The Company uses financialfutures and interest rate swaps to hedge anticipated asset purchases andliability issuances and financialfutures and options for hedging the Company’s equity exposure containedin equity indexed annuity product contracts that offer equity returns tocontractholders.  In addition, the Company uses interest rateswaps to hedge interest rate risk inherent in funding agreements.

 

When derivatives meet specific criteria, they may be designated asaccounting hedges and accounted for as fair value, cash flow, foreign currencyfair value or foreign currency cash flow hedges.  The Company designates certain of itsinterest rate and foreign currency swap contracts andcertain investment risk transfer reinsurance agreements as fair value hedgeswhen the hedging instrument is highly effective in offsetting the risk ofchanges in the fair value of the hedged item. The Company designates certain of its foreign currency swap contracts ascash flow hedges when the hedging instrument is highly effective in offsettingthe exposure of variations in cash flows for the hedged risk that could affectnet income.  Amounts are reclassified tonet investment income or realized capital gains and losses as the hedged itemaffects net income.

 

25

----

 

Asset replication refers to the “synthetic” creation of assets throughthe use of derivatives and primarily investment grade host bonds to replicatesecurities that are either unavailable in the cash markets or more economicalto acquire in synthetic form.  TheCompany replicates fixed income securities using a combination of a creditdefault swap and one or more highly rated fixed income securities tosynthetically replicate the economic characteristics of one or more cash marketsecurities.

 

The Company’s primary embedded derivatives are conversion options infixed income securities, which provide the Company with the right to convertthe instrument into a predetermined number of shares of common stock; equityoptions in annuity product contracts, which provide equity returns tocontractholders; and equity-indexed notes containing equity call options, whichprovide a coupon payout that is determined using one or more equity-basedindices.

 

The notional amounts specified in the contracts are used to calculatethe exchange of contractual payments under the agreements and are generally notrepresentative of the potential for gain or loss on these agreements.  However, the notional amounts specified inselling protection credit default swaps represent the maximum amount ofpotential loss, assuming no recoveries.

 

Fair value, which is equalto the carrying value, is the estimated amount that the Company would receive(pay) to terminate the derivative contracts at the reporting date.  The carrying value amounts for OTCfree-standing derivatives have been further adjusted for the effects, if any,of legally enforceable master netting agreements and are presented on a net basisin the Condensed Consolidated Statements of Financial Position.  For certain exchange traded derivatives, theexchange requires margin deposits as well as daily cash settlements of marginaccounts.  As of September 30, 2009,the Company pledged $16 million of securities in the form of margin deposits.

 

The net impact to pre-tax income forderivatives includes valuation and settlements of derivatives.  For those derivatives which qualify for fairvalue hedge accounting, net income includes the changes in the fair value ofthe hedged risk, and therefore reflects any hedging ineffectiveness.  For cash flow hedges, gains and lossesamortized from accumulated other comprehensive income are reported in netincome.  For embedded derivatives inconvertible fixed income securities and equity-indexed notes, net incomeincludes the change in fair value of the embedded derivative and accretionincome related to the host instrument.

 

26

----

 

The following table provides a summary of thevolume and fair value positions of derivative instruments as well as theirreporting location in the Condensed Consolidated Statements of FinancialPosition at September 30, 2009.

 
| **($ in millions, except number of  contracts)**             | ** ** | **Asset derivatives**      | ** ** |
|-------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                        | ** ** | ** **                 | ** ** | **Volume****(1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **Balance sheet location** | ** ** | **Notional  amount** | ** ** | **Number  of  contracts** | ** ** | **Fair  value,  net** | ** ** | ** ** | **Gross  asset** | ** ** | **Gross  liability** | ** ** |
| **Derivatives designated as  accounting hedging instruments**     |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                     |       | Other investments          | $          | 820 |   | n/a | $ | (89 | ) | $ | — | $ | (89 | ) |
| Foreign currency swap agreements                                  |       | Other investments          |       | 15 |   | n/a |   | (5 | ) |   | — |   | (5 | ) |
| Foreign currency and interest rate swap agreements                |       | Other investments          |       | 435 |   | n/a |   | 165 |   |   | 165 |   | — |   |
| Total                                                             |       |                       | $          | 1,270 |   | n/a | $ | 71 |   | $ | 165 | $ | (94 | ) |
|                                                              |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                     |       | Other investments          | $          | 898 |   | n/a | $ | 17 |   | $ | 42 | $ | (25 | ) |
| Interest rate cap and floor agreements                            |       | Other investments          |       | 2,204 |   | n/a |   | (6 | ) |   | 5 |   | (11 | ) |
| Financial futures contracts and options                           |       | Other assets               |       | n/a |   | 549 |   | — |   |   | — |   | — |   |
| **Equity and index contracts**                                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Options, financial futures and warrants (2)                       |       | Other investments          |       | 75 |   | 21,650 |   | 410 |   |   | 410 |   | — |   |
| **Foreign currency contracts**                                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency swap agreements                                  |       | Other investments          |       | 9 |   | n/a |   | (1 | ) |   | — |   | (1 | ) |
| **Embedded derivative financial  instruments**                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Conversion options in fixed income securities                     |       | Fixed income securities    |       | 322 |   | n/a |   | 124 |   |   | 124 |   | — |   |
| Equity-indexed call options in fixed income  securities           |       | Fixed income securities    |       | 475 |   | n/a |   | 80 |   |   | 80 |   | — |   |
| **Credit default contracts**                                      |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Credit Default Swaps – Buying Protection                     |       | Other investments          |       | 25 |   | n/a |   | — |   |   | — |   | — |   |
| **Other contract**                                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Other contracts                                                   |       | Other investments          |       | 75 |   | n/a |   | — |   |   | — |   | — |   |
| Other contracts                                                   |       | Other assets               |       | 6 |   | n/a |   | 2 |   |   | 2 |   | — |   |
| Total                                                             |       |                       | $          | 4,089 |   | 22,199 | $ | 626 |   | $ | 663 | $ | (37 | ) |
|                                                              |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| **Total derivative assets**                                       |       |                       | $          | 5,359 |   | 22,199 | $ | 697 |   | $ | 828 | $ | (131 | ) |

 

----

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

 

(2)     In addition to the number of contractspresented in the table, the Company held 837,100 stock warrants.  Each stock warrant can be exercised into asingle share of common stock.

 

27

----

 
| **($ in millions, except number of contracts)**                               | ** ** | **Liability  derivatives**                     | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                         | ** ** | ** **                                     | ** ** | **Volume****(1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                         | ** ** | **Balance  sheet location**                    | ** ** | **Notional  amount** | ** ** | **Number  of  contracts** | ** ** | **Fair  value,  net** | ** ** | ** ** | **Gross  asset** | ** ** | **Gross  liability** | ** ** |
| **Derivatives designated as accounting hedging  instruments**                      | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  rate swap agreements                                                     |       | Other  liabilities & accrued expenses | $          | 1,962 |   | n/a | $ | (222 | ) | $ | — | $ | (222 | ) |
| Foreign  currency swap agreements                                                  |       | Other  liabilities & accrued expenses |       | 193 |   | n/a |   | (16 | ) |   | 3 |   | (19 | ) |
| Foreign  currency and interest rate swap agreements                                |       | Other  liabilities & accrued expenses |       | 435 |   | n/a |   | 75 |   |   | 75 |   | — |   |
| Foreign  currency and interest rate swap agreements                                |       | Contractholder  funds                          |       | n/a |   | n/a |   | 31 |   |   | 31 |   | — |   |
| Total                                                                              |       |                                           | $          | 2,590 |   | n/a | $ | (132 | ) | $ | 109 | $ | (241 | ) |
|                                                                               |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as accounting hedging  instruments**                  |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                                        |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| Interest  rate swap agreements                                                     |       | Other  liabilities & accrued expenses | $          | 3,139 |   | n/a | $ | (17 | ) | $ | 40 | $ | (57 | ) |
| Interest  rate cap and floor agreements                                            |       | Other  liabilities & accrued expenses |       | 3,401 |   | n/a |   | (5 | ) |   | 16 |   | (21 | ) |
| Financial  futures contracts and options                                           |       | Other  liabilities & accrued expenses |       | n/a |   | 991 |   | — |   |   | — |   | — |   |
| **Equity and index contracts**                                                     |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| Options,  financial futures and warrants                                           |       | Other  liabilities & accrued expenses |       | 36 |   | 22,569 |   | (223 | ) |   | 1 |   | (224 | ) |
| **Foreign currency contracts**                                                     |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| Foreign  currency swap agreements                                                  |       | Other  liabilities & accrued expenses |       | 105 |   | n/a |   | 3 |   |   | 3 |   | — |   |
| Foreign  currency forwards and options                                             |       | Other  liabilities & accrued expenses |       | 215 |   | n/a |   | 1 |   |   | 2 |   | (1 | ) |
| **Embedded derivative financial instruments**                                      |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| Guaranteed  accumulation benefits                                                  |       | Contractholder  funds                          |       | 1,105 |   | n/a |   | (74 | ) |   | — |   | (74 | ) |
| Guaranteed  withdrawal benefits                                                    |       | Contractholder  funds                          |       | 815 |   | n/a |   | (45 | ) |   | — |   | (45 | ) |
| Equity-indexed  and forward starting options in life and annuity product contracts |       | Contractholder  funds                          |       | 4,199 |   | n/a |   | (221 | ) |   | — |   | (221 | ) |
| Other  embedded derivative financial instruments                                   |       | Contractholder  funds                          |       | 85 |   | n/a |   | (1 | ) |   | — |   | (1 | ) |
| **Credit default contracts**                                                       |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| Credit  Default Swaps — Buying Protection                                     |       | Other  liabilities & accrued expenses |       | 692 |   | n/a |   | (34 | ) |   | 5 |   | (39 | ) |
| Credit  Default Swaps — Selling Protection                                    |       | Other  liabilities & accrued expenses |       | 451 |   | n/a |   | (73 | ) |   | — |   | (73 | ) |
| Total                                                                              |       |                                           | $          | 14,243 |   | 23,560 | $ | (689 | ) | $ | 67 | $ | (756 | ) |
|                                                                               |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| **Total derivative liabilities**                                                   |       |                                           | $          | 16,833 |   | 23,560 | $ | (821 | ) | $ | 176 | $ | (997 | ) |
|                                                                               |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |
| **Total derivatives**                                                              |       |                                           | $          | 22,192 |   | 45,759 | $ | (124 | ) |   |   |   |   |   |

 

----

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

 

The following table provides a summary of theimpacts of the Company’s foreign currency contracts in cash flow hedging relationshipsin the Condensed Consolidated Statements of Operations and the CondensedConsolidated Statements of Financial Position. Amortization of net gains from accumulated other comprehensive incomerelated to cash flow hedges is expected to be less than $1 million during thenext twelve months.

 
| **($ in millions)**                                                           | ** ** | **Three months ended********September 30, 2009** | ** ** | ** ** | **Nine months ended********September 30, 2009** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|------------|------------------------------------------------------|------------|
| **Effective portion**                                                              |       |                                                  |       |       |                                                 |       |
| Loss recognized in OCI on derivatives during the  period                           | $          | (12                                                   | )          | $          | (36                                                  | )          |
| Loss recognized in OCI on derivatives during the  term of the hedging relationship | $          | (20                                                   | )          | $          | (20                                                  | )          |
| Gain reclassified from AOCI into income (net  investment income)                   | $          | —                                                |       | $          | 1                                                    |       |
| Loss reclassified from AOCI into income (realized  capital gains and losses)       | $          | (2                                                    | )          | $          | (1                                                   | )          |
| **Ineffective portion and amount  excluded from effectiveness testing**            |       |                                                  |       |       |                                                 |       |
| Gain recognized in income on derivatives (realized  capital gains and losses)      | $          | —                                                |       | $          | —                                               |       |

 

28

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The following table presents gains and lossesfrom valuation, settlements and hedge ineffectiveness reported on derivativesused in fair value hedging relationships and derivatives not designated asaccounting hedging instruments in the Condensed Consolidated Statements ofOperations.

 
| **($ in millions)**                                          |   | **Three months ended September 30, 2009** |   |
|-------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                              |   | **Net  investment  income**               |   |   | **Realized  capital  gains and  losses** |   |   | **Contract  benefits** |   |   | **Interest  credited to  contractholder  funds** |   |   | **Total gain  (loss)  recognized  in net  income on  derivatives** |   |
| **Derivatives in fair value accounting  hedging relationships**   |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           | $      | (55                                       | )      | $ | — |   | $ | — |   | $ | — |   | $ | (55 | ) |
| Foreign currency and interest rate contracts                      |   | —                                    |   |   | (3 | ) |   | — |   |   | 12 |   |   | 9 |   |
| Subtotal                                                          |   | (55                                       | )      |   | (3 | ) |   | — |   |   | 12 |   |   | (46 | ) |
|                                                              |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |   | —                                    |   |   | (109 | ) |   | — |   |   | — |   |   | (109 | ) |
| Equity and index contracts                                        |   | —                                    |   |   | — |   |   | — |   |   | 68 |   |   | 68 |   |
| Embedded derivative financial instruments                         |   | —                                    |   |   | 54 |   |   | 36 |   |   | (100 | ) |   | (10 | ) |
| Foreign currency contracts                                        |   | —                                    |   |   | 1 |   |   | — |   |   | — |   |   | 1 |   |
| Credit default contracts                                          |   | —                                    |   |   | 3 |   |   | — |   |   | — |   |   | 3 |   |
| Other contracts                                                   |   | —                                    |   |   | — |   |   | — |   |   | 2 |   |   | 2 |   |
| Subtotal                                                          |   | —                                    |   |   | (51 | ) |   | 36 |   |   | (30 | ) |   | (45 | ) |
| Total                                                             | $      | (55                                       | )      | $ | (54 | ) | $ | 36 |   | $ | (18 | ) | $ | (91 | ) |

 
|                                                              |   | **Nine months ended September 30, 2009** |   |
|-------------------------------------------------------------------|--------|-------------------------------------------------------------------|--------|
|                                                              |   | **Net  investment  income**                                       |   |   | **Realized  capital  gains and  losses** |   |   | **Contract  benefits** |   |   | **Interest  credited to  contractholder  funds** |   |   | **Total gain  (loss)  recognized  in net  income on  derivatives** |   |
| **Derivatives in fair value  accounting hedging relationships**   |   |                                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           | $      | 23                                                                |   | $ | 10 |   | $ | — |   | $ | (13 | ) | $ | 20 |   |
| Foreign currency and interest rate contracts                      |   | —                                                            |   |   | (6 | ) |   | — |   |   | 72 |   |   | 66 |   |
| Subtotal                                                          |   | 23                                                                |   |   | 4 |   |   | — |   |   | 59 |   |   | 86 |   |
|                                                              |   |                                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |   |                                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |   | —                                                            |   |   | 165 |   |   | — |   |   | — |   |   | 165 |   |
| Equity and index contracts                                        |   | —                                                            |   |   | — |   |   | — |   |   | 77 |   |   | 77 |   |
| Embedded derivative financial instruments                         |   | —                                                            |   |   | 56 |   |   | 146 |   |   | (185 | ) |   | 17 |   |
| Foreign currency contracts                                        |   |                                                              |   |   | 1 |   |   | — |   |   | — |   |   | 1 |   |
| Credit default contracts                                          |   | —                                                            |   |   | 9 |   |   | — |   |   | — |   |   | 9 |   |
| Other contracts                                                   |   | —                                                            |   |   | — |   |   | — |   |   | 1 |   |   | 1 |   |
| Subtotal                                                          |   | —                                                            |   |   | 231 |   |   | 146 |   |   | (107 | ) |   | 270 |   |
| Total                                                             | $      | 23                                                                |   | $ | 235 |   | $ | 146 |   | $ | (48 | ) | $ | 356 |   |

 

29

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The following table provides a summary of thechanges in fair value of the Company’s fair value hedging relationships in theCondensed Consolidated Statements of Operations.

 
| **($ in millions)**                                                | ** ** | **Three  months ended September 30, 2009** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                              | ** ** | **Gain  (loss) on derivatives**                 | ** ** | **Gain  (loss) on hedged risk** | ** ** |
| **Location of gain or (loss) recognized  in net income on derivatives** | ** ** | **Interest  rate  contracts**                   | ** ** | ** ** | **Foreign  currency &  interest rate  contracts** | ** ** | ** ** | **Contractholder  funds** | ** ** | ** ** | **Investments** | ** ** |
| Interest credited to contractholder funds                               | $          | —                                          |       | $ | 1 |   | $ | (1 | ) | $ | — |   |
| Net investment income                                                   |       | (21                                             | )          |   | — |   |   | — |   |   | 21 |   |
| Realized capital gains and losses                                       |       | —                                          |       |   | (3 | ) |   | — |   |   | — |   |
| Total                                                                   | $          | (21                                             | )          | $ | (2 | ) | $ | (1 | ) | $ | 21 |   |

 
| ** **                                                              | ** ** | **Nine  months ended September 30, 2009** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                              | ** ** | **Gain  (loss) on derivatives**                | ** ** | **Gain  (loss) on hedged risk** | ** ** |
| **Location of gain or (loss) recognized  in net income on derivatives** | ** ** | **Interest  rate  contracts**                  | ** ** | ** ** | **Foreign  currency &  interest rate  contracts** | ** ** | ** ** | **Contractholder  funds** | ** ** | ** ** | **Investments** | ** ** |
| Interest credited to contractholder funds                               | $          | (26                                            | )          | $ | 45 |   | $ | (19 | ) | $ | — |   |
| Net investment income                                                   |       | 124                                            |       |   | — |   |   | — |   |   | (124 | ) |
| Realized capital gains and losses                                       |       | 10                                             |       |   | (6 | ) |   | — |   |   | — |   |
| Total                                                                   | $          | 108                                            |       | $ | 39 |   | $ | (19 | ) | $ | (124 | ) |

 

The Company manages its exposure to creditrisk by utilizing highly rated counterparties, establishing risk controllimits, executing legally enforceable master netting agreements (“MNAs”) andobtaining collateral where appropriate. The Company uses MNAs for OTC derivative transactions, includinginterest rate swap, foreign currency swap, interest rate cap, interest ratefloor, credit default swap, forward and certain option agreements (includingswaptions).  These agreements permiteither party to net payments due for transactions covered by theagreements.  Under the provisions of theagreements, collateral is either pledged or obtained when certain predeterminedexposure limits are exceeded.  As of September 30,2009, counterparties pledged $54 million in cash and $39 million in securitiesto the Company, and the Company pledged $256 million in securities tocounterparties which includes $188 million of collateral posted under MNAs forcontracts containing credit-risk-contingent provisions that are in a liabilityposition and $68 million of collateral posted under MNAs for contracts withoutcredit-risk-contingent liabilities.  TheCompany has not incurred any losses on derivative financial instruments due tocounterparty nonperformance.  Otherderivatives including futures and certain option contracts are traded onorganized exchanges, which require margin deposits and guarantee the executionof trades, thereby mitigating any potential credit risk associated withtransactions executed on organized exchanges.

 

Counterparty credit exposure represents theCompany’s potential loss if all of the counterparties concurrently fail toperform under the contractual terms of the contracts and all collateral, ifany, becomes worthless.  This exposure ismeasured by the fair value of OTC free-standing derivative contracts with apositive fair value at the reporting date reduced by the effect, if any, oflegally enforceable master netting agreements.

 

The following table summarizes thecounterparty credit exposure by counterparty credit rating as it relates tointerest rate swap, foreign currency swap, interest rate cap, interest ratefloor, credit default swap, forward and certain option agreements (includingswaptions).

 
| **($ in millions)** | ** ** | **September 30, 2009**       | ** ** | **December 31, 2008**  | ** ** |
|--------------------------|------------|-----------------------------------|------------|-----------------------------|------------|
| **Rating****(1)**        | ** ** | **Number  of  counter-  parties** | ** ** | **Notional  amount****(2)** | ** ** | **Credit  exposure****(2)** | ** ** | **Exposure,  net of  collateral****(2)** | ** ** | **Number   of  counter-  parties** | ** ** | **Notional  amount****(2)** | ** ** | **Credit  exposure****(2)** | ** ** | **Exposure,  net of  collateral****(2)** | ** ** |
| AA-                      |       | —                            | $          | —                      | $          | — | $ | — |   | 1 | $ | 236 | $ | 5 | $ | 5 |   |
| A+                       |       | 2                                 |       | 4,185                       |       | 67 |   | 1 |   | 2 |   | 242 |   | 8 |   | 8 |   |
| A                        |       | 2                                 |       | 1,070                       |       | 37 |   | 15 |   | 2 |   | 1,730 |   | 35 |   | 15 |   |
| A-                       |       | 1                                 |       | 166                         |       | 23 |   | 23 |   | 1 |   | 216 |   | 25 |   | 25 |   |
| Total                    |       | 5                                 | $          | 5,421                       | $          | 127 | $ | 39 |   | 6 | $ | 2,424 | $ | 73 | $ | 53 |   |

 

----

(1)     Rating is the lower ofS&P or Moody’s ratings.

 

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

 

30

----

 

Market risk is the risk that the Company willincur losses due to adverse changes in market rates and prices.  Market risk exists for all of the derivativefinancial instruments the Company currently holds, as these instruments maybecome less valuable due to adverse changes in market conditions.  To limit this risk, the Company’s seniormanagement has established risk control limits. In addition, changes in fair value of the derivative financialinstruments that the Company uses for risk management purposes are generallyoffset by the change in the fair value or cash flows of the hedged riskcomponent of the related assets, liabilities or forecasted transactions.

 

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

 

The following summarizes the fair value ofderivative instruments with termination, cross-default or collateralcredit-risk-contingent features that are in a liability position as of September 30,2009, as well as the fair value of assets and collateral that are nettedagainst the liability in accordance with provisions within legally enforceableMNAs.

 
| **($ in millions)**                                                                                                              | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                                                                            | ** ** | ** ** | ** ** |
| Gross liability fair value of contracts containing  credit-risk-contingent features                                                   | $          | 495        |       |
| Gross asset fair value of contracts containing  credit-risk-contingent features and subject to MNAs                                   |       | (261       | )          |
| Collateral posted under MNAs for contracts  containing credit-risk-contingent features                                                |       | (188       | )          |
| Maximum amount of additional exposure for  contracts with credit-risk-contingent featuresif all  features were triggered concurrently | $          | 46         |       |

 

**Credit derivatives — selling protection**

 

Creditdefault swaps (“CDS”) are utilized for selling credit protection againsta specified credit event.  A creditdefault swap is a derivative instrument, representing an agreement between twoparties to exchange the credit risk of a specified entity (or a group ofentities), or an index based on the credit risk of a group of entities (allcommonly referred to as the “reference entity” or a portfolio of “referenceentities”), for a periodic premium.  Inselling protection, CDS are used to replicate fixed income securities and tocomplement the cash market when credit exposure to certain issuers is notavailable or when the derivative alternative is less expensive than the cashmarket alternative.  CDS typically have afive-year term.

 

31

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The following table shows the CDS notionalamounts by credit rating and fair value of protection sold as of September 30,2009:

 
| **($ in millions)**         | ** ** | **Notional  amount  credit rating underlying notional** | ** ** | ** ** | ** ** |
|----------------------------------|------------|---------------------------------------------------------|------------|------------|------------|
| ** **                       | ** ** | **AAA**                                                 | ** ** | **AA**     | ** ** | **A** | ** ** | **BBB** | ** ** | **BB and  lower** | ** ** | **Total** | ** ** | **Fair  value** | ** ** |
| **Single name**                  |       |                                                    |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment grade  corporate debt | $          | —                                                  | $          | 10         | $          | 45 | $ | 46 | $ | 15 | $ | 116 | $ | (6 | ) |
| Municipal                        |       | —                                                  |       | 25         |       | — |   | — |   | — |   | 25 |   | (5 | ) |
| Subtotal                         |       | —                                                  |       | 35         |       | 45 |   | 46 |   | 15 |   | 141 |   | (11 | ) |
| **First-to-default**             |       |                                                    |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment gradecorporate debt   |       | —                                                  |       | —     |       | 45 |   | 45 |   | — |   | 90 |   | (1 | ) |
| Municipal                        |       | —                                                  |       | 20         |       | 135 |   | — |   | — |   | 155 |   | (29 | ) |
| Subtotal                         |       | —                                                  |       | 20         |       | 180 |   | 45 |   | — |   | 245 |   | (30 | ) |
| **Index**                        |       |                                                    |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment gradecorporate debt   |       | 1                                                       |       | 5          |       | 21 |   | 26 |   | 12 |   | 65 |   | (32 | ) |
| **Total**                        | $          | 1                                                       | $          | 60         | $          | 246 | $ | 117 | $ | 27 | $ | 451 | $ | (73 | ) |

 

The following table shows the CDS notional amountsby credit rating and fair value of protection sold as of December 31,2008:

 
| **($ in millions)**       | ** ** | **Notional amount  credit rating underlying notional** | ** ** | ** ** | ** ** |
|--------------------------------|------------|----------------------------------------------------------------------------|------------|------------|------------|
| ** **                     | ** ** | **AAA**                                                                    | ** ** | **AA**     | ** ** | **A** | ** ** | **BBB** | ** ** | **BB  and  lower** | ** ** | **Total** | ** ** | **Fair  value** | ** ** |
| **Single name**                |       |                                                                       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment gradecorporate debt | $          | 10                                                                         | $          | —     | $          | 115 | $ | 91 | $ | — | $ | 216 | $ | (10 | ) |
| High yield debt                |       | —                                                                     |       | —     |       | — |   | — |   | 6 |   | 6 |   | (3 | ) |
| Municipal                      |       | —                                                                     |       | 25         |       | — |   | — |   | — |   | 25 |   | (11 | ) |
| Sovereign                      |       | —                                                                     |       | —     |       | — |   | 20 |   | 5 |   | 25 |   | (1 | ) |
| Subtotal                       |       | 10                                                                         |       | 25         |       | 115 |   | 111 |   | 11 |   | 272 |   | (25 | ) |
| **First-to-default**           |       |                                                                       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment gradecorporate debt |       | —                                                                     |       | —     |       | 30 |   | 60 |   | — |   | 90 |   | (5 | ) |
| Municipal                      |       | —                                                                     |       | 120        |       | 35 |   | — |   | — |   | 155 |   | (43 | ) |
| Subtotal                       |       | —                                                                     |       | 120        |       | 65 |   | 60 |   | — |   | 245 |   | (48 | ) |
| **Total**                      | $          | 10                                                                         | $          | 145        | $          | 180 | $ | 171 | $ | 11 | $ | 517 | $ | (73 | ) |

 

In selling protection with CDS, the Companysells credit protection on an identified single name, a basket of names in afirst-to-default (“FTD”) structure or credit derivative index (“CDX”) that isgenerally investment grade, and in return receives periodic premiums throughexpiration or termination of the agreement. With single name CDS, this premium or credit spread generallycorresponds to the difference between the yield on the referenced entity’spublic fixed maturity cash instruments and swap rates, at the time theagreement is executed.  With FTD baskets,because of the additional credit risk inherent in a basket of named credits,the premium generally corresponds to a high proportion of the sum of the creditspreads of the names in the basket and the correlation between the names.  CDX index is utilized to take a position on multiple(generally 125) reference entities.  Creditevents are typically defined as bankruptcy, failure to pay, or restructuring,depending on the nature of the reference credit.  If a credit event occurs, the Company settleswith the counterparty, either through physical settlement or cashsettlement.  In a physical settlement, areference asset is delivered by the buyer of protection to the Company, inexchange for cash payment at par, whereas in a cash settlement, the Companypays the difference between par and the prescribed value of the referenceasset.  When a credit event occurs in asingle name or FTD basket (for FTD, the first credit event occurring for anyone name in the basket), the contract terminates at time of settlement.  For CDX index, the reference entity’s nameincurring the credit event is removed from the index while the contractcontinues until expiration.  The maximumpayout on a CDS is the contract notional amount.  A physical settlement may afford the Companywith recovery rights as the new owner of the asset.

 

32

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The Company monitors risk associated with credit derivatives throughindividual name credit limits at both a credit derivative and a combined cashinstrument/credit derivative level.  Theratings of individual names for which protection has been sold are alsomonitored.

 

**7.  Reinsurance**

 

Theeffects of reinsurance on premiums and contract charges are as follows:

 
| **($ in millions)**                           | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                         | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Premiums and contract charges**                  |       |                                             |       |                                            |       |   |   |   |   |
| Direct                                             | $          | 542                                              | $          | 560                                             | $          | 1,642 | $ | 1,688 |   |
| Assumed                                            |       |                                             |       |                                            |       |   |   |   |   |
| Affiliate                                          |       | 26                                               |       | 16                                              |       | 76 |   | 46 |   |
| Non-affiliate                                      |       | 5                                                |       | 7                                               |       | 16 |   | 19 |   |
| Ceded—non-affiliate                           |       | (198                                             | )          | (217                                            | )          | (588 | ) | (663 | ) |
|                                               |       |                                             |       |                                            |       |   |   |   |   |
| Premiums  and contract charges, net of reinsurance | $          | 375                                              | $          | 366                                             | $          | 1,146 | $ | 1,090 |   |

 

The effects ofreinsurance on contract benefits are as follows:

 
| **($ in millions)**               | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                             | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Contract benefits**                  |       |                                             |       |                                            |       |   |   |   |   |
| Direct                                 | $          | 296                                              | $          | 580                                             | $          | 1,535 | $ | 1,563 |   |
| Assumed                                |       |                                             |       |                                            |       |   |   |   |   |
| Affiliate                              |       | 16                                               |       | 8                                               |       | 49 |   | 26 |   |
| Non-affiliate                          |       | 4                                                |       | 5                                               |       | 18 |   | 19 |   |
| Ceded—non-affiliate  (1)          |       | 11                                               |       | (232                                            | )          | (584 | ) | (563 | ) |
|                                   |       |                                             |       |                                            |       |   |   |   |   |
| Contract  benefits, net of reinsurance | $          | 327                                              | $          | 361                                             | $          | 1,018 | $ | 1,045 |   |

 

----

(1)   Thethree months ended September 30, 2009 include a $166 million decrease inthe reinsurance recoverable related to the ceded variable annuity contractguarantees as a result of improved equity market conditions during 2009.

 

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

 
| **($ in millions)**                                       | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Interest credited to contractholder funds**                  |       |                                             |       |                                            |       |   |   |   |   |
| Direct                                                         | $          | 488                                              | $          | 580                                             | $          | 1,605 | $ | 1,744 |   |
| Assumed                                                        |       |                                             |       |                                            |       |   |   |   |   |
| Affiliate                                                      |       | 3                                                |       | 2                                               |       | 8 |   | 8 |   |
| Non-affiliate                                                  |       | 3                                                |       | 5                                               |       | 9 |   | 12 |   |
| Ceded—non-affiliate                                       |       | (9                                               | )          | (14                                             | )          | (24 | ) | (32 | ) |
|                                                           |       |                                             |       |                                            |       |   |   |   |   |
| Interest  credited to contractholder funds, net of reinsurance | $          | 485                                              | $          | 573                                             | $          | 1,598 | $ | 1,732 |   |

 

**8.   ****Guaranteesand Contingent Liabilities**

 

**Guarantyfunds**

 

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 Company’s policy is to accrue a guarantyfund assessment when the entity for which the insolvency relates has beendeclared financially 

 

33

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insolvent by a court of competent jurisdiction and,in certain states, that is also a final order of liquidation, and the amount ofloss is reasonably estimable.

 

The New York Liquidation Bureau (the “Bureau”) has publicly reportedthat Executive Life Insurance Company of New York (“Executive Life”) iscurrently under its jurisdiction as part of a 1992 court-ordered rehabilitationplan and may only be able to meet future obligations of its annuity contactsfor the next fifteen years. However, Executive Life does not have a liquidityproblem at this time, and an order of liquidation has not been sought by theBureau.  The shortfall was estimated bythe Bureau to be $1.27 billion at October 29, 2008.

 

If Executive Life were to be declared insolvent in the future, theCompany may have exposure to future guaranty fund assessments.  The Company’s exposure will ultimately dependon the level of guaranty fund system participation, as well as the viability ofa plan of the Bureau to obtain voluntary contributions, primarily from theoriginal insurance companies that acquired structured settlement annuitycontracts from Executive Life.  Undercurrent law, the Company may be allowed to recoup a portion of the amount ofany additional guaranty fund assessment in periods subsequent to therecognition of the assessment by offsetting future premium taxes.  The Company’s New York market share wasapproximately 4.1% in 2007 based on industry annuity premium.

 

**Guarantees**

 

The Company owns certain fixedincome securities that obligate the Company to exchange credit risk or toforfeit principal due, depending on the nature or occurrence of specifiedcredit events for the referenced entities. In the event all such specified credit events were to occur, the Company’smaximum amount at risk on these fixed income securities, as measured by theamount of the aggregate initial investment, was $168 million at September 30,2009.  The obligations associated withthese fixed income securities expire at various dates during the next fiveyears.

 

Related to the disposalthrough reinsurance of substantially all of the Company’s variable annuitybusiness to Prudential Financial, Inc. and its subsidiary in 2006, theCompany has agreed to indemnify Prudential for certain pre-closing contingentliabilities (including extra-contractual liabilities of the Company andliabilities specifically excluded from the transaction) that the Company hasagreed 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.  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 Company provides standardindemnifications to contractual counterparties in connection with numeroustransactions, 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 oftenstandard contractual terms and are entered into in the normal course ofbusiness based on 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 to all guarantees was notmaterial as of September 30, 2009.

 

**Regulation and Compliance**

 

The Company is subject tochanging social, economic and regulatory conditions.  From time to time, regulatory authorities orlegislative bodies seek to impose additional regulations regarding agent andbroker compensation and otherwise expand overall regulation of insuranceproducts and the insurance industry.  Inaddition, the Company establishes procedures and policies to both facilitatecompliance with laws and regulations and create prudent and transparentoperations.  The Company routinelyreviews its processes to validate compliance with laws, rules andregulations and internal policies and procedure.  As a result of these reviews, the Company mayfrom time to time conclude that certain processes, policies and procedures needto be modified.  Such modifications, andthe Company evaluations leading to such modifications, may be accompanied bypayments being made and costs being incurred.  The ultimate changes and eventual effects of these actions on theCompany’s business, if any, are uncertain.

 

34

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**Legaland regulatory proceedings and inquiries**

 

***Background***

 

TheCompany and certain affiliates are involved in a number of lawsuits, regulatoryinquiries, and other legal proceedings arising out of various aspects of itsbusiness.  As background to the “Proceedings”subsection below, please note the following:

 

·             These mattersraise difficult and complicated factual and legal issues and are subject tomany uncertainties and complexities, including the underlying facts of each matter;novel legal issues; variations between jurisdictions in which matters are beinglitigated, heard, or investigated; differences in applicable laws and judicialinterpretations; the length of time before many of these matters might beresolved by settlement, through litigation or otherwise; the fact that some ofthe lawsuits are putative class actions in which a class has not been certifiedand in which the purported class may not be clearly defined; the fact that someof the lawsuits involve multi-state class actions in which the applicable law(s) forthe claims at issue is in dispute and therefore unclear; and the currentchallenging legal environment faced by large corporations and insurancecompanies.

 

·             The outcome of these matters may 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.  Theoutcome may also be affected by future state or federal legislation, the timingor substance of which cannot be predicted.

 

·             In the lawsuits, plaintiffs seek a variety ofremedies including equitable relief in the form of injunctive and otherremedies and monetary relief in the form of contractual and extra-contractualdamages.  In some cases, the monetarydamages sought include punitive damages. Often specific information about the relief sought, such as the amountof damages, is not available because plaintiffs have not requested specificrelief in their pleadings.  In theCompany’s experience, when specific monetary demands are made in pleadings,they bear little relation to the ultimate loss, if any, to the Company.

 

·             In connectionwith regulatory examinations and proceedings, government authorities may seekvarious forms of relief, including penalties, restitution and changes inbusiness practices.  The Company may notbe advised of the nature and extent of relief sought until the final stages ofthe examination or proceeding.

 

·             For the reasons specifiedabove, it is often not possible to make meaningful estimates of the amount orrange of loss that could result from the matters described below in the “Proceedings”subsection.  The Company reviews thesematters on an ongoing basis and follows appropriate accounting guidance whenmaking accrual and disclosure decisions. When assessing reasonably possible and probable outcomes, the Companybases its decisions on its assessment of the ultimate outcome following allappeals.

 

·             Due to the complexity and scope of the mattersdisclosed in the “Proceedings” subsection below and the many uncertainties thatexist, the ultimate outcome of these matters cannot be reasonablypredicted.  In the event of anunfavorable outcome in one or more of these matters, the ultimate liability maybe in excess of amounts currently reserved, if any, and may be material to theCompany’s operating results or cash flows for a particular quarterly or annualperiod.  However, based on informationcurrently known to it, management believes that the ultimate outcome of allmatters described below, as they are resolved over time, is not likely to havea material adverse effect on the financial position of the Company.

 

***Proceedings***

 

Legalproceedings involving Allstate agencies and AIC may impact the Company, evenwhen the Company is not directly involved, because the Company sells itsproducts through a variety of distribution channels including Allstateagencies.  Consequently, informationabout the more significant of these proceedings is provided in the followingparagraph.

 

35

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AIC is defending certain matters relating toits agency program reorganization announced in 1999.  These matters are in various stages ofdevelopment.

 

·                  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 asked the court toclarify 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 U.S. Court of Appeals for 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 ThirdCircuit along with the merits of the appeal. In July 2009, the Third Circuit vacated the decision which grantedAIC’s summary judgment motions, remanded the cases to the trial court foradditional discovery, and directed that the cases be reassigned to anothertrial court judge.

 

·                  The EEOC also filed another lawsuit in 2004alleging age discrimination with respect to a policy limiting the rehire ofagents affected by the agency program reorganization (the “EEOC II” suit).  In EEOC II, in 2006, the court grantedpartial summary judgment to the EEOC. Although the court did not determine that AIC was liable for agediscrimination under the ADEA, it determined that the rehire policy resulted ina disparate impact, reserving for trial the determination on whether AIC hadreasonable factors other than age to support the rehire policy.  AIC’s interlocutory appeal from the partialsummary judgment was granted.  In June 2008,the U.S. Court of Appeals for the Eighth Circuit affirmed summary judgment inthe EEOC’s favor.  In September 2008,the Eighth Circuit 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.  TheEighth Circuit then dismissed AIC’s appeal, determining that it lacked jurisdictionto consider the appeal at this stage in the litigation.  On September 11, 2009, a proposedsettlement embodied in a stipulated order agreed to by the parties was filedwith the trial court.  The stipulatedorder, which resolves this litigation and was entered by the trial court,provides for a payment which is immaterial in amount to be allocated among 90claimants and certain other relief.

 

·                  Aputative nationwide class action has also been filed by former employee agentsalleging various violations of ERISA, including a worker classificationissue.  These plaintiffs are challengingcertain amendments to the Agents Pension Plan and are seeking to have exclusiveagent independent contractors treated 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 U.S. Court of Appeals for theThird Circuit issued an order in December 2007 stating that the notice ofappeal was not taken from a final order within the meaning of the federal lawand thus not appealable at this time.  In March 2008, the Third Circuit decided that the appeal should notsummarily be dismissed and that the question of whether the matter isappealable at this time will be addressed by the Third Circuit along with themerits of the appeal.  In July 2009,the Third Circuit vacated the decision which granted AIC’s motion to dismissthe case, remanded the case to the trial court for additional discovery, anddirected that the case be reassigned to another trial court judge.

 

In all of these various matters, plaintiffsseek compensatory and punitive damages, and equitable relief.  AIC has been vigorously defending theselawsuits and other matters related to its agency program reorganization.

 

36

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***Other Matters***

** **

Various other legal, governmental, andregulatory actions, including state market conduct exams, and othergovernmental and regulatory inquiries are currently pending that involve theCompany and specific aspects of its conduct of business.  Like other members of the insurance industry,the Company is the target of a number of class action lawsuits and other typesof proceedings, some of which involve claims for substantial or indeterminateamounts.  These actions are based on avariety of issues and target a range of the Company’s practices.  The outcome of these disputes is currentlyunpredictable.

 

One or more of these matterscould have an adverse effect on the Company’s operating results or cash flowsfor a particular quarterly or annual period. However, based on informationcurrently known to it, management believes that the ultimate outcome of allmatters described inthis “Other Matters” subsection, in excess of amounts currently reserved, if any, asthey are resolved over time is not likely to have a material effect on the operating results, cashflows or financial position of the Company.

 

**9.  Income Taxes**

 

Areconciliation of the statutory federal income tax rate to the effective incometax rate on income from operations for the nine-month period ended September 30is as follows:

 
| **($ in millions)**                    | ** ** | **2009** | ** ** | ** ** | **2008** | ** ** |
|---------------------------------------------|------------|----------|------------|------------|----------|------------|
|                                        |       |     |       |       |     |       |   |   |   |   |
| Statutory federal income tax rate - benefit | $          | (143     | )          | (35.0      | )%       | $          | (371 | ) | (35.0 | )% |
| Dividends received deduction                |       | (8       | )          | (2.0       | )        |       | (13 | ) | (1.2 | ) |
| Other                                       |       | (2       | )          | (0.5       | )        |       | (10 | ) | (0.9 | ) |
| Valuation allowance                         |       | 137      |       | 33.5       |     |       | — |   | — |   |
| Effective income tax rate - benefit         | $          | (16      | )          | (4.0       | )%       | $          | (394 | ) | (37.1 | )% |

 

There was no valuationallowance for deferred tax assets as of September 30, 2009 compared to avaluation allowance of $9 million at December 31, 2008, primarily due to areduction in capital losses that have not been recognized for tax purposes anda reduction in gross unrealized losses on equity securities.  Income tax expense for the nine months ended September 30,2009 includes expense of $142 million attributable to an increase in thevaluation allowance relating to the deferred tax asset on capital lossesrecorded in the first quarter of 2009. This valuation allowance was released in connection with the adoption ofnew accounting guidance on April 1, 2009; however, the release wasrecorded as an increase to retained income and therefore did not reverse theamount recorded in income tax expense on a year-to-date basis.  The release of the valuation allowance isrelated to the reversal of previously recorded other-than-temporary impairmentwrite-downs that would not have been recorded under the new OTTI accountingguidance.  Although realization is notassured, management believes it is more likely than not that the deferred taxassets will be realized based on the Company’s assessment that the deductionsultimately recognized for tax purposes will be fully utilized.

 

During the second quarterof 2009, the Corporation received the Internal Revenue Service’s (“IRS”) auditreport related to the examination of federal income tax returns filed for years2005 and 2006.  The Corporation hasprotested certain adjustments to the Appeals Division of the IRS.  Any adjustments that may result from IRS examinationsof tax returns are not expected to have a material effect on the results ofoperations, cash flows or financial position of the Company.

 

37

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**10.    Other Comprehensive Income**

 

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

 
| **($ in millions)**                                                                   | ** ** | **Three months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                                                                                 | ** ** | **Pre-tax**                               | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding gains and losses arising  during the period, net of related offsets | $          | 1,526                                     | $          | (534 | ) | $ | 992 | $ | (1,014 | ) | $ | 355 | $ | (659 | ) |
| Less: reclassification adjustment of realized  capital gains and losses                    |       | (102                                      | )          | 36 |   | (66 | ) | (489 | ) | 171 |   | (318 | ) |
| Unrealized net capital gains and losses                                                    |       | 1,628                                     |       | (570 | ) | 1,058 |   | (525 | ) | 184 |   | (341 | ) |
| Other comprehensive income (loss)                                                          | $          | 1,628                                     | $          | (570 | ) | 1,058 | $ | (525 | ) | $ | 184 |   | (341 | ) |
| Net loss                                                                                   |       |                                      |       |   |   | (57 | ) |   |   |   |   | (184 | ) |
| Comprehensive income (loss)                                                                |       |                                      |       |   | $ | 1,001 |   |   |   |   | $ | (525 | ) |
|                                                                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                                 | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| ** **                                                                                 | ** ** | **Pre-tax**                              | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                                       |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding gains and losses arising  during the period, net of related offsets | $          | 3,794                                    | $          | (1,325 | ) | $ | 2,469 | $ |  (2,717 | ) | $ |  951 | $ |  (1,766 | ) |
| Less: reclassification adjustment of realized  capital gains and losses                    |       | (249                                     | )          | 87 |   | (162 | ) | (1,635 | ) |   | 572 |   | (1,063 | ) |
| Unrealized net capital gains and losses                                                    |       | 4,043                                    |       | (1,412 | ) | 2,631 |   | (1,082 | ) |   | 379 |   | (703 | ) |
| Other comprehensive income (loss)                                                          | $          | 4,043                                    | $          | (1,412 | ) | 2,631 | $ |  (1,082 | ) | $ |  379 |   | (703 | ) |
| Net loss                                                                                   |       |                                     |       |   |   | (393 | ) |   |   |   |   |   | (667 | ) |
| Comprehensive income (loss)                                                                |       |                                     |       |   | $ |  2,238 |   |   |   |   |   | $ |  (1,370 | ) |
|                                                                                            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

38

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholder of

AllstateLife Insurance Company

Northbrook,Illinois

 

We have reviewed the accompanying condensedconsolidated statement of financial position of Allstate Life Insurance Companyand subsidiaries (the “Company”), an affiliate of The Allstate Corporation, asof September 30, 2009, and the related condensed consolidated statementsof operations for the three-month and nine-month periods ended September 30,2009 and 2008, and condensed consolidated statements of cash flows for thenine-month periods ended September 30, 2009 and 2008.  These interim financial statements are theresponsibility of the Company’s management.

 

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.

 

Asdiscussed in Note 1 to the condensed consolidated financial statements, theCompany changed its presentation and method of accounting forother-than-temporary impairments of debt securities in the second quarter of2009.

 

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 31,2008, 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 17, 2009, 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 31,2008 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 10,2009

 

39

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**Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE-MONTH ANDNINE-MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND 2008**

 

**OVERVIEW**

 

The following discussion highlightssignificant factors influencing the consolidated financial position and resultsof operations of Allstate Life Insurance Company (referred to in this documentas “we”, “our”, “us”, or the “Company”). It should be read in conjunction with the condensed consolidatedfinancial statements and notes thereto found under Part I. Item 1.contained herein, and with the discussion, analysis, consolidated financialstatements and notes thereto in Part I. Item 1. and Part II. Item 7.and Item 8. of the Allstate Life Insurance Company Annual Report on Form 10-Kfor 2008.  We operate as a single segmententity based on the manner in which we use financial information to evaluatebusiness performance and determine the allocation of resources.

 

**HIGHLIGHTS**

 

·                  Net loss was $57million and $393 million in the third quarter and first nine months of 2009,respectively, compared to $184 million and $667 million in the third quarterand first nine months of 2008, respectively.

·                  Net realizedcapital losses totaled $232 million and $148 million in the third quarter andfirst nine months of 2009, respectively, compared to $568 million and $1.93billion in the third quarter and first nine months of 2008, respectively.

·                  Investments as of September 30, 2009totaled $59.93 billion, reflecting an increase in carrying value of $154million from $59.77 billion as of December 31, 2008 and a decrease of$4.89 billion from $64.81 billion as of September 30, 2008.  Net investment income decreased 20.8% to $722million in the third quarter and 20.0% to $2.26 billion in the first nine monthsof 2009 from $912 million and $2.83 billion in the third quarter and first ninemonths of 2008, respectively.

·                  Contractholder fund deposits totaled $679million and $1.50 billion in the third quarter of 2009 and 2008, respectively,all of which were related to individual products.  Contractholder fund deposits for the first ninemonths of 2009 reflect deposits on individual products of $2.61 billion and nodeposits on institutional products compared to deposits on individual andinstitutional products of $4.09 billion and $4.16 billion, respectively, in thefirst nine months of 2008.

·                  Maturities and retirements of institutionalproducts totaled $212 million and $3.33 billion in the third quarters of 2009and 2008, respectively, and $4.72 billion and $7.46 billion in the first ninemonths of 2009 and 2008, respectively.

·                  Restructuring charges of $4 million and $23million in the third quarter and first nine months of 2009, respectively, wererecorded in connection with our initiative to lower operating expenses, withtargeted annual savings of $90 million beginning in 2011.

 

40

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**OPERATIONS**

 

Summarized financial data is presented in thefollowing table.

 
| **($ in millions)**                                             | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                           | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Revenues**                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Premiums                                                             | $          | 134                                        | $          | 138                                       | $          | 440 | $ | 425 |   |
| Contract charges                                                     |       | 241                                        |       | 228                                       |       | 706 |   | 665 |   |
| Net investment income                                                |       | 722                                        |       | 912                                       |       | 2,260 |   | 2,826 |   |
| Realized capital gains and losses                                    |       | (232                                       | )          | (568                                      | )          | (148 | ) | (1,928 | ) |
| Total revenues                                                       |       | 865                                        |       | 710                                       |       | 3,258 |   | 1,988 |   |
|                                                                 |       |                                       |       |                                      |       |   |   |   |   |
| **Costs and expenses**                                               |       |                                       |       |                                      |       |   |   |   |   |
| Contract benefits                                                    |       | (327                                       | )          | (361                                      | )          | (1,018 | ) | (1,045 | ) |
| Interest credited to contractholder funds                            |       | (485                                       | )          | (573                                      | )          | (1,598 | ) | (1,732 | ) |
| Amortization of deferred policy acquisition costs  (“DAC”) |       | (61                                        | )          | 26                                        |       | (758 | ) | 32 |   |
| Operating costs and expenses                                         |       | (74                                        | )          | (100                                      | )          | (244 | ) | (285 | ) |
| Restructuring and related charges                                    |       | (4                                         | )          | —                                    |       | (23 | ) | — |   |
| Interest expense                                                     |       | (11                                        | )          | (6                                        | )          | (32 | ) | (12 | ) |
| Total costs and expenses                                             |       | (962                                       | )          | (1,014                                    | )          | (3,673 | ) | (3,042 | ) |
|                                                                 |       |                                       |       |                                      |       |   |   |   |   |
| Gain (loss) on disposition of operations                             |       | 2                                          |       | 2                                         |       | 6 |   | (7 | ) |
| Income tax benefit                                                   |       | 38                                         |       | 118                                       |       | 16 |   | 394 |   |
| Net  loss                                                            | $          | (57                                        | )          | $                                         | (184       | ) | $ | (393 | ) | $ | (667 | ) |
|                                                                 |       |                                       |       |                                      |       |   |   |   |   |   |   |   |
| Investments at  September 30                                    |       |                                       |       |                                      |       |   | $ | 59,926 |   | $ | 64,814 |   |

 

*Net loss* was $57 million and $393 million in thethird quarter and first nine months of 2009, respectively, compared to $184million and $667 million in the third quarter and first nine months of 2008,respectively.  The improvements of $127million and $274 million in the third quarter and first nine months of 2009,respectively, were primarily due to lower net realized capital losses, interestcredited to contractholder funds and contract benefits, partially offset bylower net investment income, higher amortization of DAC and, in the first ninemonths of 2009, a $142 million increase in the valuation allowance relating tothe deferred tax asset on capital losses that was recorded in the first quarterof 2009.  This valuation allowance wasreleased in connection with our adoption of new OTTI accounting guidance on April 1,2009; however, the release was recorded as an increase to retainedincome and therefore did not reverse the amount recorded in income tax expenseon a year-to-date basis.

 

**Analysis of Revenues**Total revenues increased21.8% or $155 million in the third quarter of 2009 and 63.9% or $1.27 billionin the first nine months of 2009, compared to the same periods of 2008, dueprimarily to lower net realized capital losses, partially offset by lower netinvestment income.

 

*Premiums*****representrevenues generated from traditional life insurance, immediate annuities withlife contingencies, and accident, health and other insurance products that havesignificant mortality or morbidity risk.

 

*Contract charges* are revenues generated frominterest-sensitive and variable life insurance and fixed annuities for whichdeposits are classified as contractholder funds or separate accountliabilities.  Contract charges areassessed against the contractholder account values for maintenance, administration,cost of insurance and surrender prior to contractually specified dates.  As a result, changes in contractholder fundsare considered in the evaluation of growth and as indicators of future levelsof revenues.

 

41

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The following table summarizes premiums and contract charges byproduct.

 
| **($ in millions)**                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                  | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Premiums**                                |       |                                       |       |                                      |       |   |   |   |   |
| Traditional life insurance                  | $          | 96                                         | $          | 90                                        | $          | 289 | $ | 271 |   |
| Immediate annuities with life contingencies |       | 15                                         |       | 25                                        |       | 83 |   | 91 |   |
| Accident, health and other                  |       | 23                                         |       | 23                                        |       | 68 |   | 63 |   |
| **Total premiums**                          |       | 134                                        |       | 138                                       |       | 440 |   | 425 |   |
|                                        |       |                                       |       |                                      |       |   |   |   |   |
| **Contract charges**                        |       |                                       |       |                                      |       |   |   |   |   |
| Interest-sensitive life insurance           |       | 229                                        |       | 215                                       |       | 671 |   | 625 |   |
| Fixed annuities                             |       | 11                                         |       | 13                                        |       | 34 |   | 39 |   |
| Variable annuities                          |       | 1                                          |       | —                                    |       | 1 |   | 1 |   |
| **Total contract charges**(1)               |       | 241                                        |       | 228                                       |       | 706 |   | 665 |   |
| ** **                                  |       |                                       |       |                                      |       |   |   |   |   |
| **Total premiums and contract  charges**    | $          | 375                                        | $          | 366                                       | $          | 1,146 | $ | 1,090 |   |

 

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(1)        Total contract charges forthe third quarter of 2009 and 2008 include contract charges related to the costof insurance totaling $153 million and $142 million, respectively.  Total contract charges for the first ninemonths of 2009 and 2008 include contract charges related to the cost ofinsurance totaling $450 million and $419 million, respectively.

 

Total premiums decreased 2.9% in the third quarter of 2009 compared tothe third quarter of 2008 due to lower sales of immediate annuities with lifecontingencies, partially offset by lower reinsurance on traditional lifeinsurance.  Total premiums increased 3.5%in the first nine months of 2009 compared to the same period of 2008 due tolower reinsurance on traditional life insurance, partially offset by lowersales of immediate annuities with life contingencies.

 

Total contract charges increased 5.7% and 6.2% in the third quarter andfirst nine months of 2009, respectively, compared to the same periods of 2008due primarily to higher contract charges on interest-sensitive life insuranceproducts resulting from increases in certain policy administration fees.

 

42

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*Contractholder funds*representinterest-bearing liabilities arising from the sale of individual andinstitutional products, such as interest-sensitive life insurance, fixedannuities 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 in contractholder funds.

 
| **($ in millions)**                                       | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                                   | ** ** | ** **                                | **2008**   | ** ** | ** ** | **2009** | ** ** | ** ** | **2008** | ** ** |
| **Contractholder funds, beginning  balance**                   | $          | 52,298                                     |       | $                                         | 60,886     |   | $ | 56,780 |   | $ | 60,464 |   |
| ** **                                                     |       |                                       |       |                                      |       |   |   |   |   |   |   |   |
| **Deposits**                                                   |       |                                       |       |                                      |       |   |   |   |   |   |   |   |
| Fixed annuities                                                |       | 342                                        |       |                                      | 1,178      |   |   | 1,612 |   |   | 3,101 |   |
| Institutional products (funding agreements)                    |       | —                                     |       |                                      | —     |   |   | — |   |   | 4,158 |   |
| Interest-sensitive life insurance                              |       | 337                                        |       |                                      | 324        |   |   | 996 |   |   | 989 |   |
| Other                                                          |       | —                                     |       |                                      | —     |   |   | — |   |   | 1 |   |
| Total deposits                                                 |       | 679                                        |       |                                      | 1,502      |   |   | 2,608 |   |   | 8,249 |   |
| ** **                                                     |       |                                       |       |                                      |       |   |   |   |   |   |   |   |
| **Interest credited**                                          |       | 486                                        |       |                                      | 588        |   |   | 1,506 |   |   | 1,785 |   |
| ** **                                                     |       |                                       |       |                                      |       |   |   |   |   |   |   |   |
| **Maturities, benefits, withdrawals  and other adjustments**   |       |                                       |       |                                      |       |   |   |   |   |   |   |   |
| Maturities and retirements of institutional  products          |       | (212                                       | )          |                                      | (3,330     | ) |   | (4,715 | ) |   | (7,460 | ) |
| Benefits                                                       |       | (377                                       | )          |                                      | (422       | ) |   | (1,202 | ) |   | (1,302 | ) |
| Surrenders and partial withdrawals                             |       | (973                                       | )          |                                      | (1,062     | ) |   | (2,812 | ) |   | (3,096 | ) |
| Contract charges                                               |       | (218                                       | )          |                                      | (206       | ) |   | (637 | ) |   | (605 | ) |
| Net transfers from separate accounts                           |       | 2                                          |       |                                      | 4          |   |   | 8 |   |   | 16 |   |
| Fair value hedge adjustments for institutional  products       |       | 1                                          |       |                                      | (164       | ) |   | 31 |   |   | (165 | ) |
| Other adjustments (1)                                          |       | (61                                        | )          |                                      | (6         | ) |   | 58 |   |   | (96 | ) |
| Total maturities, benefits, withdrawals and other  adjustments |       | (1,838                                     | )          |                                      | (5,186     | ) |   | (9,269 | ) |   | (12,708 | ) |
| **Contractholder funds, ending  balance**                      | $          | 51,625                                     |       | $                                         | 57,790     |   | $ | 51,625 |   | $ | 57,790 |   |

 

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(1)       The table above illustratesthe changes in contractholder funds, which are presented gross of reinsurancerecoverables on the Condensed Consolidated Statements of FinancialPosition.  The table above is intended tosupplement our discussion and analysis of revenues, which are presented net ofreinsurance on the Condensed Consolidated Statements of Operations.  As a result, the net change in contractholderfunds associated with products reinsured to third parties is reflected as acomponent of the other adjustments line.

 

Contractholderfunds decreased 1.3% and 5.1% in the third quarters of 2009 and 2008,respectively, and decreased 9.1% and 4.4% in the first nine months of 2009 and2008, respectively.  Averagecontractholder funds decreased 12.4% and 8.3% in the third quarter and firstnine months of 2009, respectively, compared to the same periods of 2008.

 

Contractholderdeposits decreased 54.8% in the third quarter of 2009 compared to the thirdquarter of 2008 due to lower deposits on fixed annuities.  In the first nine months of 2009,contractholder deposits decreased 68.4% compared to the same period of 2008because there were no issuances of institutional products in the first ninemonths of 2009 compared to $4.16 billion in the prior year period and lower depositson fixed annuities.  Deposits on fixedannuities decreased 71.0% and 48.0% in the third quarter and first nine monthsof 2009, respectively, compared to the same periods of 2008 due to pricingactions relating to our efforts to improve returns on new business and reduceour concentration in spread based products. Sales of our institutional products vary from period to period based onmanagement’s assessment of market conditions, investor demand and operationalpriorities such as our current focus on reducing our concentration in spreadbased products.

 

Maturities and retirementsof institutional products decreased 93.6% to $212 million in the third quarterof 2009 from $3.33 billion in the third quarter of 2008.  In the first nine months of 2009, maturitiesand retirements of institutional products decreased 36.8% to $4.72 billion from$7.46 billion in the prior year period. These decreases were primarily due to lower retirements of extendibleinstitutional market obligations in 2009. In the first nine months of 2009, the lower retirements of extendibleinstitutional market obligations were partially offset by the redemption of$1.39 billion of institutional product liabilities in accordance with cashtender offers announced in May 2009 to reduce the amount of ouroutstanding obligations and related interest expense.  During the third quarter and first ninemonths of 2009, we retired $9 million and $1.45 billion, respectively, ofextendible institutional 

 

43

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market obligations for whichinvestors had elected to non-extend their maturity date.  This compares to retirements of extendibleinstitutional market obligations totaling $2.25 billion and $4.64 billion inthe third quarter and first nine months of 2008, respectively.

 

Surrenders and partialwithdrawals on deferred fixed annuities and interest-sensitive life insuranceproducts decreased 8.4% to $973 million in the third quarter of 2009 and 9.2%to $2.81 billion in the first nine months of 2009 from $1.06 billion and $3.10billion in the third quarter and first nine months of 2008, respectively, dueprimarily to lower surrenders and partial withdrawals on deferred fixedannuities.  The annualized surrender andpartial withdrawal rate on deferred fixed annuities and interest-sensitive lifeinsurance products, based on the beginning of period contractholder funds, was8.9% in the first nine months of 2009 compared to 9.8% in the first nine monthsof 2008.

 

*Net investment income* decreased20.8% or $190 million to $722 million in the third quarter of 2009 and 20.0% or$566 million to $2.26 billion in the first nine months of 2009 from $912million and $2.83 billion in the third quarter and first nine months of 2008,respectively.  For further discussion of netinvestment income, see the Investments section of Management’s Discussion and Analysis(“MD&A”).

 

*Net realized capital gains andlosses* reflected net losses of $232 million and $148 million in the thirdquarter and first nine months of 2009, respectively, compared to net losses of$568 million and $1.93 billion in the same periods of 2008, respectively.  For further discussion of realized capitalgains and losses, see the Investments section of the MD&A.

 

**Analysis of Costs and Expenses** Total costs and expenses decreased 5.1%or $52 million in the third quarter of 2009 and increased 20.7% or $631 millionin the first nine months of 2009, compared to the same periods of 2008.  The decline in the third quarter of 2009reflects lower interest credited to contractholder funds, contract benefits andoperating costs and expenses, partially offset by higher amortization ofDAC.  The increase in the first ninemonths of 2009 primarily reflects higher amortization of DAC, partially offsetby lower interest credited to contractholder funds, operating costs andexpenses and contract benefits.

 

*Contract benefits* decreased 9.4% or $34 million in the third quarter of2009 and 2.6% or $27 million in the first nine months of 2009, compared to thesame periods of 2008.  The decline inboth periods reflects improved mortality experience on annuities andtraditional life insurance products.

 

We analyze ourmortality and morbidity results using the difference between premiums andcontract charges earned for the cost of insurance and contract benefitsexcluding the portion related to the implied interest on immediate annuitieswith life contingencies (“benefit spread”). This implied interest totaled $138 million and $417 million in the thirdquarter and first nine months of 2009, respectively, compared to $137 millionand $413 million in the third quarter and first nine months of 2008,respectively.  The benefit spread byproduct group is disclosed in the following table.

 
| **($ in millions)** | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **               | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Life insurance           | $          | 99                                         | $          | 79                                        | $          | 307 | $ | 261 |   |
| Annuities                |       | (1                                         | )          | (23                                       | )          | (18 | ) | (49 | ) |
| Total benefit spread     | $          | 98                                         | $          | 56                                        | $          | 289 | $ | 212 |   |

 

Benefit spread increased 75.0% or $42 million in thethird quarter of 2009 and 36.3% or $77 million in the first nine months of 2009compared to the same periods of 2008. The increase in both periods was primarily due to improved mortalityexperience on annuities and traditional life insurance and increased contractcharges on interest-sensitive life insurance products for the cost ofinsurance, partially offset by lower premiums on immediate annuities with lifecontingencies.

 

*Interest credited to contractholder funds* decreased 15.4% or $88 million in thethird quarter of 2009 and 7.7% or $134 million in the first nine months of2009, compared to the same periods of 2008. These declines were due primarily to lower average contractholder funds,partially offset by unfavorable changes in amortization of deferred salesinducements (“DSI”).

 

Amortization of DSI for the third quarter and firstnine months of 2009 reflected a charge to income of $4 million and $114million, respectively, compared to a credit to income of $2 million and $17million for the third

 

44

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quarter and first nine months of 2008, respectively.  The unfavorable changes of $6 million and$131 million in the third quarter and first nine months of 2009, respectively,were predominately the result of unfavorable changes in amortization relatingto realized capital gains and losses.  Inaddition, the comparison of the first nine months of 2009 to the same period of2008 was unfavorably impacted by the acceleration of amortization relating toour annual comprehensive review of assumptions in the first quarter.  The acceleration of amortization of DSI dueto changes in assumptions increased interest credited to contractholder fundsby $38 million in the first quarter of 2009 compared to amortizationdeceleration which decreased interest credited to contractholder funds by $1million in the first quarter of 2008.

 

In order to analyze the impact of net investmentincome and interest credited to contractholders on net income, we monitor thedifference between net investment income and the sum of interest credited tocontractholder funds and the implied interest on immediate annuities with lifecontingencies, which is included as a component of contract benefits on theCondensed Consolidated Statements of Operations (“investment spread”).

 

The investment spread by product group is shown in thefollowing table.

 
| **($ in millions)**                                 | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                               | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Annuities                                                | $          | 39                                         | $          | 115                                       | $          | 53 | $ | 362 |   |
| Life insurance                                           |       | 1                                          |       | 8                                         |       | 7 |   | 37 |   |
| Institutional products                                   |       | 5                                          |       | 13                                        |       | 28 |   | 56 |   |
| Net investment income on investments supporting  capital |       | 54                                         |       | 66                                        |       | 157 |   | 226 |   |
| Total investment spread                                  | $          | 99                                         | $          | 202                                       | $          | 245 | $ | 681 |   |

 

Investment spreaddeclined 51.0% or $103 million in the third quarter of 2009 and 64.0% or $436million in the first nine months of 2009, compared to the same periods of2008.  These declines reflect lower netinvestment income, partially offset by decreased interest credited tocontractholder funds.

 

To further analyze investment spreads, the followingtables summarize the weighted average investment yield on assets supportingproduct liabilities and capital, interest crediting rates and investmentspreads.

 
| ** **                                                           | ** ** | **Three months ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                           | ** ** | **Weighted average  investment yield**    | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
| ** **                                                           | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.4                                       | %          | 6.0 | % | 4.7 | % | 4.7 | % | 0.7 | % | 1.3 | % |
| Deferred fixed annuities                                             |       | 4.5                                       |       | 5.7 |   | 3.6 |   | 3.8 |   | 0.9 |   | 1.9 |   |
| Immediate fixed annuities with and without life  contingencies       |       | 6.4                                       |       | 6.7 |   | 6.4 |   | 6.5 |   | — |   | 0.2 |   |
| Institutional products                                               |       | 2.9                                       |       | 3.7 |   | 2.0 |   | 3.2 |   | 0.9 |   | 0.5 |   |
| Investments supporting capital, traditional life  and other products |       | 3.4                                       |       | 5.0 |   | N/A |   | N/A |   | N/A |   | N/A |   |

 
| ** **                                                           | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                           | ** ** | **Weighted average  investment yield**   | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
| ** **                                                           | ** ** | **2009**                                 | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.4                                      | %          | 6.1 | % | 4.6 | % | 4.6 | % | 0.8 | % | 1.5 | % |
| Deferred fixed annuities                                             |       | 4.8                                      |       | 5.6 |   | 3.7 |   | 3.8 |   | 1.1 |   | 1.8 |   |
| Immediate fixed annuities with and without life  contingencies       |       | 6.3                                      |       | 6.8 |   | 6.5 |   | 6.5 |   | (0.2 | ) | 0.3 |   |
| Institutional products                                               |       | 3.1                                      |       | 4.3 |   | 2.1 |   | 3.5 |   | 1.0 |   | 0.8 |   |
| Investments supporting capital, traditional life  and other products |       | 3.3                                      |       | 5.6 |   | N/A |   | N/A |   | N/A |   | N/A |   |

 

45

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The following table summarizes our product liabilities and indicatesthe account value of those contracts and policies in which an investment spreadis generated.

 
| **($ in millions)**                                         | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                       | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Immediate fixed annuities with life contingencies                | $          | 8,414                  | $          | 8,316 |   |
| Other life contingent contracts and other                        |       | 3,795                  |       | 3,825 |   |
| Reserve for life-contingent contract benefits                    | $          | 12,209                 | $          | 12,141 |   |
|                                                             |       |                   |       |   |   |
| Interest-sensitive life insurance                                | $          | 9,556                  | $          | 9,220 |   |
| Deferred fixed annuities                                         |       | 32,946                 |       | 34,195 |   |
| Immediate fixed annuities without life  contingencies            |       | 3,853                  |       | 3,891 |   |
| Institutional products                                           |       | 4,394                  |       | 10,042 |   |
| Market value adjustments related to fair value  hedges and other |       | 876                    |       | 442 |   |
| Contractholder funds                                             | $          | 51,625                 | $          | 57,790 |   |

 

*Amortization of DAC* increased $87 million inthe third quarter of 2009 and $790 million in the first nine months of 2009,compared to the same periods of 2008, due primarily to an unfavorable change inamortization relating to realized capital gains and losses, partially offset bylower amortization due to lower investment spread on deferred fixedannuities.  In addition, the comparisonof the first nine months of 2009 to the same period of 2008 was unfavorablyimpacted by the acceleration of amortization relating to our annualcomprehensive review of assumptions in the first quarter.  The components of amortization of DAC aresummarized in the following table.

 
| **($ in millions)**                                                                                        | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                                      | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Amortization  of DAC before amortizationrelating to realized capital gains and lossesand changes in assumptions | $          | (89                                              | )          | $                                               | (125       | ) | $ | (322 | ) | $ | (366 | ) |
| Accretion  (amortization) relating to realized capital gains and losses (1)                                |       | 28                                               |       |                                            | 151        |   |   | (158 | ) |   | 375 |   |
| Amortization  (acceleration) deceleration forchanges in assumptions (“DAC  unlocking”)                |       | —                                           |       |                                            | —     |   |   | (278 | ) |   | 23 |   |
| Total  amortization of DAC                                                                                      | $          | (61                                              | )          | $                                               | 26         |   | $ | (758 | ) | $ | 32 |   |

 

----

(1)       The impact of realized capital gains and losses on amortization of DACis dependent upon the relationship between the assets that give rise to thegain or 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.

 

During the first quarterof 2009, we completed our annual comprehensive review of the profitability ofinvestment products to determine DAC balances for our interest-sensitive life,annuities and other investment contracts. The review covered assumptions for investment returns, including capitalgains and losses, interest crediting rates to policyholders, the effect of anyhedges, persistency, mortality and expenses in all product lines.  This review resulted in an acceleration ofDAC amortization (charge to income) of $278 million pre-tax.  $289 million related to fixed annuities, ofwhich $210 million was attributable to market value adjusted annuities, and $18million related to variable life insurance.  Partially offsetting these amounts wasamortization deceleration (credit to income) for interest-sensitive lifeinsurance of $29 million.  The principalassumption impacting estimated future gross profits and the related DACamortization was an increase in the level of expected realized capital lossesin 2009 and 2010.  This resulted in themajority of the market value adjusted annuity DAC balance being reduced to zerosince the products in force were estimated to have no gross profits.  Market value adjusted annuity DAC will not berecapitalized while there are no estimated gross profits.  Reduced estimated future gross profits fortraditional fixed annuities and variable life insurance resulted in acceleratedDAC amortization.  For ourinterest-sensitive life insurance products, the amortization deceleration wasdue to higher estimated future gross profits due to a favorable change in ourmortality assumptions, partially offset by increased expected capital losses.

 

In the first quarter of2008, our annual comprehensive review of the profitability of investmentproducts resulted in the deceleration of DAC amortization (credit to income)for changes in assumptions of $23 million, of which $17 million related to fixedannuities and $6 million related to interest-sensitive and variable lifeinsurance.  

 

46

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The first quarter 2008net amortization deceleration of $17 million on fixed annuities was dueprimarily to higher than expected investment spreads partially offset byincreased expenses.  The first quarter2008 net amortization deceleration of $6 million on interest-sensitive andvariable life insurance products was due to higher than expected benefitspreads partially offset by increased expenses.

 

When DAC amortization for a quarterly period ispotentially negative (which would result in an increase of the DAC balance) asa result of negative actual gross profits, the specific facts and circumstancessurrounding the potential negative amortization are considered to determinewhether it is appropriate for recognition in the consolidated financialstatements.  Negative amortization isonly recorded when the increased DAC balance is determined to be recoverablebased on facts and circumstances.

 

*Operating costs and expenses*decreased 26.0% or $26 million in the third quarter of 2009 and 14.4% or $41million in the first nine months of 2009, compared to the same periods of2008.  The following table summarizesoperating costs and expenses.

 
| **($ in millions)**           | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                         | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Non-deferrable acquisition costs   | $          | 19                                         | $          | 21                                        | $          | 63 | $ | 61 |   |
| Other operating costs and expenses |       | 55                                         |       | 79                                        |       | 181 |   | 224 |   |
| Total operating costs and expenses | $          | 74                                         | $          | 100                                       | $          | 244 | $ | 285 |   |
|                               |       |                                       |       |                                      |       |   |   |   |   |
| Restructuring  and related charges | $          | 4                                          | $          | —                                    | $          | 23 | $ | — |   |

 

Other operating costs and expenses decreased 30.4% or$24 million and 19.2% or $43 million in the third quarter and first nine monthsof 2009, respectively, compared to the same periods of 2008, due primarily toour expense reduction actions, which resulted in lower employee, professionalservices and sales support expenses.

 

During thethird quarter and first nine months of 2009, restructuring and related chargesof $4 million and $23 million, respectively, were recorded in connection withour previously announced plan to improve efficiency and narrow our focus ofproduct offerings.  In accordance withthis plan, among other actions, we continue to anticipate the reduction ofapproximately 1,000 workforce positions through a combination of attrition,position elimination and outsourcing in 2009 and 2010.  This reduction reflects approximately 30% ofour work force at the time the plan was initiated.  Reductions in workforce positions combinedwith other actions completed as of September 30, 2009 reflectapproximately 80% of our targeted annual savings of $90 million beginning in2011.

 

*Income tax benefit*of $38 million for the third quarter of 2009 compared to a benefit of $118million for the third quarter of 2008 and income tax benefit of $16 million forthe first nine months of 2009 compared to a benefit of $394 million for thesame period in the prior year.  Thedecrease in the benefit of $80 million in the third quarter of 2009 was mostly attributableto the decline in the pre-tax net loss. The decrease in the benefit of $378 million in the first nine months of2009 was primarily the result of a reduction in the pre-tax net loss in thefirst nine months of 2009 and an increase in the valuation allowance relatingto the deferred tax asset on capital losses. Income tax benefit for the first nine months of 2009 includes expense of$142 million attributable to an increase in the valuation allowance relating tothe deferred tax asset on capital losses recorded in the first quarter of2009.  This valuation allowance was released in connection with the adoption ofnew OTTI accounting guidance on April 1, 2009; however, the release wasrecorded as an increase to retained income and therefore did not reverse theamount recorded in income tax benefit on a year-to-date basis.  For further discussion of changes inthis valuation allowance see the Deferred Taxes section of the MD&A.

 

47

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**INVESTMENT HIGHLIGHTS**

 

·                  Investments as of September 30, 2009 totaled$59.93 billion, an increase of 0.3% from $59.77 billion as of December 31,2008 and an increase of 3.4% from $57.96 billion as of June 30, 2009.

·                  Unrealized net capital losses totaled $2.74 billion asof September 30, 2009, declining from $6.70 billion as of December 31,2008 and declining from $5.75 billion as of June 30, 2009.

·                  Net investment income was $722 million in the thirdquarter of 2009, a decrease of 20.8% from $912 million in the third quarter of2008, and $2.26 billion in the first nine months of 2009, a decrease of 20.0%from $2.83 billion in the first nine months of 2008.

·                  Net realized capital losses were $232million in the third quarter of 2009 compared to net realized capital losses of$568 million in the third quarter of 2008, and net realized capital losses of$148 million in the first nine months of 2009 compared to net realized capitallosses of $1.93 billion in the first nine months of 2008.

·                  During the first nine months of 2009, ourfixed income and mortgage loan portfolio generated cash flows totaling $5.72billion which has increased our flexibility to take advantage of marketopportunities and manage liabilities.

·                  During the three months and nine monthsended September 30, 2009, we sold primarily fixed income securitiesrealizing investment gains of $106 million and $627 million, respectively.

 

**INVESTMENTS**

 

We continued tofocus our strategic risk mitigation efforts towards managing portfolio risk,while our return optimization efforts focus on investing in new opportunitiesto generate income and capital appreciation.

 

·                  Fixed income portfolio valuations haveimproved resulting in a $2.99 billion and $3.95 billion favorable increase inthe fixed income net unrealized position since June 30, 2009 and December 31,2008, respectively.  For the three monthperiod, fair values of fixed income securities increased as a result ofsignificant tightening in credit spreads for certain fixed income securitiesand a decline in risk-free interest rates. For the nine month period, fair values of fixed income securitiesincreased as a result of significant tightening in credit spreads for certainfixed income securities that more than offset a rise in risk-free interestrates.

·                  Commercial real estate exposure wasreduced by 12.6% or $1.87 billion of amortized cost since June 30, 2009,and 23.2% or $3.91 billion of amortized cost since December 31, 2008,primarily through targeted dispositions and principal repayments from borrowers.

·                  As a part of our actions taken to managerisk and rating changes, we took advantage of improved market conditions andhave sold $1.2 billion during 2009 of other below investment grade assets,primarily corporate fixed income securities and bank loans, and realized asmall capital gain.

·                  Net investment income for the quarter and the nine months ended September 30,2009 has been impacted by lower yields, actions to shorten duration andmaintain additional liquidity in the portfolio, along with reduced investmentbalances.

·                  During the second and third quarter of 2009,increased market stability drove a more positive market outlook and improvedliquidity in the portfolio, which led us to deploy $5.11 billion of short-terminvestments and cash receipts into primarily fixed income securities togenerate income and capital appreciation.

 

48

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The composition of theinvestment portfolio at September 30, 2009 is presented in the tablebelow.

 
| **($ in  millions)**         | ** ** | **Investments** | ** ** | **Percent  to total** | ** ** |
|-----------------------------------|------------|-----------------|------------|-----------------------|------------|
| Fixed income securities (1)       | $          | 46,321          |       | 77.3                  | %          |
| Mortgage loans                    |       | 8,674           |       | 14.5                  |       |
| Equity securities (2)             |       | 188             |       | 0.3                   |       |
| Limited partnership interests (3) |       | 1,017           |       | 1.7                   |       |
| Short-term (4)                    |       | 1,731           |       | 2.9                   |       |
| Policy loans                      |       | 816             |       | 1.3                   |       |
| Other                             |       | 1,179           |       | 2.0                   |       |
| Total                             | $          | 59,926          |       | 100.0                 | %          |

 

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(1)        Fixed income securities are carried at fairvalue.  Amortized cost basis for thesesecurities was $49.06 billion.

 

(2)        Equity securities are carried at fair value.  Cost basis for these securities was $167million.

 

(3)        We have commitments to invest in additional limitedpartnership interests totaling $878 million.

 

(4)        Short-term investments are carried at fairvalue.  Amortized cost basis for theseinvestments was $1.73 billion.

 

Total investments increasedto $59.93 billion at September 30, 2009, from $59.77 billion at December 31,2008, primarily due to improved market conditions resulting in highervaluations for fixed income securities and a March 2009 capital contribution of $250million from Allstate Insurance Company (“AIC”) that was almost entirely offsetby net reductions in contractholder obligations of $5.16 billion primarily frommaturities and retirements of institutional products.  Fair values of fixed income securitiesincreased as a result of significant tightening in credit spreads for certainfixed income securities that more than offset a rise in risk-free interestrates.

 

*Fixed income securities* are listed in the tablebelow.

 
| **($ in millions)**                                      | ** ** | **Fair  value at********September 30,  2009** | ** ** | **Percent  to  total********investments** | ** ** | ** ** | **Fair  value at********December 31,  2008** | ** ** | **Percent  to  total********investments** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------|------------|------------|---------------------------------------------------|------------|-------------------------------------------|------------|
| U.S. government and agencies                                  | $          | 4,906                                              |       | 8.2                                       | %          | $          | 3,687                                             |       | 6.2                                       | %          |
| Municipal                                                     |       | 4,678                                              |       | 7.8                                       |       |       | 3,308                                             |       | 5.5                                       |       |
| Corporate                                                     |       | 26,107                                             |       | 43.6                                      |       |       | 24,269                                            |       | 40.6                                      |       |
| Foreign government                                            |       | 1,807                                              |       | 3.0                                       |       |       | 2,100                                             |       | 3.5                                       |       |
| Residential mortgage-backed****securities  (“RMBS”) |       | 4,553                                              |       | 7.6                                       |       |       | 3,973                                             |       | 6.7                                       |       |
| Commercial mortgage-backed securities (“CMBS”)      |       | 2,481                                              |       | 4.1                                       |       |       | 3,730                                             |       | 6.2                                       |       |
| Asset-backed securities (“ABS”)                     |       | 1,774                                              |       | 3.0                                       |       |       | 1,369                                             |       | 2.3                                       |       |
| Redeemable preferred stock                                    |       | 15                                                 |       | —                                    |       |       | 10                                                |       | —                                    |       |
| Total fixed income securities                                 | $          | 46,321                                             |       | 77.3                                      | %          | $          | 42,446                                            |       | 71.0                                      | %          |

 

At September 30, 2009, 93.6% of the fixed income securitiesportfolio was rated investment grade, which is defined as a security having arating from the NationalAssociation of Insurance Commissioners (“NAIC”) of 1 or 2; a ratingof Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB from Standardand Poor’s (“S&P”), Fitch or Dominion or a rating of aaa, aa, a or bbb from A.M.Best; or a comparable internal rating if an externally provided rating is notavailable.

 

49

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The followingtable summarizes the fair value and unrealized net capital gains and losses forfixed income securities by Moody’s equivalent rating as of September 30,2009.

 
| **($ in millions)**                                                         | ** ** | **Aaa**               | ** ** | **Aa**                      | ** ** | ** **            | **A**      | ** **                  |
|----------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------------|------------|-----------------------|------------|-----------------------------|
| ** **                                                                       | ** ** | **Fair********value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair********value** | ** ** | **Unrealized  gain/(loss)** | ** ** | ** ** | **Fair********value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
|                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| U.S. government and agencies                                                     | $          | 4,906                 | $          | 190                         | $          | —                | $          | —                      |   | $ | — | $ | — |   |
|                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| Municipal                                                                        |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| Tax exempt                                                                       |       | —                |       | —                      |       | 31                    |       | 1                           |   |   | — |   | — |   |
| Taxable                                                                          |       | 135                   |       | 2                           |       | 1,634                 |       | (3                          | ) |   | 1,385 |   | (60 | ) |
| Auction rate securities (“ARS”)                                        |       | 542                   |       | (26                         | )          | 16                    |       | (2                          | ) |   | 36 |   | (3 | ) |
|                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| Corporate                                                                        |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| Public                                                                           |       | 941                   |       | 14                          |       | 911                   |       | 28                          |   |   | 3,987 |   | 201 |   |
| Privately placed                                                                 |       | 412                   |       | 38                          |       | 859                   |       | 32                          |   |   | 2,928 |   | 97 |   |
| Hybrid                                                                           |       | —                |       | —                      |       | 37                    |       | 6                           |   |   | 533 |   | (123 | ) |
|                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| Foreign government                                                               |       | 1,171                 |       | 230                         |       | 31                    |       | 2                           |   |   | 313 |   | 37 |   |
|                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| RMBS                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| U.S. government sponsored entities (“U.S. Agency”)                     |       | 2,624                 |       | 88                          |       | —                |       | —                      |   |   | — |   | — |   |
| Prime residential mortgage-backed securities  (“Prime”)                |       | 429                   |       | (30                         | )          | 57                    |       | (13                         | ) |   | 31 |   | (4 | ) |
| Alt-A residential mortgage-backed securities  (“Alt-A”)                |       | 74                    |       | (10                         | )          | 17                    |       | (5                          | ) |   | 20 |   | (11 | ) |
| Subprime residential mortgage-backed securities (“Subprime”)           |       | 130                   |       | (27                         | )          | 358                   |       | (185                        | ) |   | 80 |   | (100 | ) |
|                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| CMBS                                                                             |       | 1,414                 |       | (191                        | )          | 283                   |       | (175                        | ) |   | 328 |   | (327 | ) |
|                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| ABS                                                                              |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| Collateralized debt obligations (“CDO”)                                |       | 65                    |       | (13                         | )          | 308                   |       | (55                         | ) |   | 274 |   | (85 | ) |
| Consumer and other asset-backed securities (“Consumer  and other ABS”) |       | 112                   |       | (3                          | )          | 92                    |       | (5                          | ) |   | 151 |   | (14 | ) |
|                                                                             |       |                  |       |                        |       |                  |       |                        |   |   |   |   |   |   |
| Redeemable preferred stock                                                       |       | —                |       | —                      |       | —                |       | —                      |   |   | — |   | — |   |
| Total fixed income securities                                                    | $          | 12,955                | $          | 262                         | $          | 4,634                 | $          | (374                        | ) | $ | 10,066 | $ | (392 | ) |

 
| ** **                     | ** ** | **Baa**               | ** ** | ** **                  | **Ba or lower** | ** ** | ** **            | **Total**  | ** **                  |
|--------------------------------|------------|-----------------------|------------|-----------------------------|---------------------------|------------|-----------------------|------------|-----------------------------|
| ** **                     | ** ** | **Fair********value** | ** ** | **Unrealized  gain/(loss)** | ** **                | ** ** | **Fair********value** | ** ** | **Unrealized  gain/(loss)** | ** ** | ** ** | **Fair********value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
| U.S. government and agencies   | $          | —                | $          | —                      |                      | $          | —                | $          | —                      |   | $ | 4,906 | $ | 190 |   |
|                           |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| Municipal                      |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| Tax exempt                     |       | 32                    |       | 3                           |                      |       | —                |       | —                      |   |   | 63 |   | 4 |   |
| Taxable                        |       | 749                   |       | (142                        | )                         |       | 63                    |       | (59                         | ) |   | 3,966 |   | (262 | ) |
| ARS                            |       | 43                    |       | (11                         | )                         |       | 12                    |       | (3                          | ) |   | 649 |   | (45 | ) |
|                           |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| Corporate                      |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| Public                         |       | 6,657                 |       | 236                         |                      |       | 524                   |       | (56                         | ) |   | 13,020 |   | 423 |   |
| Privately placed               |       | 6,025                 |       | (52                         | )                         |       | 1,324                 |       | (83                         | ) |   | 11,548 |   | 32 |   |
| Hybrid                         |       | 617                   |       | (181                        | )                         |       | 352                   |       | (63                         | ) |   | 1,539 |   | (361 | ) |
|                           |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| Foreign government             |       | 269                   |       | 7                           |                      |       | 23                    |       | —                      |   |   | 1,807 |   | 276 |   |
|                           |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| RMBS                           |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| U.S. Agency                    |       | —                |       | —                      |                      |       | —                |       | —                      |   |   | 2,624 |   | 88 |   |
| Prime                          |       | —                |       | —                      |                      |       | 24                    |       | (16                         | ) |   | 541 |   | (63 | ) |
| Alt-A                          |       | 80                    |       | (31                         | )                         |       | 159                   |       | (78                         | ) |   | 350 |   | (135 | ) |
| Subprime                       |       | 76                    |       | (73                         | )                         |       | 394                   |       | (633                        | ) |   | 1,038 |   | (1,018 | ) |
|                           |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| CMBS                           |       | 219                   |       | (154                        | )                         |       | 237                   |       | (307                        | ) |   | 2,481 |   | (1,154 | ) |
|                           |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| ABS                            |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| CDO                            |       | 217                   |       | (168                        | )                         |       | 327                   |       | (338                        | ) |   | 1,191 |   | (659 | ) |
| Consumer and other ABS         |       | 167                   |       | (21                         | )                         |       | 61                    |       | (14                         | ) |   | 583 |   | (57 | ) |
|                           |       |                  |       |                        |                      |       |                  |       |                        |   |   |   |   |   |   |
| Redeemable preferred stock     |       | 13                    |       | (1                          | )                         |       | 2                     |       | —                      |   |   | 15 |   | (1 | ) |
| Total  fixed income securities | $          | 15,164                | $          | (588                        | )                         | $          | 3,502                 | $          | (1,650                      | ) | $ | 46,321 | $ | (2,742 | ) |

 

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*MunicipalBonds,* includingtax exempt, taxable and ARS securities, totaled $4.68 billion as of September 30,2009 with an unrealized net capital loss of $303 million.  Taxable municipal bonds have an unrealizednet capital loss of $262 million resulting from wider credit spreads since thetime of initial purchase, which were largely due to the macroeconomicconditions and credit market deterioration that persisted into 2009, as well asissue or issuer specific conditions.

 

Included in ourmunicipal bond holdings at September 30, 2009 are $58 million of municipalsecurities which are not rated by third party credit rating agencies, but arerated by the NAIC and also internally rated. Our initial investment decisions and ongoing monitoring procedures forthese securities are based on a thorough due diligence process which includes,but is not limited to, an assessment of the credit quality, structure, andliquidity risks of the issue.

 

Municipal bonds include pre-refunded municipals withfair values of $3 million of Aaa and $21 million of A at September 30,2009.  Pre-refunded municipals aregenerally escrowed by Aaa rated securities, such as U.S. government orgovernmental agency securities. Municipal bonds with a fair value of $1.91 billion are insured by sixbond insurers.

 

*Corporatebonds,* includingpublically traded, privately placed and hybrid securities, totaled $26.11billion as of September 30, 2009 with unrealized net capital gain of $94million.  Privately placed securitiesprimarily consist of corporate issued senior debt securities that are inunregistered form or are directly negotiated with the borrower.  Privately placed corporate securities arerated by the NAIC in instances when information is provided to them.  Approximately 43.9% of the privately placedcorporate securities in our portfolio are rated by an independent ratingagency.

 

The followingtable shows additional details of our hybrid securities reported in corporatefixed income securities as of September 30, 2009.

 
| **($ in millions)**        | ** ** | **Public**            | ** ** | ** **                 | **Privately placed securities** | ** ** | ** **            | **Total**  | ** **                 |
|---------------------------------|------------|-----------------------|------------|----------------------------|---------------------------------|------------|-----------------------|------------|----------------------------|
| ** **                      | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** **                      | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** |
| United Kingdom (“UK”) | $          | 85                    | $          | (12                        | )                               | $          | 98                    | $          | (13                        | ) | $ | 183 | $ | (25 | ) |
| Europe (non-UK)                 |       | 156                   |       | (18                        | )                               |       | 383                   |       | (95                        | ) |   | 539 |   | (113 | ) |
| Asia/Australia                  |       | 34                    |       | (3                         | )                               |       | 254                   |       | (41                        | ) |   | 288 |   | (44 | ) |
| North America                   |       | 357                   |       | (107                       | )                               |       | 172                   |       | (72                        | ) |   | 529 |   | (179 | ) |
| Total                           | $          | 632                   | $          | (140                       | )                               | $          | 907                   | $          | (221                       | ) | $ | 1,539 | $ | (361 | ) |

 

Hybrid securities haveattributes most similar to those of fixed income securities such as statedinterest rates, mandatory redemption dates or an interest rate step-up featurewhich is intended to incent the issuer to redeem the security at a specifiedcall date.  Hybrid securities includepublicly-traded and privately placed securities. ** **While hybrid securities are generally issued byinvestment grade-rated financial institutions, they have structural featureswhich make them more sensitive to credit market deterioration.  Specifically, features allowing deferral ofpayment have significantly impacted prices as they continue to be impacted by thestress in the global financial system. $1.44 billion of our hybrid securities with $355 million of unrealizednet capital losses are Tier 1 securities, and $96 million with $6 million ofunrealized net capital losses are Tier 2 securities.  Tier 1 securities are lower in the capitalstructure than Tier 2 securities.

 

*RMBS*, *CMBS* and *ABS* are structured securities that are primarilycollateralized by residential and commercial real estate related loans andother consumer related borrowings.  Thecash flows 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, or rating class, which wouldoriginally qualify for a rating of Aaa typically has priority in receiving theprincipal repayments on the collateral. 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.  Senior Aaa classes generally share any lossesfrom the underlying collateral on a pro-rata basis after losses are absorbed byclasses with lower original ratings and include other “junior” or “subordinate”Aaa securities.  For certain senior Aaaclasses, the losses may be shared pro-rata. The collateral can have fixed interest rates, variable interest rates(such as adjustable rate mortgages (“ARM”)), or are hybrid, meaning that theycontain features of both fixed and variable rate mortgages.

 

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*RMBS*,including U.S. Agency, Prime, Alt-A and Subprime, totaled $4.55 billion, with87.4% rated investment grade, at September 30, 2009.  The RMBS portfolio is subject to interestrate risk since price volatility and the ultimate realized yield are affectedby the rate of prepayment of the underlying mortgages.  The credit risk associated with our RMBS ismitigated due to the fact that 57.6% of the portfolio consists of securitiesthat were issued by, or have underlying collateral that is guaranteed by, U.S.government agencies.  The following table shows our RMBS at September 30,2009 based upon vintage year.

 
| **($ in millions)** | ** ** | **U.S.  Agency** | ** ** | **Prime**                   | ** ** | ** **          | **Alt-A**  | ** **                  | ** ** | **Subprime** | ** **      | ** ** | **Total  RMBS**             | ** ** |
|--------------------------|------------|------------------|------------|-----------------------------|------------|---------------------|------------|-----------------------------|------------|--------------|-----------------|------------|-----------------------------|------------|
| ** **               | ** ** | **Fair  value**  | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair**

**value** | ** ** | **Unrealized  gain/(loss)** | ** ** | ** **   | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
| 2009                     | $          | 321              | $          | 4                           | $          | —              | $          | —                      |       | $            | —          | $          | —                      |       | $ | — | $ | — |   | $ | 321 | $ | 4 |   |
| 2008                     |       | 445              |       | 8                           |       | —              |       | —                      |       |         | —          |       | —                      |       |   | — |   | — |   |   | 445 |   | 8 |   |
| 2007                     |       | 135              |       | 4                           |       | 72                  |       | (11                         | )          |         | 37              |       | (25                         | )          |   | 291 |   | (414 | ) |   | 535 |   | (446 | ) |
| 2006                     |       | 189              |       | 7                           |       | 37                  |       | (12                         | )          |         | 58              |       | (24                         | )          |   | 274 |   | (300 | ) |   | 558 |   | (329 | ) |
| 2005                     |       | 352              |       | 11                          |       | 114                 |       | (24                         | )          |         | 108             |       | (44                         | )          |   | 215 |   | (188 | ) |   | 789 |   | (245 | ) |
| Pre-2005                 |       | 1,182            |       | 54                          |       | 318                 |       | (16                         | )          |         | 147             |       | (42                         | )          |   | 258 |   | (116 | ) |   | 1,905 |   | (120 | ) |
| Total                    | $          | 2,624            | $          | 88                          | $          | 541                 | $          | (63                         | )          | $            | 350             | $          | (135                        | )          | $ | 1,038 | $ | (1,018 | ) | $ | 4,553 | $ | (1,128 | ) |

 

Prime arecollateralized by residential mortgage loans issued to prime borrowers.  As of September 30, 2009, $455 millionof the Prime were fixed rate and $86 million were variable rate.

 

Alt-A includessecurities collateralized by residential mortgage loans issued to borrowerswith stronger credit profiles than subprime borrowers, but who do not qualifyfor prime financing terms due to high loan-to-value ratios or limitedsupporting documentation.  As of September 30,2009, $282 million of the Alt-A were fixed rate and $68 million were variablerate.

 

Subprime includessecurities that are collateralized by mortgage loans issued to borrowers thatcannot qualify for Prime or Alt-A financing terms due in part to weak orlimited credit history.  It also includessecurities that are collateralized by certain second lien mortgages regardlessof the borrower’s credit history.  TheSubprime portfolio consisted of $865 million and $170 million of first lien andsecond lien securities, respectively. Subprime included $517 million of fixed rate and $521 million ofvariable rate securities.  At September 30,2009, $201 million or 19.4% of the total Subprime securities are insured byfour bond insurers.

 

*CMBS* totaled $2.48 billion, with 89.7% rated investmentgrade, at September 30, 2009.  TheCMBS portfolio is subject to credit risk, but unlike certain other structuredsecurities, is generally not subject to prepayment risk due to protectionswithin the underlying commercial mortgages whereby borrowers are effectivelyrestricted from prepaying their mortgages due to changes in interestrates.  Of the CMBS investments, 93.6%are traditional conduit transactions collateralized by pools of commercialmortgages, broadly diversified across property types and geographicalarea.  The remainder consists ofnon-traditional CMBS such as small balance transactions, large loan pools andsingle borrower transactions.

 

Thefollowing table shows our CMBS portfolio at September 30, 2009 based uponvintage year.

 
| **($ in millions)** | ** ** | **Fair********value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
|-------------------------------|------------|-----------------------|------------|-----------------------------|------------|
| 2007                          | $          | 750                   | $          | (461                        | )          |
| 2006                          |       | 519                   |       | (480                        | )          |
| 2005                          |       | 359                   |       | (132                        | )          |
| Pre-2005                      |       | 853                   |       | (81                         | )          |
| Total  CMBS                   | $          | 2,481                 | $          | (1,154                      | )          |

 

The unrealized netcapital loss of $1.15 billion at September 30, 2009 on our CMBS portfoliowas the result of wider credit spreads than initial purchase levels, which waslargely due to the macroeconomic conditions and credit market deterioration,including the impact of real estate valuations, that has persisted into2009.  While CMBS spreads have tightenedduring 2009, credit spreads in most rating classes remain wider than initialpurchase levels, which is particularly evident in our 2005-2007 vintage yearsubordinated senior Aaa and non-traditional CMBS, as well as our 2005-2007vintage year Aa and lower rated securities. These holdings accounted for $968 million, or 83.9%, of the unrealizednet capital loss.  Our analysis indicatesthat the vast majority of our CMBS portfolio is well insulated from a severerise in commercial mortgage default rates.

 

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*ABS,* including CDO and Consumer and other ABS, totaled$1.77 billion, with 81.0% rated investment grade, at September 30,2009.  Credit risk is managed by monitoring the performanceof the collateral.  In addition, many ofthe securities in the ABS portfolio are credit enhanced with features such asover-collateralization, subordinated structures, reserve funds, guaranteesand/or insurance.  A portion of the ABSportfolio is also subject to interest rate risk since ultimate realized yieldsare affected by the rate of prepayment of the underlying assets.

 

CDO totaled $1.19billion, with 72.5% rated investment grade, at September 30, 2009.  CDO consist primarily of obligations securedby high yield and investment grade corporate credits including $906 million ofcash flow collateralized loan obligations (“CLO”) and $80 million of syntheticCDO with unrealized losses of $371 million and $148 million, respectively.  The remaining $205 million of securitiesconsisted of trust preferred CDO, market value CDO, project finance CDO, CDOsthat invest in CDOs, collateralized bond obligations and other CLO withunrealized losses of $140 million.

 

Cash flow CLO are structureswhere the underlying assets are primarily comprised of below investment gradesenior 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.  A transaction will typically issuenotes with various capital structure class (i.e. Aaa, Aa, A, etc.) as well asequity-like tranches.  In general, thesesecurities are structured with overcollaterization (“OC”) ratios andperformance is impacted by downgrades, defaults and recoveries of theunderlying assets within the structures. Downgrades of underlying assets, along with increased defaults reduce OCratios over time.  A violation of thesenior OC test, usually at the Aaa level, could result in an event of defaultof the structure.  This would give thecontrolling class certain rights which could include diverting cash flows orliquidating the underlying portfolio to pay off the senior liabilities.

 

Synthetic CDO primarily consist of a portfolio ofcorporate credit default swaps (“CDS”) which are collateralized by Aaa ratedLIBOR-based securities (i.e. “fully funded” synthetic CDO).  Our synthetic CDO collateral primarilyis actively managed by external managers monitoring the CDS selection andperformance.

 

Consumer and otherABS totaled $583 million, with 89.5% rated investment grade, at September 30,2009.  Consumer and other ABS consists of$193 million of auto, $75 million of credit card and $315 million of othersecurities with unrealized gains of $1 million, unrealized losses of $1 millionand unrealized losses of $57 million, respectively.

 

*Mortgage loans* Our mortgage loan portfolio totaled $8.67 billion at September 30,2009 and primarily comprised loans secured by first mortgages on developedcommercial real estate.  Keyconsiderations used to manage our exposure include property type and geographicdiversification.  Our exposure to anymetropolitan area is also highly diversified, with the largest exposure notexceeding 9.1% of the portfolio.  Theportfolio is diversified across several property types, with the largestconcentrations of 33.6% in office and 25.3% in retail property types.  Debt service coverage ratio represents theamount of cash flows from the property available to the borrower to meetprincipal and interest payment obligations. The average debt service coverage ratio of the portfolio as of September 30,2009 was 1.9, and only 4.9% of the mortgage loan portfolio had a debt servicecoverage ratio under 1.0 primarily related to instances where the borrower hasthe financial capacity to fund the revenue shortfalls from the properties forthe foreseeable term.

 

In the first nine monthsof 2009, $590 million of commercial mortgage loans were contractuallydue.  Of these, 59% were paid as due, 31%were extended generally for less than one year and 10% are in the process ofrefinancing or restructuring negotiations. In addition, $672 million that were not contractually due in the firstnine months of 2009 were paid in full. We currently have five loans totaling $35 million in the process of foreclosure.  We are aggressively pursuing workoutsolutions for $105 million of delinquent loans, which includes refinancing,extensions and sales.

 

The net carrying value ofimpaired loans at September 30, 2009 and December 31, 2008 was$217 million and $159 million, respectively.  We recognized $30 million and $73million of realized capital losses related to valuation allowances on mortgageloans for the three months and nine months ended September 30, 2009,respectively, primarily due to vacancies resulting from tenant bankruptcies andthe risk associated with refinancing near-term maturities due to decliningcollateral valuations.  Total valuationallowances of $72 million were held as of September 30, 2009.  Realized capital losses recognized onmortgage loans held for sale totaled $6 million for the nine months ended September 30,2009.

 

53

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*Limitedpartnership interests* consist of investments in private equity/debt funds, real estate fundsand hedge funds.  The overall limitedpartnership interests portfolio is well diversified across a number of metricsincluding fund sponsors, vintage years, strategies, geography (includinginternational), and company/property types.

 

The following tablepresents information about our limited partnership interests as of September 30,2009.

 
| **($ in millions)**

** **          | ** ** | **Private  equity/ debt  funds** | ** ** | **Real estate  funds** | ** ** | **Hedge  funds** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|------------------------|------------|------------------|------------|-----------|------------|
| Cost method of accounting (“Cost”)  | $          | 389                              | $          | 116                    | $          | —           | $          | 505       |       |
| Equity method of accounting (“EMA”) |       | 322                              |       | 156                    |       | 34               |       | 512       |       |
| Total                                         | $          | 711                              | $          | 272                    | $          | 34               | $          | 1,017     |       |
|                                          |       |                             |       |                   |       |             |       |      |       |
| Number of sponsors                            |       | 72                               |       | 31                     |       | 1                |       |      |       |
| Number of individual funds                    |       | 111                              |       | 57                     |       | 2                |       |      |       |
| Largest exposure to single fund               | $          | 22                               | $          | 18                     | $          | 23               |       |      |       |

 

Our aggregate limitedpartnership exposure represented 1.7% and 2.0% of total invested assets as of September 30,2009 and December 31, 2008, respectively.

 

The following table shows the results from our limitedpartnership interests by fund type and accounting classification.

 
| **($ in millions)**   | ** ** | **Three months ended********September 30,** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|
| ** **                 | ** ** | **2009**                                         | ** ** | ** ** | **2008** | ** ** |
| ** **                 | ** ** | **Cost**                                         | ** ** | **EMA****(1)** | ** ** | ** ** | **Total********income** | ** ** | ** ** | **Impairment write-downs****(2)** | ** ** | ** ** | **Cost** | ** ** | **EMA****(1)** | ** ** | ** ** | **Total********income** | ** ** | ** ** | **Impairment write-downs****(2)** | ** ** |
| Private equity/ debt funds | $          | 2                                                | $          | 5 |   | $ | 7 |   | $ | (2 | ) | $ | 5 | $ | — |   | $ | 5 |   | $ | — |   |
| Real estate funds          |       | —                                           |       | (12 | ) |   | (12 | ) |   | (25 | ) |   | — |   | (6 | ) |   | (6 | ) |   | (27 | ) |
| Hedge funds                |       | —                                           |       | 1 |   |   | 1 |   |   | — |   |   | — |   | (3 | ) |   | (3 | ) |   | — |   |
| Total                      | $          | 2                                                | $          | (6 | ) | $ | (4 | ) | $ | (27 | ) | $ | 5 | $ | (9 | ) | $ | (4 | ) | $ | (27 | ) |

 
| ** **                 | ** ** | **Nine months ended********September 30,** | ** ** |
|----------------------------|------------|-------------------------------------------------|------------|
| ** **                 | ** ** | **2009**                                        | ** ** | ** ** | **2008** | ** ** |
| ** **                 | ** ** | **Cost**                                        | ** ** | **EMA****(1)** | ** ** | ** ** | **Total********income** | ** ** | ** ** | **Impairment  write-downs****(2)** | ** ** | ** ** | **Cost** | ** ** | **EMA****(1)** | ** ** | ** ** | **Total********income** | ** ** | ** ** | **Impairment  write-downs****(2)** | ** ** |
| Private equity/ debt funds | $          | 6                                               | $          | (40 | ) | $ | (34 | ) | $ | (43 | ) | $ | 16 | $ | 26 |   | $ | 42 |   | $ | (4 | ) |
| Real estate funds          |       | —                                          |       | (78 | ) |   | (78 | ) |   | (99 | ) |   | 3 |   | (7 | ) |   | (4 | ) |   | (30 | ) |
| Hedge funds                |       | —                                          |       | 2 |   |   | 2 |   |   | — |   |   | — |   | (5 | ) |   | (5 | ) |   | — |   |
| Total                      | $          | 6                                               | $          | (116 | ) | $ | (110 | ) | $ | (142 | ) | $ | 19 | $ | 14 |   | $ | 33 |   | $ | (34 | ) |

 

----

(1)   Beginning in the fourthquarter of 2008, income from EMA limited partnerships (“EMA LP”) is reported inrealized capital gains and losses.  EMALP income for periods prior to the fourth quarter of 2008 is reported in netinvestment income.

 

(2)   Impairment write-downsrelated to Cost limited partnerships were $27 million and $137 million in thethree months and nine months ended September 30, 2009, respectively,compared to $26 million and $33 million in the three months and nine monthsended September 30, 2008, respectively. Impairment write-downs related to EMA LP were $5 million in the ninemonths ended September 30, 2009 compared to $1 million and $1 million thethree months and nine months ended September 30, 2008, respectively.  There were no impairment write-downs relatedto EMA LP in the three months ended September 30, 2009.

 

Limited partnership interests, excluding impairmentwrite-downs, generated losses of $4 million and $110 million in the threemonths and nine months ended September 30, 2009, respectively, compared tolosses of $4 million and income of $33 million in the three months and ninemonths ended September 30, 2008, respectively.  The loss from limited partnership interestsin the nine months ended September 30, 2009 compared to income in the ninemonths ended September 30, 2008 is primarily related to losses frompartnerships accounted for under the equity method of accounting resulting fromreduced valuations on the net asset value of the partnerships.  Income on EMA LP is recognized on a delay dueto the availability of the related financial statements.  The recognition of income on hedge funds isprimarily on a one-month delay and the income recognition on privateequity/debt funds 

 

54

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and real estate funds are generally on a three-monthdelay.  Limited partnership interestsaccounted for under the cost method of accounting recognize income only uponcash distributions by the partnership.

 

**Unrealizednet capital losses**totaled $2.74 billion as of September 30, 2009, compared to unrealized netcapital losses of $5.75 billion as of June 30, 2009, $7.46 billion as of March 31,2009 and $6.70 billion as of December 31, 2008.  The decrease since December 31, 2008 forfixed income securities was primarily a result of tightening credit spreads oncertain fixed income securities during 2009 that more than offset the rise inrisk-free interest rates.  The unrealizednet capital gain for equity securities as of September 30, 2009 comparedto unrealized net capital loss as of December 31, 2008 was a result ofimprovements in equity security valuations as a result of improving equitymarket conditions.  The following tablepresents unrealized net capital gains and losses, pre-tax and after-tax.

 
| **($ in millions)**                           | ** ** | **September 30,********2009** | ** ** | ** ** | **June 30,  2009** | ** ** | ** ** | **March 31,  2009** | ** ** | ** ** | **December 31,  2008** | ** ** |
|----------------------------------------------------|------------|------------------------------------|------------|------------|-------------------------|------------|------------|--------------------------|------------|------------|-----------------------------|------------|
| U.S. government and  agencies                      | $          | 190                                |       | $          | 213                     |       | $          | 459                      |       | $          | 895                         |       |
| Municipal                                          |       | (303                               | )          |       | (489                    | )          |       | (600                     | )          |       | (668                        | )          |
| Corporate                                          |       | 94                                 |       |       | (1,458                  | )          |       | (3,233                   | )          |       | (3,147                      | )          |
| Foreign government                                 |       | 276                                |       |       | 222                     |       |       | 348                      |       |       | 448                         |       |
| RMBS                                               |       | (1,128                             | )          |       | (1,375                  | )          |       | (1,147                   | )          |       | (960                        | )          |
| CMBS                                               |       | (1,154                             | )          |       | (1,737                  | )          |       | (2,033                   | )          |       | (1,982                      | )          |
| ABS                                                |       | (716                               | )          |       | (1,107                  | )          |       | (1,253                   | )          |       | (1,270                      | )          |
| Redeemable preferred stock                         |       | (1                                 | )          |       | (4                      | )          |       | (7                       | )          |       | (6                          | )          |
| Fixed income securities (1)                        |       | (2,742                             | )          |       | (5,735                  | )          |       | (7,466                   | )          |       | (6,690                      | )          |
| Equity securities                                  |       | 21                                 |       |       | (4                      | )          |       | (17                      | )          |       | (24                         | )          |
| Short-term investments                             |       | —                             |       |       | —                  |       |       | 2                        |       |       | 3                           |       |
| Derivatives                                        |       | (19                                | )          |       | (11                     | )          |       | 20                       |       |       | 14                          |       |
| Unrealized net capital gains and losses, pre-tax   |       | (2,740                             | )          |       | (5,750                  | )          |       | (7,461                   | )          |       | (6,697                      | )          |
| Amounts recognized for:                            |       |                               |       |       |                    |       |       |                     |       |       |                        |       |
| Insurance reserves (2)                             |       | —                             |       |       | —                  |       |       | —                   |       |       | (378                        | )          |
| DAC and DSI (3)                                    |       | 2,679                              |       |       | 4,061                   |       |       | 3,778                    |       |       | 3,493                       |       |
| Amounts recognized                                 |       | 2,679                              |       |       | 4,061                   |       |       | 3,778                    |       |       | 3,115                       |       |
|                                               |       |                               |       |       |                    |       |       |                     |       |       |                        |       |
| Deferred income taxes                              |       | 16                                 |       |       | 586                     |       |       | 1,283                    |       |       | 1,245                       |       |
| Unrealized net capital gains and losses, after-tax | $          | (45                                | )          | $          | (1,103                  | )          | $          | (2,400                   | )          | $          | (2,337                      | )          |

 

----

(1)   Unrealized net capital gainsand losses for fixed income securities as of September 30, 2009 and June 30,2009 comprises $(436) million and $(384) million, respectively, related tounrealized net capital losses on fixed income securities withother-than-temporary impairment and $(2,306) million and $(5,351) million,respectively, related to other unrealized net capital gains and losses.

 

(2)   The insurance reservesadjustment represents the amount by which the reserve balance would increase ifthe net unrealized gains in the applicable product portfolios were realized andreinvested at current lower interest rates, resulting in a premium deficiency.  Although we evaluate premium deficiencies onthe combined performance of our life insurance and immediate annuities withlife contingencies, the adjustment primarily relates to structured settlementannuities with life contingencies, in addition to annuity buy-outs and certainpayout annuities with life contingencies. The insurance reserves adjustment changed to zero as of March 31,2009 due to the applicable product portfolios now being in an aggregate netunrealized loss position.  The change inthe unrealized balance resulted from realizing prior unrealized gains upon thesale of certain government securities in the first quarter of 2009.

 

(3)   The DAC and DSI adjustmentrepresents the amount by which the amortization of DAC and DSI would increaseor decrease if the unrealized gains or losses in the respective productportfolios were realized.  Only theunrealized net capital losses on the fixed annuity and interest-sensitive lifeproduct portfolios are used in this calculation.  Recapitalization of the DAC and DSI balancesis limited to the originally deferred costs plus interest.  The DAC adjustment (85% of the total DAC andDSI adjustment balance) was limited as of December 31, 2008 and March 31,2009 because the calculated amount, when added to the DAC balance before theimpact of unrealized capital gains and losses, was greater than originallydeferred costs plus interest.  The DSIadjustment was limited in all periods presented.  In periods subsequent to the adjustmentreaching the limitation, the change in the adjustment will not trend in alinear relationship with the change in unrealized gains and losses until suchtime as the adjustment is below the limitation. The DAC adjustment came below the limitation as of June 30, 2009and remains below at September 30, 2009. The DSI adjustment remains at its limitation at September 30,2009.  The limitation amount changes fromperiod to period based on changes in the DAC and DSI balances before the impactof unrealized capital gains and losses, as well as new deferrals and interest.

 

The net unrealized loss for the fixed incomeportfolio totaled $2.74 billion, comprised of $1.81 billion of gross unrealizedgains and $4.55 billion of gross unrealized losses at September 30,2009.  This is compared to a netunrealized loss for the fixed income portfolio totaling $6.69 billion,comprised of $1.92 billion of gross unrealized gains and $8.61 billion of grossunrealized losses at December 31, 2008.

 

55

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Grossunrealized gains and losses as of September 30, 2009 on fixed incomesecurities by type and sector are provided in the table below.

 
| **($ in millions)**                   | ** ** | ** **       | ** ** | ** **    | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Amortized**        | ** ** | ** **              | ** ** |
|--------------------------------------------|------------|------------------|------------|---------------|------------|----------------------|------------|------------|------------|------------|----------------|------------|----------------------|------------|-------------------------|------------|
| ** **                                 | ** ** | ** **       | ** ** | ** **    | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **cost as a**        | ** ** | **Fair value**          | ** ** |
| ** **                                 | ** ** | **Par**          | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | ** ** | **Fair**   | ** ** | **percent of** | ** ** | **as a percent**     | ** ** |
| ** **                                 | ** ** | **value****(1)** | ** ** | **cost**      | ** ** | **Gains**            | ** ** | **Losses** | ** ** | ** ** | **value**      | ** ** | **par value****(2)** | ** ** | **of par value****(2)** | ** ** |
| Corporate:                                 |       |             |       |          |       |                 |       |       |       |       |           |       |                 |       |                    |       |
| Banking                                    | $          | 3,605            | $          | 3,391         | $          | 38                   | $          | (417       | )          | $          | 3,012          |       | 94.1                 | %          | 83.6                    | %          |
| Financial services                         |       | 2,516            |       | 2,463         |       | 69                   |       | (129       | )          |       | 2,403          |       | 97.9                 |       | 95.5                    |       |
| Utilities                                  |       | 5,108            |       | 5,094         |       | 317                  |       | (92        | )          |       | 5,319          |       | 99.7                 |       | 104.1                   |       |
| Consumer goods (cyclical and non-cyclical) |       | 3,782            |       | 3,790         |       | 189                  |       | (80        | )          |       | 3,899          |       | 100.2                |       | 103.1                   |       |
| Other                                      |       | 1,272            |       | 1,128         |       | 38                   |       | (60        | )          |       | 1,106          |       | 88.7                 |       | 86.9                    |       |
| Capital goods                              |       | 2,706            |       | 2,702         |       | 117                  |       | (54        | )          |       | 2,765          |       | 99.9                 |       | 102.2                   |       |
| Transportation                             |       | 1,404            |       | 1,418         |       | 62                   |       | (49        | )          |       | 1,431          |       | 101.0                |       | 101.9                   |       |
| Basic industry                             |       | 1,286            |       | 1,300         |       | 48                   |       | (36        | )          |       | 1,312          |       | 101.1                |       | 102.0                   |       |
| Communications                             |       | 1,464            |       | 1,464         |       | 72                   |       | (27        | )          |       | 1,509          |       | 100.0                |       | 103.1                   |       |
| Technology                                 |       | 690              |       | 700           |       | 31                   |       | (17        | )          |       | 714            |       | 101.4                |       | 103.5                   |       |
| Energy                                     |       | 1,648            |       | 1,660         |       | 79                   |       | (14        | )          |       | 1,725          |       | 100.7                |       | 104.7                   |       |
| FDIC guaranteed                            |       | 898              |       | 903           |       | 9                    |       | —     |       |       | 912            |       | 100.6                |       | 101.6                   |       |
| Total corporate fixed income portfolio     |       | 26,379           |       | 26,013        |       | 1,069                |       | (975       | )          |       | 26,107         |       | 98.6                 |       | 99.0                    |       |
|                                       |       |             |       |          |       |                 |       |       |       |       |           |       |                 |       |                    |       |
| U.S. government and agencies               |       | 5,022            |       | 4,716         |       | 192                  |       | (2         | )          |       | 4,906          |       | 93.9                 |       | 97.7                    |       |
| Municipal                                  |       | 9,083            |       | 4,981         |       | 125                  |       | (428       | )          |       | 4,678          |       | 54.8                 |       | 51.5                    |       |
| Foreign government                         |       | 2,074            |       | 1,531         |       | 277                  |       | (1         | )          |       | 1,807          |       | 73.8                 |       | 87.1                    |       |
| RMBS                                       |       | 5,965            |       | 5,681         |       | 93                   |       | (1,221     | )          |       | 4,553          |       | 95.2                 |       | 76.3                    |       |
| CMBS                                       |       | 3,678            |       | 3,635         |       | 27                   |       | (1,181     | )          |       | 2,481          |       | 98.8                 |       | 67.5                    |       |
| ABS                                        |       | 3,026            |       | 2,490         |       | 22                   |       | (738       | )          |       | 1,774          |       | 82.3                 |       | 58.6                    |       |
| Redeemable preferred stock                 |       | 21               |       | 16            |       | —               |       | (1         | )          |       | 15             |       | 76.2                 |       | 71.4                    |       |
| Total fixed income securities              | $          | 55,248           | $          | 49,063        | $          | 1,805                | $          | (4,547     | )          | $          | 46,321         |       | 88.8                 |       | 83.8                    |       |

 

----

(1)   Included in par value are zero-coupon securities that aregenerally purchased at a deep discount to the par value that is received atmaturity.  These included corporate,municipal, foreign government and U.S. government and agencies zero-couponsecurities with par value of $857 million, $5.46 billion, $1.31 billion and$1.30 billion, respectively.

 

(2)   Excluding the impact of zero-coupon securities, the percentage ofamortized cost to par value would be 99.4% for corporates, 99.3% formunicipals, 103.5% for foreign governments, and 101.5% for U.S. government andagencies.  Similarly, excluding theimpact of zero-coupon securities, the percentage of fair value to par valuewould be 99.6% for corporates, 98.2% for municipals, 111.7% for foreigngovernments, and 102.8% for U.S. government and agencies.

 

The banking, financial services, utilitiesand consumer goods sectors had the highest concentration of gross unrealizedlosses in our corporate fixed income securities portfolio at September 30,2009.  While credit spreads havetightened in the second and third quarters of 2009 from the historically highlevels observed in the fourth quarter of 2008 and the first quarter of 2009,they remain wider than levels at initial purchase for certain securities in theportfolio.  As of September 30,2009, $781 million or 80.1% of the gross unrealized losses in the corporatefixed income portfolio relate to securities rated investment grade.  $2.10 billion or 58.8% of the grossunrealized losses in the remaining fixed income securities relate to securitiesrated investment grade.

 

For fixed income securities, 68.4% of the grossunrealized losses at September 30, 2009 were from $3.11 billion ofsecurities with a fair value below 70% of amortized cost, or 6.0% of our fixedincome portfolio.  The percentageof fair value to amortized cost for fixed income securities with grossunrealized losses at September 30, 2009 are shown in the following table.

 
| **($ in millions)**                                    | ** ** | **Amortized********cost** | ** ** | **Unrealized********gain/(loss)** | ** ** | ** ** | **Fair********value** | ** ** | **Percent  to********total  fixed********income********securities** | ** ** |
|-------------------------------------------------------------|------------|---------------------------|------------|-----------------------------------|------------|------------|-----------------------|------------|---------------------------------------------------------------------|------------|
| > 80% of amortized  cost                                 | $          | 13,024                    | $          | (893                              | )          | $          | 12,131                |       | 26.2                                                                | %          |
| 70% to 80% of amortized  cost                               |       | 2,154                     |       | (546                              | )          |       | 1,608                 |       | 3.5                                                                 |       |
| < 70% of amortized  cost                                 |       | 5,895                     |       | (3,108                            | )          |       | 2,787                 |       | 6.0                                                                 |       |
| Gross unrealized losses on fixed income securities          |       | 21,073                    |       | (4,547                            | )          |       | 16,526                |       | 35.7                                                                |       |
| Gross unrealized gains on fixed income securities           |       | 27,990                    |       | 1,805                             |       |       | 29,795                |       | 64.3                                                                |       |
| Net unrealized gains and losses on fixed income  securities | $          | 49,063                    | $          | (2,742                            | )          | $          | 46,321                |       | 100.0                                                               | %          |

 

56

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The following table presents gross unrealized lossesby type of fixed income security with a fair value below 70% of amortized costat September 30, 2009.

 
| **($ in millions)**       | ** ** | **Fair value** | ** ** | **Gross unrealized  losses** | ** ** |
|--------------------------------|------------|----------------|------------|------------------------------|------------|
| Municipal                      | $          | 241            | $          | (221                         | )          |
| Corporate                      |       | 350            |       | (221                         | )          |
| RMBS                           |       | 730            |       | (1,039                       | )          |
| CMBS                           |       | 791            |       | (986                         | )          |
| ABS                            |       | 675            |       | (641                         | )          |
| Total  fixed income securities | $          | 2,787          | $          | (3,108                       | )          |

 

We continue tobelieve that the unrealized losses on these securities are not predictive ofthe ultimate performance.  The unrealizedlosses should reverse over the remaining lives of the securities.  As of September 30, 2009, we do not havethe intent to sell and it is not more likely than not we will be required tosell these securities before the recovery of their amortized cost basis.  Our evaluation of whether it is more likelythan not we will be required to sell a security before recovery of itsamortized cost basis is substantially enhanced by our liquidity position, whichcushions us from the need to liquidate securities with significant unrealizedlosses to meet cash obligations.  Duringthe first nine months of 2009, our fixed income securities portfolio providedapproximately $4.28 billion in principal and interest cash flows, of whichsubstantially all have been received in accordance with the contractual terms.

 

While the federalgovernment is working to re-establish liquidity for certain RMBS, CMBS and ABSissues, we continue to have unrealized losses on a fair value reportingbasis.  We anticipate that thesesecurities will recover in line with our best estimate of the expected cashflows which are used for other-than-temporary impairment evaluations as well asmanaging the portfolio.

 

The net unrealized gain for the equityportfolio totaled $21 million, comprised of $29 million of unrealized gains and$8 million of unrealized losses at September 30, 2009.  This is compared to a net unrealized loss forthe equity portfolio totaling $24 million, comprised of $1 million ofunrealized gains and $25 million of unrealized losses at December 31,2008.  Within the equity portfolio, thelosses were in the banking, real estate and financial services sectors.  The unrealized losses in these sectors werecompany and sector specific.  Asof September 30, 2009, we have the intent and ability to hold our equitysecurities with unrealized losses until recovery.

 

We have a comprehensiveportfolio monitoring process to identify and evaluate each fixed income andequity security whose carrying value may be other-than-temporarilyimpaired.  The process includes aquarterly review of all securities through a screening process which identifiesinstances where the fair value compared to amortized cost for fixed incomesecurities and cost for equity securities is below established thresholds, andalso includes the monitoring of other criteria such as ratings, ratingsdowngrades or payment defaults.  Thesecurities identified, in addition to other securities for which we may have aconcern, are evaluated based on facts and circumstances for inclusion on ourwatch-list.  All investments in an unrealized loss position at September 30,2009 were included in our portfolio monitoring process for determining whetherdeclines in value were other than temporary.

 

57

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The following table summarizes fixed incomeand equity securities in a gross unrealized loss position according tosignificance, aging and investment grade classification.

 
| **($ in millions, except number of issues)**                                                                                                                     | ** ** | **September 30,  2009** | ** ** | ** ** | **December 31,  2008**  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **Fixed  income**            | ** ** | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Fixed  income** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                                 | ** ** | **Investment  grade**        | ** ** | ** ** | **Below  investment  grade** | ** ** | ** ** | **Equity** | ** ** | ** ** | **Total** | ** ** | ** ** | **Investment  grade** | ** ** | ** ** | **Below  investment  grade** | ** ** | ** ** | **Equity** | ** ** | ** ** | **Total** | ** ** |
|                                                                                                                                                                       |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (I): Unrealized  loss less than 20% of cost (1) (2)                                                                                                     |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number  of issues                                                                                                                                                          |       | 983                          |       |       | 138                          |       |   | 4 |   |   | 1,125 |   |   | 1,933 |   |   | 113 |   |   | 4 |   |   | 2,050 |   |
| Fair  value                                                                                                                                                                | $          | 11,252                       |       | $          | 879                          |       | $ | 4 |   | $ | 12,135 |   | $ | 18,433 |   | $ | 622 |   | $ | 31 |   | $ | 19,086 |   |
| Unrealized                                                                                                                                                                 | $          | (819                         | )          | $          | (74                          | )          | $ | (1 | ) | $ | (894 | ) | $ | (1,627 | ) | $ | (82 | ) | $ | (3 | ) | $ | (1,712 | ) |
|                                                                                                                                                                       |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (II):  Unrealized loss greater than or equal to 20% of cost for a period of less  than 6 consecutive months (1) (2)                                          |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number  of issues                                                                                                                                                          |       | 20                           |       |       | 17                           |       |   | 4 |   |   | 41 |   |   | 853 |   |   | 183 |   |   | 35 |   |   | 1,071 |   |
| Fair  value                                                                                                                                                                | $          | 165                          |       | $          | 72                           |       | $ | 11 |   | $ | 248 |   | $ | 6,346 |   | $ | 802 |   | $ | 24 |   | $ | 7,172 |   |
| Unrealized                                                                                                                                                                 | $          | (61                          | )          | $          | (41                          | )          | $ | (3 | ) | $ | (105 | ) | $ | (4,442 | ) | $ | (553 | ) | $ | (22 | ) | $ | (5,017 | ) |
|                                                                                                                                                                       |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 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) (2) |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number  of issues                                                                                                                                                          |       | 206                          |       |       | 59                           |       |   | 3 |   |   | 268 |   |   | 193 |   |   | 19 |   |   | — |   |   | 212 |   |
| Fair  value                                                                                                                                                                | $          | 1,266                        |       | $          | 390                          |       | $ | 14 |   | $ | 1,670 |   | $ | 783 |   | $ | 79 |   | $ | — |   | $ | 862 |   |
| Unrealized                                                                                                                                                                 | $          | (670                         | )          | $          | (289                         | )          | $ | (4 | ) | $ | (963 | ) | $ | (1,579 | ) | $ | (139 | ) | $ | — |   | $ | (1,718 | ) |
|                                                                                                                                                                       |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (IV):  Unrealized loss greater than or equal to 20% of cost for 12 or more  consecutive months (1) (2)                                                       |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number  of issues                                                                                                                                                          |       | 270                          |       |       | 181                          |       |   | — |   |   | 451 |   |   | 33 |   |   | 4 |   |   | — |   |   | 37 |   |
| Fair  value                                                                                                                                                                | $          | 1,612                        |       | $          | 890                          |       | $ | — |   | $ | 2,502 |   | $ | 66 |   | $ | 7 |   | $ | — |   | $ | 73 |   |
| Unrealized                                                                                                                                                                 | $          | (1,333                       | )          | $          | (1,260                       | )          | $ | — |   | $ | (2,593 | ) | $ | (176 | ) | $ | (13 | ) | $ | — |   | $ | (189 | ) |
|                                                                                                                                                                       |       |                         |       |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  number of issues                                                                                                                                                    |       | 1,479                        |       |       | 395                          |       |   | 11 |   |   | 1,885 |   |   | 3,012 |   |   | 319 |   |   | 39 |   |   | 3,370 |   |
| Total  fair value                                                                                                                                                          | $          | 14,295                       |       | $          | 2,231                        |       | $ | 29 |   | $ | 16,555 |   | $ | 25,628 |   | $ | 1,510 |   | $ | 55 |   | $ | 27,193 |   |
| Total  unrealized losses                                                                                                                                                   | $          | (2,883                       | )          | $          | (1,664                       | )          | $ | (8 | ) | $ | (4,555 | ) | $ | (7,824 | ) | $ | (787 | ) | $ | (25 | ) | $ | (8,636 | ) |

 

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(1)   For fixedincome securities, cost represents amortized cost.

 

(2)   Gross unrealized lossesresulting from factors other than credit on fixed income securities withother-than-temporary impairments for which we have recorded a credit loss inearnings are included as follows: Category (I) $3million, Category (II) $12 million, Category (III) $74 million, andCategory (IV) $377 million.

 

The largest individual unrealized loss was$11 million for Category (I), $15 million for Category (II), $48 million forCategory (III) and $32 million for Category (IV) as of September 30,2009.

 

Categories (I) and (II) havegenerally been adversely affected by overall economic conditions includinginterest rate increases and the market’s evaluation of certain sectors.  The degree to which and/or length of timethat the securities have been in an unrealized loss position does not suggestthat these securities pose a high risk of being other-than-temporarilyimpaired.

 

Categories (III) and (IV) areaffected by macroeconomic and credit pressures upon real estate valuations andborrowers, and issue, issuer or industry specific conditions.  All of the securities in these categories aremonitored for other-than-temporary impairment.

 

Category (III) and (IV) fixedincome securities at September 30, 2009 are listed in the following table.

 
| **($ in  millions)** | ** ** | **Category  (III)**   | ** ** | ** **             | **Category  (IV)** | ** ** |
|---------------------------|------------|-----------------------|------------|------------------------|--------------------|------------|
| ** **                | ** ** | **Fair********value** | ** ** | **Unrealized  losses** | ** **         | ** ** | **Fair********value** | ** ** | **Unrealized  losses** | ** ** |
| ** **                | ** ** | ** **            | ** ** | ** **             | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Municipal                 | $          | 383                   | $          | (264                   | )                  | $          | 24 | $ | (14 | ) |
| Corporate                 |       | 426                   |       | (193                   | )                  |       | 532 |   | (224 | ) |
| CMBS                      |       | 382                   |       | (219                   | )                  |       | 689 |   | (864 | ) |
| RMBS                      |       | 380                   |       | (240                   | )                  |       | 551 |   | (864 | ) |
| ABS                       |       | 85                    |       | (43                    | )                  |       | 706 |   | (627 | ) |
|                      | $          | 1,656                 | $          | (959                   | )                  | $          | 2,502 | $ | (2,593 | ) |

 

58

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Gross unrealized losses on fixed incomesecurities in Category (II) decreased $4.89 billion since December 31,2008.  This change was primarily theresult of losses shifting into Category (III) and (IV) due tocontinued aging of losses in a continuous unrealized loss position of greaterthan or equal to 20% of amortized cost and the resetting of unrealized lossesto the historical point of impairment for securities impacted by the adoptionof new OTTI accounting guidance on April 1, 2009.  The remainder of the reduction in Category (II) isa result of improved market conditions resulting in higher valuations, whicheither caused a shift to Category (I) or created an overall grossunrealized gain position.

 

The gross unrealized losses on fixed incomesecurities in Category (III) and (IV) totaled $3.55 billion at September 30,2009 and comprised $2.00 billion of investment grade securities and $1.55billion of below investment grade securities.  Consistent with theirrating, our monitoring indicates that the investment grade securities have arelatively low risk of default.  $1.48 billion and $1.38 billion ofinvestment grade and below investment grade securities, respectively, relate toRMBS, CMBS and ABS which we determined through our best estimate of future cashflows to have sufficient expected cash flows to recover our amortized costbasis or which are reliably insured.  Additionally, $451 million ofCategory (III) and (IV) unrealized losses relate to factors otherthan credit on other-than-temporarily impaired securities for which a creditloss was recognized in earnings.

 

We continue to believe that the unrealizedlosses on these securities are not predictive of the ultimate performance.

 

Whenever ourinitial analysis indicates that a fixed income security’s unrealized loss of20% or more for at least 36 months or any equity security’s unrealized loss of20% or more for at least 12 months is temporary, additional evaluations andmanagement approvals are required to substantiate that the unrealized loss isrelated to other factors and recognition of a credit loss write-down is notappropriate.  As of September 30,2009, no securities met these criteria.

 

We also monitor the quality of our fixedincome and bank loan portfolios by categorizing certain investments as “problem”,“restructured” or “potential problem.” Problem fixed income securities and bank loans are in default withrespect to principal or interest and/or are investments issued by companiesthat have gone into bankruptcy subsequent to our acquisition or loan.  Fixed income and bank loan investments arecategorized as restructured when the debtor is in financial difficulty and wegrant a concession.  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 according to the original terms, which causes us to believe theseinvestments may be classified as problem or restructured in the future.

 

59

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The following table summarizes problem, restructured and potentialproblem fixed income securities and bank loans, which are reported in otherinvestments.

 
| **($ in millions)**              | ** ** | **September 30, 2009** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **Par   value****(1)**      | ** ** | **Amortized  cost ****(1)** | ** ** | **Amortized  cost as a  percent of  par value** | ** ** | ** ** | **Fair********value ****(2)** | ** ** | **Fair********value as a  percent of   par value** | ** ** | **Percent of  total fixed  income and  bank loan  portfolios** | ** ** |
| Restructured                          | $          | 67                          | $          | 53 |   | 79.1 | % | $ | 49 |   | 73.1 | % | 0.1 | % |
| Problem                               |       | 864                         |       | 222 |   | 25.7 |   |   | 184 |   | 21.3 |   | 0.4 |   |
| Potential problem                     |       | 1,872                       |       | 1,320 |   | 70.5 |   |   | 730 |   | 39.0 |   | 1.6 |   |
| Total                                 | $          | 2,803                       | $          | 1,595 |   | 56.9 |   | $ | 963 |   | 34.4 |   | 2.1 | % |
| Cumulative write-downs recognized (3) |       |                        | $          | 1,064 |   |   |   |   |   |   |   |   |   |   |

 
| ** **                            | ** ** | **December 31, 2008** | ** ** |
|---------------------------------------|------------|----------------------------|------------|
| ** **                            | ** ** | **Par   value****(1)**     | ** ** | **Amortized  cost ****(1)** | ** ** | **Amortized  cost as a  percent of  par value** | ** ** | ** ** | **Fair********value ****(2)** | ** ** | **Fair********value as a  percent of   par value** | ** ** | **Percent of  total fixed  income and  bank loan  portfolios** | ** ** |
| Restructured                          | $          | 71                         | $          | 57 |   | 80.3 | % | $ | 57 |   | 80.3 | % | 0.1 | % |
| Problem                               |       | 837                        |       | 188 |   | 22.5 |   |   | 147 |   | 17.6 |   | 0.3 |   |
| Potential problem                     |       | 1,194                      |       | 432 |   | 36.2 |   |   | 297 |   | 24.9 |   | 0.7 |   |
| Total                                 | $          | 2,102                      | $          | 677 |   | 32.2 |   | $ | 501 |   | 23.8 |   | 1.1 | % |
| Cumulative write-downs recognized (3) |       |                       | $          | 1,294 |   |   |   |   |   |   |   |   |   |   |

 

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| (1)    | The difference between par value and amortized cost of  $1.21 billion at September 30, 2009 and $1.43 billion at  December 31, 2008 is primarily attributable to write-downs.  Par value has been reduced by principal  payments. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                             |
| (2)    | Bank  loans are reflected at amortized cost.                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                             |
| (3)    | Cumulative  write-downs recognized only reflects impairment write-downs related to  investments within the problem, potential problem and restructured  categories.                                                                              |

 

At September 30,2009, amortized cost for the problem category was $222 million and wascomprised of $79 million of corporates (primarily privately placed), $61million of bank loans, $51 million of Subprime, $12 million of municipal bonds,$9 million of other CDO, $9 million of Consumer and other ABS and $1 million ofAlt-A.  The increase of $34 million over December 31,2008 is primarily attributable to the addition of bank loans and Subprime.  The amortized cost of problem investmentswith a fair value less than 70% of amortized cost totaled $79 million, withunrealized losses of $54 million and fair value of $25 million.

 

At September 30,2009, amortized cost for the potential problem category was $1.32 billion andwas comprised of $464 million of Subprime, $424 million of corporates(primarily privately placed and hybrids), $160 million of Alt-A, $125 millionof other CDO, $93 million of CMBS, $24 million of bank loans, $23 million ofmunicipal bonds and $7 million of Consumer and other ABS.  The increase of $888 million from December 31,2008 is primarily attributable to the additions of Subprime and corporates(primarily privately placed).  Theamortized cost of potential problem investments with a fair value less than 70%of amortized cost totaled $918 million, with unrealized losses of $592 millionand fair value of $326 million.

 

We evaluated each of theseinvestments through our portfolio monitoring process at September 30, 2009and recorded write-downs reflecting the estimated credit loss when appropriate.  We further concluded that any remainingunrealized losses on these investments were due to factors other than creditloss and were temporary in nature.  Forfixed income securities, we have not made the decision to sell and it is notmore likely than not we will be required to sell before recovery of theamortized cost basis.

 

60

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**NetInvestment Income** The following tablepresents net investment income.

 
| **($ in millions)**          | ** ** | **Three months ended********September 30,** | ** ** | ** ** | **Nine months ended********September 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                         | ** ** | ** ** | **2008**                                        | ** ** | ** ** | **2009** | ** ** | ** ** | **2008** | ** ** |
| Fixed income securities           | $          | 635                                              |       | $          | 772                                             |       | $ | 1,955 |   | $ | 2,370 |   |
| Mortgage loans                    |       | 118                                              |       |       | 143                                             |       |   | 381 |   |   | 434 |   |
| Equity securities                 |       | 2                                                |       |       | 2                                               |       |   | 4 |   |   | 6 |   |
| Limited partnership interests     |       | 2                                                |       |       | (4                                              | )          |   | 6 |   |   | 33 |   |
| Short-term                        |       | 2                                                |       |       | 31                                              |       |   | 12 |   |   | 79 |   |
| Other                             |       | (12                                              | )          |       | (2                                              | )          |   | (28 | ) |   | 11 |   |
| Investment income, before expense |       | 747                                              |       |       | 942                                             |       |   | 2,330 |   |   | 2,933 |   |
| Investment expense                |       | (25                                              | )          |       | (30                                             | )          |   | (70 | ) |   | (107 | ) |
| Net investment income (1)         | $          | 722                                              |       | $          | 912                                             |       | $ | 2,260 |   | $ | 2,826 |   |

 

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(1)   Beginning in the fourth quarter of 2008,income from EMA LP is reported in realized capital gains and losses.  EMA LP income for periods prior to the fourthquarter of 2008 is reported in net investment income.  The amount of EMA LP income included in netinvestment income was $(9) million and $14 million in the three months andnine months ended September 30, 2008, respectively.

 

Net investment income decreased 20.8% or $190 million in the third quarter of 2009 anddecreased 20.0% or $566 million in the first nine months of 2009 compared tothe same periods of 2008.  Thedecline in both periods was primarily due to lower yields, actions to shortenduration and maintain additional liquidity in the portfolio, along with reducedinvestment balances resulting from reduced contractholder obligations.  Lower yields were particularly impacted byshort-term and variable rate assets.

 

During the first ninemonths of 2009, our fixed income and mortgage loan portfolio continued togenerate significant cash flows from maturities, principal and interestreceipts totaling $5.72 billion.  Thesecash flows increased our flexibility to take advantage of market opportunitiesand manage liabilities.  Increased market stability drove a morepositive market outlook and improved liquidity in the portfolios, which led usto deploy $5.11 billion of short-term investments and cash receipts intoprimarily fixed income securities to generate income and capital appreciation.

 

**Net Realized Capital Gains and Losses**The followingtable presents the components of realized capital gains and losses and therelated tax effect.

 
| **($ in millions)**                                           | ** ** | **Three months ended  September 30,** | ** ** | ** ** | **Nine months ended********September 30,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|------------|------------|-------------------------------------------------|------------|
| ** **                                                         | ** ** | **2009**                                   | ** ** | ** ** | **2008**                                        | ** ** | ** ** | **2009** | ** ** | ** ** | **2008** | ** ** |
| Impairment  write-downs                                            | $          | (278                                       | )          | $          | (354                                            | )          | $ | (833 | ) | $ | (757 | ) |
| Change in  intent write-downs                                      |       | (1                                         | )          |       | (262                                            | )          |   | (58 | ) |   | (1,016 | ) |
| Net  other-than-temporary impairment losses recognized in earnings |       | (279                                       | )          |       | (616                                            | )          |   | (891 | ) |   | (1,773 | ) |
| Sales                                                              |       | 106                                        |       |       | 119                                             |       |   | 627 |   |   | 63 |   |
| Valuation  of derivative instruments                               |       | (60                                        | )          |       | (146                                            | )          |   | 202 |   |   | (340 | ) |
| Settlements  of derivative instruments                             |       | 7                                          |       |       | 75                                              |       |   | 30 |   |   | 122 |   |
| EMA LP  income                                                     |       | (6                                         | )          |       | —                                          |       |   | (116 | ) |   | — |   |
| Realized  capital gains and losses, pre-tax                        |       | (232                                       | )          |       | (568                                            | )          |   | (148 | ) |   | (1,928 | ) |
| Income  tax benefit (expense) (1)                                  |       | 82                                         |       |       | 198                                             |       |   | (86 | ) |   | 674 |   |
| Realized  capital gains and losses, after-tax                      | $          | (150                                       | )          | $          | (370                                            | )          | $ | (234 | ) | $ | (1,254 | ) |

 

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(1)         Income tax benefit for thenine months ended September 30, 2009 includes expense of $142 million attributable to an increase in thevaluation allowance relating to the deferred tax asset on capital losses recordedin the first quarter of 2009. This valuation allowance was released in connection with the adoption ofnew OTTI accounting guidance on April 1, 2009; however, the release wasrecorded as an increase to retained income and therefore did not reverse theamount recorded in income tax benefit on a year-to-date basis.  For a further discussion of changes in thisvaluation allowance, see the Deferred Taxes section of the MD&A.

 

61

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*Impairmentwrite-downs* arepresented in the following table.

 
| **($ in millions)**       | ** ** | **Three months ended  September 30,** | ** ** | ** ** | **Nine months ended********September 30,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|------------|-------------------------------------------------|------------|
| ** **                     | ** ** | **2009**                                   | ** ** | ** ** | **2008**                                        | ** ** | ** ** | **2009** | ** ** | ** ** | **2008** | ** ** |
| Fixed  income securities       | $          | (221                                       | )          | $          | (326                                            | )          | $ | (568 | ) | $ | (712 | ) |
| Mortgage  loans                |       | (30                                        | )          |       | —                                          |       |   | (73 | ) |   | — |   |
| Equity  securities             |       | —                                     |       |       | (1                                              | )          |   | (20 | ) |   | (7 | ) |
| Limited  partnership interests |       | (27                                        | )          |       | (27                                             | )          |   | (142 | ) |   | (34 | ) |
| Other  investments             |       | —                                     |       |       | —                                          |       |   | (30 | ) |   | (4 | ) |
| Impairment  write-downs        | $          | (278                                       | )          | $          | (354                                            | )          | $ | (833 | ) | $ | (757 | ) |

 

Impairment write-downs in the three months and ninemonths ended September 30, 2009 were primarily the result of recoveryassessments related to investments with commercial real estate exposure,including limited partnership interests, equity securities, mortgage loans andCMBS; RMBS which experienced deterioration in expected cash flows; and hybridcorporate fixed income securities. $4 million and $86 million of the fixed income security write-downs forthe three months and nine months ended September 30, 2009 related tosecurities that were disposed.  Of the remaining,$175 million or 80.6% and $351million or 72.8% of the fixed income security write-downs for the three monthsand nine months ended September 30, 2009, respectively, related toimpaired securities that were performing in line with anticipated or contractualcash flows but were written down primarily because of expected deterioration inthe performance of the underlying collateral or our assessment of theprobability of future default.  For thesesecurities, as of September 30, 2009, there have either been no defaultsor defaults have only impacted classes lower than our position in the capitalstructure.  $29 million and $37 millionof the fixed income security write-downs for the three months and nine monthsended September 30, 2009, respectively, related to securities experiencinga significant departure from anticipated cash flows; however, we believe theyretain economic value.  $13 million and$94 million for the three months and nine months ended September 30, 2009,respectively, related to fixed income securities for which future cash flowsare very uncertain.  Equity securitieswere written down primarily due to the length of time and extent fair value wasbelow cost, considering our assessment of the financial condition, near-termand long-term prospects of the issuer, including relevant industry conditionsand trends.

 

Hybrid corporate fixed income securities areassessed for other-than-temporary impairment as fixed income securities, whenthey are expected to perform like a fixed income security.  However, when credit-related reasons increasethe risk of deferred payment, they may be assessed for other-than-temporaryimpairment in a manner similar to equity securities.  In the third quarter of 2009, hybridsecurities issued by European financial institutions with a fair value of $145million were assessed as equity securities and written down forother-than-temporary impairment resulting in $108 million of realized capitallosses.  In the nine months ended September 30,2009, other-than-temporary impairments for hybrid securities totaled $138million.

 

Limitedpartnership impairment write-downs related primarily to Cost limitedpartnerships which experienced significant declines in portfolio valuations andwe could not assert the recovery period would be temporary.  To determine if an other-than-temporaryimpairment has occurred related to a Cost limited partnership, we evaluatewhether an impairment indicator has occurred in the period that may have a significantadverse effect on the carrying value of the investment.  Impairment indicators may include: actualrecent cash flows received being significantly less than expected cash flows;reduced valuations based on financing completed at a lower value; completedsale of a material underlying investment at a price significantly lower thanexpected; significantly reduced valuations of the investments held by thelimited partnerships or any other recent adverse events since the lastfinancial statements received that might affect the fair value of the investee’scapital.

 

62

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*Change inintent write-downs*are presented in the following table.

 
| **($ in millions)**      | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                    | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Fixed  income securities      | $          |                                             | —     |                                            | $          |   | (251 | ) | $ |   | (40 | ) | $ |   | (960 | ) |
| Mortgage  loans               |       | —                                           |       |                                            | (11        | ) |   | (6 | ) |   | (44 | ) |
| Equity  securities            |       | —                                           |       |                                            | —     |   |   | (6 | ) |   | (12 | ) |
| Other  investments            |       | (1                                               | )          |                                            | —     |   |   | (6 | ) |   | — |   |
| Change  in intent write-downs | $          |                                             | (1         | )                                               | $          |   | (262 | ) | $ |   | (58 | ) | $ |   | (1,016 | ) |

 

BeginningApril 1, 2009, change in intent write-downs for fixed income securities reflectinstances where we have made the decision to sell the security or it is morelikely than not we will be required to sell the security before recovery of itsamortized cost basis.  For periods priorto April 1, 2009 for fixed income securities and all periods for equitysecurities, change in intent write-downs reflect instances where we could notassert a positive intent to hold until recovery.  Change in intent write-downs for mortgageloans and other investments reflect instances where the loans have beenclassified as held for sale.

 

The change inintent write-downs in the three months and nine months ended September 30,2009 were a result of ongoing comprehensive reviews of our portfolios resultingin write-downs of individually identified investments.

 

*Sales*generated $106 million and $627 millionof net realized gains for the three months and nine months ended September 30,2009, respectively, and were primarily due to $108 million and $616 million ofgains on sales of U.S. and foreign governmental securities for the three monthsand nine months ended September 30, 2009, respectively.  In the third quarter of 2009, we sold $1.13billion of CMBS, $33 million of CDO, $19 million of RMBS and realized capitallosses of $28 million, capital gains of $32 million and capital gains of $3million, respectively.

 

*Valuationand settlement of derivative instruments*net realized capital gains totaling $232 million forthe nine months ended September 30, 2009 included $202 million of gains onthe valuation of derivative instruments and $30 million of gains on thesettlement of derivative instruments. For the nine months ended September 30, 2008, net realized capitallosses on the valuation and settlement of derivative instruments totaled $218million.

 

At September 30,2009, our securities with embedded options totaled $746 million and decreasedin fair value from December 31, 2008 by $226 million, comprised ofrealized capital gains on valuation of $56 million, net sales activity of $316million, and unrealized net capital gains reported in other comprehensiveincome (“OCI”) of $34 million for the host securities.  Net unrealized capital gains were furtherdecreased by $20 million due to amortization and impairment write-downs on thehost securities.  The change in fairvalue of embedded options is bifurcated from the host securities, separatelyvalued and reported in realized capital gains and losses, while the change inthe difference between the fair value and the amortized cost of the hostsecurities is reported in OCI.  Totalamortized cost exceeded total fair value by $26 million at September 30,2009.  Valuation gains and losses areconverted into cash for securities with embedded options upon our election tosell these securities.  In the event theeconomic value of the options is not realized, we will recover the par value ifheld to maturity unless the issuer of the note defaults.  Total par value exceeded fair value by $51million at September 30, 2009.

 

Gainsfrom the risk reduction programs, primarily our duration gap managementprogram, were related to an increase in interest rates.

 

A changing interest rate environment will drivechanges in our portfolio duration targets at a tactical level.  A duration target and range is establishedwith an economic view of liabilities relative to a long-term investmentportfolio view.  Tactical durationmanagement is accomplished through both cash market transactions including newpurchases and derivative activities that generate realized gains andlosses.  As a component of our approachto managing portfolio duration, realized gains and losses on certain derivativeinstruments are most appropriately considered in conjunction with theunrealized gains and losses on the fixed income portfolio.  This approach mitigates the impacts ofgeneral interest rate changes to the overall financial condition of theCompany.

 

63

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The table belowpresents the realized capital gains and losses (pre-tax) on the valuation andsettlement of derivative instruments shown by underlying exposure andderivative strategy.

 
| **($ in millions)**                                | ** ** | **Nine  months ended September 30,** | ** ** | ** **      | ** ** |
|---------------------------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| ** **                                              | ** ** | **2009**                             | ** ** | **2008**        | ** ** | **2009  Explanations** | ** ** |
| ** **                                              | ** ** | **Valuation**                        | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| **Risk reduction**                                      |       |                                 |       | ** **      |       |   |   |   |   |   |   |
| Duration  gap management                                | $          |                                 | 125        |            | $          |   | 50 |   | $ |   | 175 |   | $ |   | (55 | ) | Interest rate caps, floors and swaps are used to  balance 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 any time with minimal additional cost.  The maximum loss on caps and floors is  limited to the amount of premiums paid.   The change in valuation reflects the changing value of expected future  settlements from changing interest rates, which may vary over the period of  the contracts.  The 2009 year-to-date  (“YTD”) gains, resulting from increasing interest rates, are offset in  unrealized capital gains and losses of our fixed income securities in OCI to  the extent it relates to changes in risk-free rates. |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| Anticipatory  hedging                                   |       | (5                                   | )          |            | (11        | ) |   | (16 | ) |   | 89 |   | 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 2009 YTD losses reflect increases in risk-free interest rates over  the life of the net long position as liability issuances exceeded asset  acquisitions. |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| Hedging of  interest rate exposure in annuity contracts |       | 6                                    |       |            | —     |   |   | 6 |   |   | (10 | ) | Value of expected future settlements on interest rate  caps and the associated value of future credited interest, which is  reportable in future periods when incurred, increased due to an increase in  interest rates. |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| Hedging  unrealized gains on equity indexed notes       |       | —                               |       |            | —     |   |   | — |   |   | 4 |   |   |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| Hedge  ineffectiveness                                  |       | 1                                    |       |            | —     |   |   | 1 |   |   | (13 | ) | The hedge ineffectiveness of $1 million includes $144  million in realized capital gains on swaps that were offset by $143 million  in realized capital losses on the hedged risk. |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| Foreign currency  contracts                             |       | 1                                    |       |            | —     |   |   | 1 |   |   | (2 | ) |   |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| Credit risk  reduction                                  |       | (23                                  | )          |            | (18        | ) |   | (41 | ) |   | 8 |   | Losses are primarily the result of tightening credit spreads on referenced credit entities. |   |
| **Total Risk reduction**                      |       |                                 | 105        |            |       |   | 21 |   |   |   | 126 |   |   |   | 21 |   |   |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| **Income  generation**                                  |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| Asset replication  — credit exposure               |       |                                 | 41         |            |       |   | 9 |   |   |   | 50 |   |   |   | (31 | ) | The 2009 YTD changes in  valuation are due to tightening credit spreads on referenced credit entities,  and 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.  For further discussion on CDS, see Note 6  of the condensed consolidated financial statements. |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| **Accounting**                                          |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |
| Equity indexed  notes                                   |       |                                 | 19         |            |       |   | — |   |   |   | 19 |   |   |   | (174 | ) | 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.   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 $63 million at September 30, 2009.   Equity-indexed notes are subject to our comprehensive portfolio  monitoring and watchlist processes to identify and evaluate when the carrying  value may be other-than-temporarily impaired.   The following table compares the September 30, 2009 and  December 31, 2008 holdings, respectively. |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | **($ in millions)** | ** ** | **September  30****,  2009** | ** ** | ** ** | **Change   in fair  value** | ** ** | ** ** | **Change due  to net sale  activity** | ** ** | ** ** | **December 31,  2008** |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Par value | $ | 475 | ** ** | $ | — | ** ** | $ | (325 | ) | $ | 800 |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Amortized cost of  host contract | $ | 340 | ** ** | $ | 16 | ** ** | $ | (162 | ) | $ | 486 |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Fair value of  equity–indexed call option | ** ** | 80 | ** ** |   | 19 | ** ** | ** ** | (71 | ) | ** ** | 132 |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Total amortized  cost | $ | 420 | ** ** | $ | 35 | ** ** | $ | (233 | ) | $ | 618 |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Total fair value | $ | 412 | ** ** | $ | 43 | ** ** | $ | (264 | ) | $ | 633 |   |
|                                                    |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Unrealized  gain/(loss) | $ | (8 | ) | $ | 8 | ** ** | $ | (31 | ) | $ | 15 |   |

 

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| **($ in millions)**                       | ** ** | **Nine  months ended September 30,** | ** ** | ** **      | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| ** **                                     | ** ** | **2009**                             | ** ** | **2008**        | ** ** | **2009  Explanations** | ** ** |
| ** **                                     | ** ** | **Valuation**                        | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| Conversion  options in fixed income securities |       |                                 | 37         |            |       |   | — |   |   |   | 37 |   |   |   | (34 | ) | 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.  Fair value exceeded par  value by $12 million at September 30, 2009.  Convertible bonds are subject to our  comprehensive portfolio monitoring and watchlist processes to identify and  evaluate when the carrying value may be other-than-temporarily impaired.  The following table compares the  September 30, 2009 and December 31, 2008 holdings, respectively. |   |
|                                           |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                           |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | **($ in millions)** | ** ** | **September  30****,  2009** | ** ** | ** ** | **Change   in fair  value** | ** ** | ** ** | **Change due  to  net sale  activity** | ** ** | ** ** | **December 31,  2008** |   |
|                                           |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Par value | $ | 322 | ** ** | $ | — | ** ** | $ | (56 | ) | $ | 378 |   |
|                                           |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Amortized cost of  host contract | $ | 228 | ** ** | $ | 4 | ** ** | $ | (23 | ) | $ | 247 |   |
|                                           |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Fair value of  conversion option | ** ** | 124 | ** ** |   | 37 | ** ** | ** ** | (3 | ) | ** ** | 90 |   |
|                                           |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Total amortized  cost | $ | 352 | ** ** | $ | 41 | ** ** | $ | (26 | ) | $ | 337 |   |
|                                           |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Total Fair value | $ | 334 | ** ** | $ | 47 | ** ** | $ | (52 | ) | $ | 339 |   |
|                                           |       |                                 |       |            |       |   |   |   |   |   |   |   |   |   |   |   | Unrealized  gain/(loss) | $ | (18 | ) | $ | 6 | ** ** | $ | (26 | ) | $ | 2 |   |

 
| ** **            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |   |
|-----------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|------------|--------|--------|--------|--------|--------|--------|
| **Total  accounting** |   |   | 56     |   |   |   | — |   |   |   | 56     |   |   |   | (208   | )      |   |   |   |   |   |   | ** ** |   |   |   |   |   |   |
| ** **            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |   |
| **Total**             | $      |   | 202    |   | $      |   | 30     |   | $      |   | 232    | (1)    |   | $      | (218   | )      |   |   |   |   |   |   | ** ** |   |   |   |   |   |   |

 

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(1)Does not include $2 million of derivative gains related to the termination offair value hedges and cash flow hedges which are included in sales and reportedwith the hedged risk.

 

Included in the table above arenet realized capital losses on the valuation and settlement of derivativeinstruments related to credit spread risk hedging from our risk mitigation andreturn optimization programs totaling $26 million for the nine months ended September 30,2009.

 

**FAIR VALUE OF ASSETS ANDLIABILITIES**

 

We have two types of situations where we haveclassified investments as Level 3 in the fair value hierarchy disclosure inNote 5.  The first is where quotescontinue to be received from independent third-party valuation serviceproviders, as all significant inputs are market observable, but there has beena significant decrease in the volume and level of activity for the asset whencompared to normal market activity such that the degree of market observabilityhas declined to a point where categorization as a Level 3 measurement isconsidered appropriate.  Among theindicators we consider in determining whether a significant decrease in thevolume and level of activity for a specific asset has occurred include thefollowing:

 

·                  Level of new issuances in the primary market;

·                  Trading volume in the secondary market;

·                  Level of credit spreads over historical levels;

·                  Bid-ask spread, and

·                  Price consensus among market participants and sources.

 

The second situation where we have classifiedsecurities in Level 3 is where specific inputs to our fair value estimationmodels which are considered significant are not market observable.  This has occurred in three principal categories.  The first is for certain of our privatelyplaced securities for which we utilize internally developed ratings.  The second is broker quotes.  The third is our ARS backed by student loansfor which a principal assumption, the anticipated date liquidity will return tothis market, is not market observable.

 

During thirdquarter 2009, certain Alt-A RMBS, Prime RMBS and ABS-credit card and auto weretransferred into Level 2 from Level 3 as a result of increased liquidity inthese markets (see Level 3 rollforward in Note 5 of the condensed consolidatedfinancial statements).  This was evidencedby increased trading volume and the narrowing of bid-ask spreads for ourspecific holdings.  When transferring these securities into Level 2, we do not change thesource of fair value estimates or modify the estimates received fromindependent third-party valuation service providers.  Accordingly, for securities included withinthis group, there was no change in fair value for a change in model resultingin a gain or loss.

 

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Transfers into Level 3 during the three and ninemonths ended September 30, 2009 included situations where a fair valuequote is not provided by our independent third-party valuation service providerand as a result the price is stale or has been replaced with a broker quoteresulting in the security being classified as Level 3.  Transfers out of Level 3 during the three andnine months ended September 30, 2009 included situations where a brokerquote was used in the prior period and a fair value quote is now available fromour independent third-party valuation service provider.  A quote utilizing the new pricing source isnot available as of the prior period, and any gains or losses related to thechange in valuation source for individual securities are not ascertainable andare not significant.

 

**DEFERREDTAXES**

 

We evaluate whether avaluation allowance for our deferred tax assets is required each reportingperiod.  A valuation allowance isestablished if, based on the weight of available evidence, it is more likelythan not that some portion or all of the deferred income tax asset will not berealized.  In determining whether avaluation allowance is needed, all available evidence is considered.  This includes the potential for capital andordinary loss carryback, future reversals of existing taxable temporarydifferences, tax planning strategies that we may employ to avoid a tax benefitfrom expiring unused and future taxable income exclusive of reversing temporarydifferences.

 

With respect to ourevaluation of the need for a valuation allowance related to the deferred taxasset on capital losses that have been realized but have not yet beenrecognized for tax purposes, we utilize prudent and feasible tax planningstrategies that optimize the ability to carry back capital losses as well asthe ability to offset future capital losses with unrealized capital gains thatcould be recognized for tax purposes.

 

With respect toour evaluation of the need for a valuation allowance related to the deferredtax asset on unrealized capital losses on fixed income and equity securities,our tax planning strategies first consider the availability of unrealizedcapital gains to offset future capital losses and then we rely on our assertionthat we have the intent and ability to hold the securities with unrealizedlosses to recovery.  As a result, theunrealized losses on these securities would not be expected to materialize andno valuation allowance on the associated deferred tax asset is needed.

 

The total deferredtax valuation allowance was zero at both September 30, 2009 and June 30,2009, $148 million at March 31, 2009 and $9 million at December 31,2008.  The following table shows howchanges in the valuation allowance were recorded in the condensed consolidatedfinancial statements in the first nine months of 2009.

 
| **($ in millions)** | ** ** | ** **                                           | **Adjustments  recorded in  the three months ended  March 31, 2009** | ** **                   | **Adjustments  recorded in  the six months ended  September 30, 2009** | ** **                                    | ** ** | ** **                                                                          |
|--------------------------|------------|------------------------------------------------------|---------------------------------------------------------------------------|------------------------------|-----------------------------------------------------------------------------|-----------------------------------------------|------------|-------------------------------------------------------------------------------------|
| ** **               | ** ** | ** **                                           | ** **                                                                | ** **                   | ** **                                                                  | ** **                                    | ** ** | **Impact  of adoption of new   OTTI accounting guidance  as of April 1, 2009** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Balance as of  December 31,  2008** | ** **                                                                | **Decrease to  income** | ** **                                                                  | **Increase  to other  comprehensive  income** | ** ** | **Increase  in retained  income**                                                   | ** ** | **Increase  in other comprehensive  income** | ** ** | **Increase  to  income** | ** ** | **Increase  to  other comprehensive  income** | ** ** | **Balance  as of  September 30,  2009** | ** ** |
|                     |       |                                                 |                                                                      |                         |                                                                        |                                          |       |                                                                                |   |   |   |   |   |   |   |   |   |
|                     | $          | 9                                                    |                                                                      | $                            | 142                                                                         |                                          | $          | (3                                                                                  | ) | $ | (142 | ) | $ | — |   | $ | (5 | ) | $ | (1 | ) | $ | — |   |
|                          |            |                                                      |                                                                           |                              |                                                                             |                                               |            |                                                                                     |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Income tax benefitfor the nine months ended September 30, 2009 includes expense of $142 million attributable to an increase in thevaluation allowance relating to the deferred tax asset on capital lossesrecorded in the first quarter of 2009, which were primarily related toother-than-temporary impairment write-downs that were not deductible for taxpurposes as of March 31, 2009.  Thisvaluation allowance was released in connection with the adoption of new OTTIaccounting guidance on April 1, 2009; however, the release was recorded asan increase to retained income and therefore did not reverse the amountrecorded in income tax benefit on a year-to-date basis.  The release of the valuation allowance isrelated to the reclassification of previously recorded other-than-temporaryimpairment write-downs from retained income to unrealized capital losses.

 

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**CAPITAL RESOURCES AND LIQUIDITY HIGHLIGHTS**

 

·                  Shareholder’sequity as of September 30, 2009was $4.86 billion, an increase of 120.1% from $2.21 billion as of December 31,2008.

·                  The Allstate Corporation (the “Corporation”)has at the parent holding company level $3.36 billion of deployable investedassets at September 30, 2009 compared to $3.64 billion at December 31,2008.

·                  As of September 30,2009, Allstate Life Insurance Company (“ALIC”) statutory surplus isapproximately $3.2 billion compared to $3.2 billion at December 31, 2008.

·                  At September 30, 2009, we held23.1% of our total cash and investment portfolio, or $13.88 billion, in cashand other liquid investments that are saleable within one quarter withoutsignificant additional net realized capital losses.

·                  In March 2009, the Corporation andAIC completed a previously approved capital contribution of $250 million ofcash to ALIC.

·                  Interest payments on our 7.00%Surplus Notes due 2028 which have an outstanding principal amount of $400million and are held by AIC, have been deferred until 2010.

 

**CAPITALRESOURCES AND LIQUIDITY**

 

**Capital Resources** consist of shareholder’sequity and surplus notes due to related parties, representing funds deployed oravailable to be deployed to support business operations.  The following table summarizes our capitalresources.

 
| **($ in millions)**                                      | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Common stock, additional  capital paid-in and retained income | $          | 4,906                        |       | $                           | 4,546      |   |
| Accumulated other  comprehensive loss                         |       | (45                          | )          |                        | (2,337     | ) |
| Total shareholder’s equity                               |       | 4,861                        |       |                        | 2,209      |   |
| Surplus notes                                                 |       | 650                          |       |                        | 650        |   |
| Total capital resources                                       | $          | 5,511                        |       | $                           | 2,859      |   |

 

*Shareholder’s equity* increased in the first nine months of 2009, dueprimarily to decreases in unrealized net capital losses on investments and acapital contribution from AIC of $250 million, partially offset by a net loss.

 

**Financial Ratings and Strength**Our ratings areinfluenced by many factors including our operating and financial performance,asset quality, liquidity, asset/liability management, overall portfolio mix,financial leverage (i.e., debt), exposure to risks, the current level ofoperating leverage and AIC’s ratings.

 

On February 2,2009, A.M. Best affirmed our A+ financial strength rating.  The outlook for the rating remainedstable.  On January 29, 2009,S&P downgraded our financial strength rating to AA- from AA.  The outlook for the rating remainednegative.  On August 6, 2009, Moody’saffirmed our A1 financial strength rating. The outlook for the rating remained stable.  On January 29, 2009, Moody’s haddowngraded our financial strength rating to A1 from Aa3.

 

The Company, AIC and theCorporation are party to the Amended and Restated Intercompany LiquidityAgreement (“Liquidity Agreement”) which allows for short-term advances of fundsto be made between parties for liquidity and other general corporatepurposes.  The Liquidity Agreement doesnot establish a commitment to advance funds on the part of any party.  The Company and AIC each serve as a lenderand borrower and the Corporation serves only as a lender.  The Company also has a capital supportagreement with AIC.  Under the capitalsupport agreement, AIC is committed to provide capital to the Company tomaintain an adequate capital level.  Themaximum amount of potential funding under each of these agreements is $1.00billion.

 

In addition to the Liquidity Agreement, the Companyalso has an intercompany loan agreement with the Corporation.  The amount of intercompany loans available tothe Company is at the discretion of the Corporation.  The maximum amount of loans the Corporationwill have outstanding to all its eligible subsidiaries at any given point intime is limited to $1.00 billion. The Corporation may use commercial paper borrowings, bank lines ofcredit and repurchase agreements to fund intercompany borrowings.

 

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ALIC and its life insurance subsidiariesprepare their statutory-basis financial statements in conformity withaccounting practices prescribed or permitted by the insurance department of theapplicable state of domicile.  Statutorysurplus is a measure that is often used as a basis for determining dividendpaying capacity, operating leverage and premium growth capacity, and it is alsoreviewed by rating agencies in determining their ratings.  As of September 30, 2009, ALIC’sstatutory surplus is approximately $3.2 billion compared to $3.2 billion at December 31,2008.

 

**Liquidity Sources and Uses**

 

We actively manage our financial position andliquidity levels in light of changing market, economic, and businessconditions.  We continue to takeproactive measures to maintain or enhance our economic and liquidity positionas capital market conditions change. Actions include managing our gross exposure to our largest exposure,interest rate risk, through active management of our investment and productportfolios as well as further mitigation through hedging.

 

We believethat 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:

 

·                  Relying onportfolio cash flows including approximately $6.67 billion of expected inflowsfrom upcoming maturities, calls and prepayments on fixed income securities,mortgage loans and bank loans, and interest receipts on investments over thenext twelve months to increase liquidity. Expected interest receipts include amounts related to variable rateinvestments for which the interest rate fluctuates in accordance with marketinterest rates.  Our expectation is basedon market interest rates as of September 30, 2009.  Further, these expected portfolio cash flowsare based on investments as of September 30, 2009 and were determinedwithout regard to increases in the portfolio for reasons such as thereinvestment of portfolio cash flows or decreases due to reductions inoutstanding contractholder funds obligations.

 

·                  The sale offixed income securities (government, municipal and investment grade corporatebonds) with unrealized capital gains at September 30, 2009.

 

With a focus on preserving capital, weconsider investments which are convertible to cash without generatingsignificant additional net realized capital losses as liquidity sources.  The following table presents cash andshort-term positions convertible to cash, and certain other liquid investmentsmeeting these criteria.

 
| **($ in millions)**                                                       | ** ** | **As of********September 30,  2009** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| Cash  and short-term positions convertible to cash available same day/next day | $          | 995                                       |       |
| Other  highly liquid investments (1)                                           |       | 6,552                                     |       |
| Other  liquid investments (2)                                                  |       | 6,336                                     |       |
| Total  liquid (3)                                                              | $          | 13,883                                    |       |
|                                                                           |       |                                      |       |
| Percent  of total cash and investments                                         |       | 23.1                                      | %          |

 

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(1)         Other highly liquid investments are defined as assets that are generallysaleable within one week, and primarily include U.S. government and agenciesbonds of $4.04 billion, sovereign governments of $818 million, corporate bondsof $786 million, agency pass through securities of $436 million and commonstocks of $144 million.  The amountsshown in the table above represent the amount of our holdings in these assets,excluding any holdings with restrictions.

 

(2)         Other liquid investments are defined as assets that are saleable withinone quarter, and primarily include corporate bonds of $2.52 billion, sovereigngovernments of $818 million, municipal bonds of $687 million, agency passthrough securities of $654 million, U.S. government and agencies bonds of $544million and short-term investments of $328 million.  The amounts shown in the table aboverepresent the amount that we believe could be sold during the fourth quarter of2009, excluding any holdings with restrictions.

 

(3)         From period to period, we may revise our definition of what is saleablewithin a quarter which may result in a variation from period to period.

 

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The above analysis identifies our access tointernal sources of liquidity.  Webelieve we have sufficient liquidity to address current planned needs frominvestments other than fixed income securities in an unrealized loss positionfor which we have asserted that we do not have the intent to sell the securityand it is not more likely than not we will be required to sell the securitybefore recovery of its amortized cost basis, and equity securities for which wehave asserted the intent to hold until recovery, combined with targeted salesof certain products.  Additionally, wehave existing intercompany agreements in place that facilitate liquiditymanagement.

 

*AllstateParent Company Capital Capacity*****The Corporation has at the parent holdingcompany level $3.36 billion of deployable cash and investments at September 30,2009.  These assets include highly liquidsecurities that are generally saleable within one week totaling $2.29 billion,additional liquid investments that are saleable within one quarter totaling$616 million, and $452 million of investments that would require more than onequarter to sell.  This provides funds forthe parent company’s relatively low fixed charges.

 

In March 2009,the Corporation and AIC completed a previously approved capital contribution of$250 million of cash to ALIC.  Thiscapital contribution was funded by a dividend of $250 million paid to theCorporation in cash by Kennett Capital Holdings, LLC, a wholly owned subsidiaryof the Corporation.

 

In addition to theCapital Support Agreement and Liquidity Agreement, which provide a maximumamount of potential funding under each agreement of $1.00 billion, the Companyalso has access to additional borrowing to support liquidity through theCorporation as follows:

 

·                  A commercial paper facility with a borrowinglimit of $1.00 billion to cover short-term cash needs.  As of September 30, 2009, there were nobalances outstanding and therefore the remaining borrowing capacity was $1.00billion; however, the outstanding balance can fluctuate daily.

·                  Aprimary credit facility is available for short-term liquidity requirements andbacks the commercial paper facility.  The$1.00 billion unsecured revolving credit facility has an initial term of fiveyears expiring in 2012 with two optional one-year extensions that can beexercised at the end of any of the remaining anniversary years of the facilityupon approval of existing or replacement lenders providing more than two-thirdsof the commitments to lend.  The programis fully subscribed among 11 lenders with the largest commitment being $185million.  The commitments of the lendersare several and no lender is responsible for any other lender’s commitment ifsuch lender fails to make a loan under the facility.  This facility contains an increase provisionthat would allow up to an additional $500 million of borrowing provided theincreased portion could be fully syndicated at a later date among existing ornew lenders.  This facility has afinancial covenant requiring that the Corporation not exceed a 37.5% debt tocapital resources ratio as defined in the agreement.  This ratio at September 30, 2009 was22.5%.  Although the right to borrowunder the facility is not subject to a minimum rating requirement, the costs ofmaintaining the facility and borrowing under it are based on the ratings of theCorporation’s senior, unsecured, nonguaranteed long-term debt.  There were no borrowings under the creditfacility during the third quarter and first nine months of 2009.  The total amount outstanding at any point intime under the combination of the commercial paper program and the creditfacility cannot exceed the amount that can be borrowed under the creditfacility.

·                  Auniversal shelf registration statement was filed by the Corporation with theSecurities and Exchange Commission on May 8, 2009.  The Corporation can use the current shelfregistration to issue an unspecified amount of debt securities, common stock(including 364 million shares of treasury stock as of September 30, 2009),preferred stock, depositary shares, warrants, stock purchase contracts, stockpurchase units and securities of trust subsidiaries.  The specific terms of any securities theCorporation issues under this registration statement will be provided in theapplicable prospectus supplements.

 

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*Liquidity Exposure*****Contractholder funds as of September 30, 2009were $51.63 billion.  The following tablesummarizes contractholder funds by their contractual withdrawal provisions at September 30,2009.

 
| **($ in millions)**                                 | ** ** | ** ** | ** ** | **Percent to  total** | ** ** |
|----------------------------------------------------------|------------|------------|------------|-----------------------|------------|
| Not  subject to discretionary withdrawal                 | $          | 8,765      |       | 17.0                  | %          |
| Subject  to discretionary withdrawal with adjustments:   |       |       |       |                  |       |
| Specified  surrender charges (1)                         |       | 22,917     |       | 44.4                  |       |
| Market  value adjustments (2)                            |       | 9,467      |       | 18.3                  |       |
| Subject  to discretionary withdrawal without adjustments |       | 10,476     |       | 20.3                  |       |
| Total  contractholder funds (3)                          | $          | 51,625     |       | 100.0                 | %          |

 

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(1)         Includes $10.80 billion of liabilities with a contractual surrendercharge of less than 5% of the account balance.

 

(2)         $7.97 billion of the contracts with market value adjusted surrendershave a 30-45 day period at the end of their initial and subsequent interestrate guarantee periods (which are typically 5 or 6 years) during which there isno surrender charge or market value adjustment.

 

(3)         Includes $1.41 billion of contractholder funds on variable annuitiesreinsured to Prudential Financial Inc. effective June 1, 2006.

 

While we are able toquantify remaining scheduled maturities for our institutional products,anticipating retail product surrenders is less precise.  Retail life and annuity products may besurrendered by customers for a variety of reasons.  Reasons unique to individual customersinclude a current or unexpected need for cash or a change in life insurancecoverage needs.  Other key factors thatmay impact the likelihood of customer surrender include the level of thecontract surrender charge, the length of time the contract has been in force,distribution channel, market interest rates, equity market conditions andpotential tax implications.  In addition,the propensity for retail life insurance policies to lapse is lower than it isfor fixed annuities because of the need for the insured to be re-underwrittenupon policy replacement.  Surrenders andpartial withdrawals for our retail annuities decreased 12.1% and 12.4% in thethird quarter and first nine months of 2009, respectively, compared to the sameperiods of 2008.  The annualizedsurrender and partial withdrawal rate on deferred annuities andinterest-sensitive life insurance, based on the beginning of yearcontractholder funds, was 8.9% and 9.8% for the first nine months of 2009 and2008, respectively.  The annualizedsurrender and partial withdrawal rate on deferred fixed annuities was 10.0% inthe first nine months of 2009 compared to 11.2% in the first nine months of2008.  We strive to promptly pay customers who request cashsurrenders, however, statutory regulations generally provide up to six monthsin most states to fulfill surrender requests.

 

Our institutionalproducts are primarily funding agreements backing medium-term notes.  As of September 30, 2009, totalinstitutional products outstanding were $4.35 billion.  The following table presents the remainingscheduled maturities for our institutional products outstanding as of September 30,2009.

 
| **($ in millions)** | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| 2010                     | $          | 1,715      |       |
| 2011                     |       | 760        |       |
| 2012                     |       | 40         |       |
| 2013                     |       | 1,750      |       |
| 2016                     |       | 85         |       |
|                     | $          | 4,350      |       |

 

Our asset-liabilitymanagement practices limit the differences between the cash flows generated byour investment portfolio and the expected cash flow requirements of our lifeinsurance, annuity and institutional product obligations.

 

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*CashFlows* Asreflected in our Condensed Consolidated Statements of Cash Flows, higher operating cash flows in thefirst nine months of 2009 compared to the first nine months of 2008 wereprimarily related to higher income tax refunds, lower expenses, decreasedcontract benefits paid and increased premiums received, partially offset bylower net investment income.  Theincrease in income tax refunds received in the first nine months of 2009 wasrelated to our actions to accelerate refunds from the overpayment of 2008estimated taxes as well as the carryback of 2008 ordinary losses to prior taxyears.

 

Higher cash flows provided by investing activities in the first ninemonths of 2009 compared to the first nine months of 2008 were primarily due toreductions of short-term investments to fund reductions in contractholder fundliabilities.

 

Higher cash flows used in financing activities inthe first nine months of 2009 compared to the first nine months of 2008 wereprimarily due to the absence of issuances of institutional products in thefirst nine months of 2009 compared to $4.16 billion in the first nine months of2008.

 

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**Item 4.Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures. *We maintaindisclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934.  Under the supervision and with the participationof our management, including our principal executive officer andprincipal financial officer, we conducted an evaluation of the effectiveness ofour disclosure controls and procedures as of the end of the period covered bythis report.  Based upon this evaluation,the principal executive officer and the principal financial officer concludedthat our disclosure controls and procedures are effective in providingreasonable assurance that material information required to be disclosed in ourreports filed with or submitted to the Securities and Exchange Commission underthe Securities Exchange Act is made known to management, including theprincipal executive officer and the principal financial officer, as appropriateto allow timely decisions regarding required disclosure.

 

*Changes inInternal Control over Financial Reporting. *During the fiscal quarter ended September 30, 2009, 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.  OTHER INFORMATION**

 

**Item 1.    LegalProceedings**

 

Information required for this Part II,Item 1 is incorporated by reference to the discussion under the heading “Regulationand Compliance” and under the heading “Legal and regulatory proceedings andinquiries” in Note 8 of the condensed consolidated financial statements in Part I,Item 1 of this Form 10-Q.

 

**Item 1A.  Risk Factors**

 

This document contains “forward-lookingstatements” that anticipate results based on our estimates, assumptions andplans that are subject to uncertainty. These statements are made subject to the safe-harbor provisions of thePrivate Securities Litigation Reform Act of 1995.  We assume no obligation to update anyforward-looking statements as a result of new information or future events ordevelopments.

 

These forward-lookingstatements do not relate strictly to historical or current facts and may beidentified by their use of words like “plans,” “seeks,” “expects,” “will,” “should,”“anticipates,” “estimates,” “intends,” “believes,” “likely,” “targets” andother words with similar meanings.  Thesestatements may address, among other things, our strategy for growth, productdevelopment, investment results, regulatory approvals, market position,expenses, financial results, litigation and reserves.  We believe that these statements are based onreasonable estimates, assumptions and plans. However, if the estimates, assumptions or plans underlying theforward-looking statements prove inaccurate or if other risks or uncertaintiesarise, actual results 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 thoseincorporated by reference in Part I, Item 1A of the Allstate LifeInsurance Company Annual Report on Form 10-K for 2008.

 

## **Changes in estimates of profitability oninterest-sensitive life, fixed annuities and other investment products mayadversely affect our profitability and financial condition through theamortization of DAC**

## ** **

DAC related to interest-sensitive life, fixed annuities and otherinvestment contracts is amortized in proportion to actual historical grossprofits and estimated future gross profits (“EGP”) over the estimated lives ofthe contracts.  The principal assumptionsfor determining the amount of EGP are investment returns, including capitalgains and losses on assets supporting contract liabilities, interest creditingrates to contractholders, and the effects of persistency, mortality, expenses,and hedges if applicable.  Updates tothese assumptions (commonly referred to as “DAC unlocking”) could adverselyaffect our profitability and financial condition.  In 2009, DAC unlocking resulted in increasedamortization of DAC of $278 million.  Inaddition in periods when actual gross profits are negative, recapitalization (“negativeamortization”) of DAC is only recorded when determined to be recoverable basedon specific facts and circumstances.

 

Examplesof such situations include the world wide financial crisis, which resulted inan unprecedented level of realized capital losses.  A principal assumption change impacting EGPand the related DAC amortization was an increase in the level of expectedrealized capital losses in 2009 and 2010. This resulted in the majority of the market value adjusted annuity DACbalance being reduced to zero since the products in force were estimated tohave no gross profits.  Market valueadjusted annuity DAC will not be recapitalized while there are no estimatedgross profits.  Facts and circumstancesmay lead to other situations where DAC is not recapitalized.  Accordingly, judgments regarding therecognition of DAC amortization may adversely affect profitability andfinancial condition.

 

**A largescale pandemic, the continued threat of terrorism, or ongoing military actionsmay have an adverse effect on the level of claim losses we incur, the value ofour investment portfolio, our competitive position, marketability of productofferings, liquidity and operating results**

 

Alarge scale pandemic, the continued threat of terrorism, within the UnitedStates and abroad, or ongoing military and other actions and heightened securitymeasures in response to these types of threats, may cause significantvolatility and losses in our investment portfolio from declines in the equitymarkets and from interest rate changes in the United States, Europe andelsewhere, and result in loss of life, disruptions to commerce and reducedeconomic activity.  Some of the assets inour investment portfolio may be adversely affected by declines in the equitymarkets and reduced economic activity caused by a large scale pandemic or thecontinued threat of terrorism.

 

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We seek to mitigate thepotential impact of terrorism on our commercial mortgage portfolio by limitinggeographical concentrations in key metropolitan areas and by requiringterrorism insurance to the extent that it is commercially available.  Additionally, a large scale pandemic or aterrorist act could have a material adverse effect on the sales, profitability,competitiveness, marketability of product offerings, liquidity and operatingresults.

 

**Proposed regulatory reforms, and themore stringent application of existing regulations, may make it more expensivefor us to conduct our business**

 

The federal government hasreleased a set of proposed regulatory reforms with respect to financialservices entities.  As part of a largereffort to strengthen the regulation of the financial services market, theproposal outlines certain reforms applicable to the insurance industry,including the establishment of an Office of National Insurance within theTreasury Department.  The reforms couldalso increase the regulation of large insurance conglomerates whose failurecould pose a systemic risk to the financial system.  In addition, the federal government hasissued a set of principles for reforming the U.S. and international regulatorycapital framework for banking firms.

 

Anyadditional legislation or regulatory requirements imposed upon us in connectionwith the federal government proposed regulatory reforms or arising from theprinciples for reforming the U.S. and international regulatory capitalframework for banking firms, and any more stringent enforcement of existingregulations by federal authorities, may make it more expensive for us toconduct our business.

 

**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 SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                    | Allstate  Life Insurance Company   |
|-------------------------|------------------------------------|
|                    | (Registrant)                       |
|                    |                               |
|                    |                               |
| November 10,  2009 |                               |
|                    | By                                 | /s/  Samuel H. Pilch |
|                    | Samuel  H. Pilch                   |
|                    | (chief accounting officer and duly |
|                    | authorized officer of  Registrant) |

 

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                      |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                 |
| 15                   |       | Acknowledgment  of awareness from Deloitte & Touche LLP, dated November 10,  2009, concerning unaudited interim financial information. |
|                 |       |                                                                                                                                                 |
| 31(i)                |       | Rule 13a-14(a) Certification  of Principal Executive Officer                                                                               |
|                 |       |                                                                                                                                                 |
| 31(i)                |       | Rule 13a-14(a) Certification  of Principal Financial Officer                                                                               |
|                 |       |                                                                                                                                                 |
| 32                   |       | Section 1350  Certifications                                                                                                                    |

 

E-1

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