**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**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 TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30, 2010**

 

**OR**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**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 or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification No.) |

** **

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

(Address of principal executive offices)          (Zip code)

 

**(847) 402-5000**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x     Noo

 

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 (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files). Yes o     Noo

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated 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 registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     Nox

 

As of August 9, 2010, 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**

**June 30,2010**

 
| ** **       | ** **                                                                                                                                | **PAGE**   |
|------------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **PART I**  | **FINANCIAL INFORMATION**                                                                                                                 |       |
|             |                                                                                                                                      |       |
| Item 1.          | Financial Statements                                                                                                                      |       |
|             |                                                                                                                                      |       |
|             | Condensed  Consolidated Statements of Operations for the Three-Month and Six-Month  Periods Ended June 30, 2010 and 2009 (unaudited) | 1          |
|             |                                                                                                                                      |       |
|             | Condensed  Consolidated Statements of Financial Position as of June 30, 2010  (unaudited) and December 31, 2009                 | 2          |
|             |                                                                                                                                      |       |
|             | Condensed  Consolidated Statements of Cash Flows for the Six-Month Periods Ended  June 30, 2010 and 2009 (unaudited)                 | 3          |
|             |                                                                                                                                      |       |
|             | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                         | 4          |
|             |                                                                                                                                      |       |
|             | Report of Independent Registered Public Accounting  Firm                                                                                  | 42         |
|             |                                                                                                                                      |       |
| Item 2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                               |       |
|             |                                                                                                                                      |       |
|             | Operations  Highlights                                                                                                                    | 43         |
|             | Operations                                                                                                                                | 43         |
|             | Investments  Highlights                                                                                                                   | 49         |
|             | Investments                                                                                                                               | 49         |
|             | Capital Resources and Liquidity Highlights                                                                                                | 73         |
|             | Capital Resources and Liquidity                                                                                                           | 73         |
|             |                                                                                                                                      |       |
| Item 4.          | Controls and  Procedures                                                                                                                  | 76         |
|             |                                                                                                                                      |       |
| **PART II** | **OTHER INFORMATION**                                                                                                                     | ** ** |
|             |                                                                                                                                      |       |
| Item 1.          | Legal Proceedings                                                                                                                         | 77         |
|             |                                                                                                                                      |       |
| Item 1A.         | Risk Factors                                                                                                                              | 77         |
|             |                                                                                                                                      |       |
| Item 6.          | Exhibits                                                                                                                                  | 77         |

 

----

 

**PART I.FINANCIAL INFORMATION**

 

**ITEM 1.FINANCIAL STATEMENTS**

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in millions)**                                           | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                         | ** ** | (unaudited)                           |       | (unaudited)                         |       |
| **Revenues**                                                       |       |                                  |       |                                |       |   |   |   |   |
| Premiums                                                           |       | $                                     | 154        |                                | $          | 154 |   | $ | 307 |   | $ | 306 |   |
| Contract charges                                                   |       | 248                                   |       | 237                                 |       | 494 |   | 465 |   |
| Net investment income                                              |       | 700                                   |       | 741                                 |       | 1,407 |   | 1,538 |   |
| Realized capital gains and losses:                                 |       |                                  |       |                                |       |   |   |   |   |
| Total other-than-temporary impairment losses                       |       | (174                                  | )          | (332                                | )          | (353 | ) | (716 | ) |
| Portion of loss recognized in other comprehensive  income          |       | (24                                   | )          | 104                                 |       | (10 | ) | 104 |   |
| Net other-than-temporary impairment losses  recognized in earnings |       | (198                                  | )          | (228                                | )          | (363 | ) | (612 | ) |
| Sales and other realized capital gains and losses                  |       | (154                                  | )          | 350                                 |       | (150 | ) | 696 |   |
| Total realized capital gains and losses                            |       | (352                                  | )          | 122                                 |       | (513 | ) | 84 |   |
|                                                               |       | 750                                   |       | 1,254                               |       | 1,695 |   | 2,393 |   |
|                                                               |       |                                  |       |                                |       |   |   |   |   |
| **Costs and expenses**                                             |       |                                  |       |                                |       |   |   |   |   |
| Contract benefits                                                  |       | 406                                   |       | 357                                 |       | 770 |   | 691 |   |
| Interest credited to contractholder funds                          |       | 439                                   |       | 548                                 |       | 891 |   | 1,113 |   |
| Amortization of deferred policy acquisition costs                  |       | 14                                    |       | 268                                 |       | 81 |   | 697 |   |
| Operating costs and expenses                                       |       | 83                                    |       | 81                                  |       | 169 |   | 170 |   |
| Restructuring and related charges                                  |       | (1                                    | )          | 2                                   |       | (1 | ) | 19 |   |
| Interest expense                                                   |       | 11                                    |       | 10                                  |       | 22 |   | 21 |   |
|                                                               |       | 952                                   |       | 1,266                               |       | 1,932 |   | 2,711 |   |
| Gain on disposition of operations                                  |       | 2                                     |       | 1                                   |       | 3 |   | 4 |   |
|                                                               |       |                                  |       |                                |       |   |   |   |   |
| **Loss from operations before  income tax (benefit) expense**      |       | (200                                  | )          | (11                                 | )          | (234 | ) | (314 | ) |
|                                                               |       |                                  |       |                                |       |   |   |   |   |
| Income tax (benefit) expense                                       |       | (73                                   | )          | (11                                 | )          | (89 | ) | 22 |   |
|                                                               |       |                                  |       |                                |       |   |   |   |   |
| **Net loss**                                                       |       | $                                     | (127       | )                                   | $          | — |   | $ | (145 | ) | $ | (336 | ) |

 

See notes to condensed consolidated financial statements.

 

1

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF FINANCIAL POSITION**

 
| ** **                                                                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **($ in  millions, except par value data)**                                                 | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ** **                                                                                       | ** ** | (unaudited)       | ** ** | ** **            | ** ** |
| **Assets**                                                                                       |       |              |       |                  |       |
| Investments                                                                                      |       |              |       |                  |       |
| Fixed income securities, at fair value (amortized  cost $48,700 and $49,842)                     |       | $                 | 48,871     |                  | $          | 47,658 |   |
| Mortgage loans                                                                                   |       | 7,039             |       | 7,780                 |       |
| Equity securities, at fair value (cost $161 and  $159)                                           |       | 172               |       | 183                   |       |
| Limited partnership interests                                                                    |       | 1,064             |       | 1,028                 |       |
| Short-term, at fair value (amortized cost $903 and  $1,669)                                      |       | 903               |       | 1,669                 |       |
| Policy loans                                                                                     |       | 825               |       | 823                   |       |
| Other                                                                                            |       | 844               |       | 1,076                 |       |
| Total investments                                                                                |       | 59,718            |       | 60,217                |       |
| Cash                                                                                             |       | 196               |       | 145                   |       |
| Deferred policy acquisition costs                                                                |       | 3,235             |       | 3,664                 |       |
| Reinsurance recoverables                                                                         |       | 4,155             |       | 4,016                 |       |
| Accrued investment income                                                                        |       | 541               |       | 540                   |       |
| Deferred income taxes                                                                            |       | —            |       | 203                   |       |
| Other assets                                                                                     |       | 506               |       | 963                   |       |
| Separate Accounts                                                                                |       | 8,003             |       | 9,072                 |       |
| **Total assets**                                                                                 |       | $                 | 76,354     |                  | $          | 78,820 |   |
|                                                                                             |       |              |       |                  |       |
| **Liabilities**                                                                                  |       |              |       |                  |       |
| Contractholder funds                                                                             |       | $                 | 47,697     |                  | $          | 50,850 |   |
| Reserve for life-contingent contract benefits                                                    |       | 12,785            |       | 12,256                |       |
| Unearned premiums                                                                                |       | 28                |       | 30                    |       |
| Payable to affiliates, net                                                                       |       | 116               |       | 119                   |       |
| Other liabilities and accrued expenses                                                           |       | 1,572             |       | 1,432                 |       |
| Deferred income taxes                                                                            |       | 262               |       | —                |       |
| Notes due to related parties                                                                     |       | 681               |       | 675                   |       |
| Separate Accounts                                                                                |       | 8,003             |       | 9,072                 |       |
| **Total liabilities**                                                                            |       | 71,144            |       | 74,434                |       |
|                                                                                             |       |              |       |                  |       |
| **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                                                                       |       | 3,189             |       | 3,189                 |       |
| Retained income                                                                                  |       | 1,824             |       | 1,969                 |       |
| Accumulated other comprehensive income:                                                          |       |              |       |                  |       |
| Unrealized net capital gains and losses:                                                         |       |              |       |                  |       |
| Unrealized net capital losses on fixed income  securities with OTTI                              |       | (207              | )          | (274                  | )          |
| Other unrealized net capital gains and losses                                                    |       | 325               |       | (1,146                | )          |
| Unrealized adjustment to DAC, DSI and insurance  reserves                                        |       | 74                |       | 643                   |       |
| Total unrealized net capital gains and losses                                                    |       | 192               |       | (777                  | )          |
| Total accumulated other  comprehensive income (loss)                                             |       | 192               |       | (777                  | )          |
| Total shareholder’s  equity                                                                 |       | 5,210             |       | 4,386                 |       |
| **Total liabilities and  shareholder’s equity**                                             |       | $                 | 76,354     |                  | $          | 78,820 |   |

 

See notes to condensed consolidated financial statements.****

 

2

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                       | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**    | ** ** |
| **($ in millions)**                                                         | ** ** | **2010**             | ** ** | **2009** | ** ** |
| ** **                                                                       | ** ** | (unaudited)          | ** ** |
| **Cash flows from operating  activities**                                        |       |                 |       |   |   |
| Net loss                                                                         |       | $                    | (145       | ) | $ | (336 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                 |       |   |   |
| Amortization and other non-cash items                                            |       | (86                  | )          | (164 | ) |
| Realized capital gains and losses                                                |       | 513                  |       | (84 | ) |
| Gain on disposition of operations                                                |       | (3                   | )          | (4 | ) |
| Interest credited to contractholder funds                                        |       | 891                  |       | 1,113 |   |
| Changes in:                                                                      |       |                 |       |   |   |
| Policy benefits and other insurance reserves                                     |       | (130                 | )          | (52 | ) |
| Unearned premiums                                                                |       | (2                   | )          | (1 | ) |
| Deferred policy acquisition costs                                                |       | (106                 | )          | 501 |   |
| Reinsurance recoverables, net                                                    |       | (195                 | )          | (240 | ) |
| Income taxes                                                                     |       | 449                  |       | 425 |   |
| Other operating assets and liabilities                                           |       | (1                   | )          | 109 |   |
| Net cash provided by operating activities                                        |       | 1,185                |       | 1,267 |   |
|                                                                             |       |                 |       |   |   |
| **Cash flows from investing  activities**                                        |       |                 |       |   |   |
| Proceeds from sales                                                              |       |                 |       |   |   |
| Fixed income securities                                                          |       | 4,914                |       | 5,516 |   |
| Equity securities                                                                |       | 75                   |       | 7 |   |
| Limited partnership interests                                                    |       | 66                   |       | 19 |   |
| Mortgage loans                                                                   |       | 44                   |       | 139 |   |
| Other investments                                                                |       | 55                   |       | 251 |   |
| Investment collections                                                           |       |                 |       |   |   |
| Fixed income securities                                                          |       | 1,270                |       | 1,817 |   |
| Mortgage loans                                                                   |       | 620                  |       | 584 |   |
| Other investments                                                                |       | 37                   |       | 57 |   |
| Investment purchases                                                             |       |                 |       |   |   |
| Fixed income securities                                                          |       | (5,122               | )          | (6,048 | ) |
| Equity securities                                                                |       | (50                  | )          | (101 | ) |
| Limited partnership interests                                                    |       | (112                 | )          | (96 | ) |
| Mortgage loans                                                                   |       | (4                   | )          | (13 | ) |
| Other investments                                                                |       | (77                  | )          | (7 | ) |
| Change in short-term investments, net                                            |       | 595                  |       | 1,893 |   |
| Change in other investments, net                                                 |       | (52                  | )          | (162 | ) |
| Net cash provided by investing activities                                        |       | 2,259                |       | 3,856 |   |
|                                                                             |       |                 |       |   |   |
| **Cash flows from financing  activities**                                        |       |                 |       |   |   |
| Capital contribution                                                             |       | —               |       | 250 |   |
| Contractholder fund deposits                                                     |       | 1,266                |       | 1,943 |   |
| Contractholder fund withdrawals                                                  |       | (4,659               | )          | (7,160 | ) |
| Net cash used in financing activities                                            |       | (3,393               | )          | (4,967 | ) |
| **Net increase in cash**                                                         |       | 51                   |       | 156 |   |
| **Cash at beginning of period**                                                  |       | 145                  |       | 93 |   |
| **Cash at end of period**                                                        |       | $                    | 196        |   | $ | 249 |   |

 

See notes to condensed consolidated financial statements.

 

3

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL 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 condensed consolidated financial statements and notes as of June 30,2010, and for the three-month and six-month periods ended June 30, 2010and 2009 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. These condensed consolidated financial statements and notes should beread in conjunction with the consolidated financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2009.  Theresults of operations for the interim periods should not be consideredindicative of results to be expected for the full year.

 

**Premiums and Contract Charges**

 

The following table summarizes premiums and contract charges byproduct.

 
| ** **                                  | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                  | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| **($ in  millions)**                   | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Premiums**                                |       |                   |       |                 |       |   |   |   |   |
| Traditional life insurance                  |       | $                      | 100        |                 | $          | 97 |   | $ | 202 |   | $ | 193 |   |
| Immediate annuities with life contingencies |       | 31                     |       | 34                   |       | 58 |   | 68 |   |
| Accident and health                         |       | 23                     |       | 23                   |       | 47 |   | 45 |   |
| Total premiums                              |       | 154                    |       | 154                  |       | 307 |   | 306 |   |
|                                        |       |                   |       |                 |       |   |   |   |   |
| **Contract charges**                        |       |                   |       |                 |       |   |   |   |   |
| Interest-sensitive life insurance           |       | 238                    |       | 226                  |       | 471 |   | 442 |   |
| Fixed annuities                             |       | 10                     |       | 11                   |       | 23 |   | 23 |   |
| **Total contract charges**                  |       | 248                    |       | 237                  |       | 494 |   | 465 |   |
| **Total premiums and contract  charges**    |       | $                      | 402        |                 | $          | 391 |   | $ | 801 |   | $ | 771 |   |

 

**Adopted accounting standards**

 

*Disclosuresabout Fair Value Measurements*

 

InJanuary 2010, the Financial Accounting Standards Board (“FASB”) issued newaccounting guidance which expands disclosure requirements relating to fairvalue measurements.  The guidance addsrequirements for disclosing amounts of and reasons for significant transfersinto and out of Levels 1 and 2 and requires gross rather than net disclosuresabout purchases, sales, issuances and settlements relating to Level 3measurements.  The guidance also providesclarification that fair value measurement disclosures are required for eachclass of assets and liabilities. Disclosures about the valuation techniques and inputs used to measurefair value for measurements that fall in either Level 2 or Level 3 are alsorequired.  The Company adopted theprovisions of the new guidance as of March 31, 2010, except fordisclosures about purchases, sales, issuances and settlements in the rollforward of activity in Level 3 fair value measurements, which are required forfiscal years beginning after December 15, 2010.  Disclosures are not required for earlierperiods presented for comparative purposes. The new guidance affects disclosures only; and therefore, the adoptionhad no impact on the Company’s results of operations or financial position.

 

*Consolidation of Variable Interest Entities*

 

In June 2009, the FASB issued new accounting guidance which requires anentity to perform a qualitative analysis to determine whether it holds acontrolling financial interest (i.e., is a primary beneficiary) in a variableinterest entity (“VIE”).  The analysisidentifies the primary beneficiary of a VIE as the entity that has both thepower to direct the activities of the VIE that most significantly impact theeconomic performance of the VIE and the

 

4

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

obligationto absorb losses, or the right to receive benefits, that could potentially besignificant to the VIE.  The Companyadopted the new guidance as of January 1, 2010.  The adoption had no impact on the Company’sresults of operations or financial position.

 

In the normal course ofinvesting activities, the Company invests in variable interests issued byVIEs.  These variable interests includestructured investments such as asset-backed securities, commercialmortgage-backed securities and residential mortgage-backed securities as wellas limited partnerships, special purpose entities and trusts.  For these variable interests, the Companyconcluded it is not the primary beneficiary due to the amount of the Company’sinterest in the VIEs and the Company’s lack of power to direct the activitiesthat are most significant to the economic performance of the VIEs.  The Company’s maximum exposure to loss onthese interests is limited to the amount of the Company’s investment, includingfuture funding commitments, as applicable.

 

**Pending accounting standards**

 

*Embedded Credit Derivatives Scope Exception*

 

InMarch 2010, the FASB issued accounting guidance that clarifies the scopeexception for embedded credit derivative features related to the transfer ofcredit risk in the form of subordination of one financial instrument toanother.  The guidance addresses how todetermine which embedded credit derivative features, including those incollateralized debt obligations and synthetic collateralized debt obligations,are considered to be embedded derivatives that should not be analyzed forpotential bifurcation and separate accounting under the existing accountingguidance for embedded derivatives.  Theguidance is effective for fiscal quarters beginning after June 15,2010.  The Company will be required tobifurcate the credit default swaps embedded in synthetic collateralized debtobligations purchased after January 1, 2007.  The amortized cost and fair value of thesynthetic collateralized debt obligations subject to the guidance are $100million and $48 million, respectively, as of June 30, 2010.  Prospectively, the periodic changes in fairvalue of the embedded credit derivatives will be recorded in net income.  The adoption of this guidance on July 1,2010 is not expected to have a material impact on the Company’s results ofoperations or financial position.

 

*Consolidation Analysis Considering Investments Held throughSeparate Accounts*

 

In April 2010, the FASBissued guidance clarifying that an insurer is not required to combine interestsin investments held in a qualifying separate account with its interests in thesame investments held in the general account when performing a consolidationevaluation.   The guidance is effectivefor fiscal years and interim periods beginning after December 15, 2010with early adoption permitted.  Theadoption of this guidance is not expected to have a material impact on theCompany’s results of operations or financial position.

 

**2.  Related PartyTransaction**

 

In March 2010, in accordance with anasset purchase agreement between Road Bay Investments, LLC (“RBI”), aconsolidated subsidiary of ALIC, and American Heritage LifeInsurance Company (“AHL”), an unconsolidated affiliate of ALIC, AHL sold to RBI mortgage loans with acarrying value of $6 million on the date of sale.  As payment, RBI issued a 7.00% note due March 26,2017 to AHL for the same amount.  Assecurity for the performance of RBI’s obligations under the agreement and note,RBI granted a pledge of and security interest in RBI’s right, title andinterest in the mortgage loans and their proceeds.  The note due from RBI to AHL is classified asnotes due to related parties in the Condensed Consolidated Statements ofFinancial Position.

 

**3.  Supplemental CashFlow Information**

 

Non-cashinvestment exchanges, including modifications of certain mortgage loans, fixedincome securities, and other investments, as well as mergers completed withequity securities and limited partnerships, totaled $319 million and $141million for the six months ended June 30, 2010 and 2009, respectively.

 

5

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Liabilitiesfor collateral received in conjunction with the Company’s securities lending andover-the-counter (“OTC”) derivatives are reported in other liabilities andaccrued expenses or other investments in the Condensed Consolidated Statementsof Financial Position.  The accompanyingcash flows are included in cash flows from operating activities in theCondensed Consolidated Statements of Cash Flows along with the activitiesresulting from management of the proceeds, which are as follows:

 
| ** **                                    | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**                     | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| **Net change in proceeds managed**            |       |                                |       |   |   |
| Net change in short-term investments          |       | $                                   | 175        |   | $ | (350 | ) |
| Operating cash flow provided (used)           |       | $                                   | 175        |   | $ | (350 | ) |
|                                          |       |                                |       |   |   |
| **Net change in liabilities**                 |       |                                |       |   |   |
| Liabilities for collateral, beginning of year |       | $                                   | (617       | ) | $ | (340 | ) |
| Liabilities for collateral, end of period     |       | (442                                | )          | (690 | ) |
| Operating cash flow (used) provided           |       | $                                   | (175       | ) | $ | 350 |   |

 

**4.  Investments**

 

**Fair values**

 

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

 
| ** **                                                | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | **Fair**   | ** ** |
|-----------------------------------------------------------|------------|---------------|------------|----------------------|------------|------------|------------|
| **($ in millions)**                                  | ** ** | **cost**      | ** ** | **Gains**            | ** ** | **Losses** | ** ** | **value** | ** ** |
| **At June 30, 2010**                                 |       |          |       |                 |       |       |       |   |   |
| U.S. government and agencies                              |       | $             | 3,233      |                 | $          | 334        |       | $ | — |   | $ | 3,567 |   |
| Municipal                                                 |       | 5,320         |       | 178                  |       | (304       | )          | 5,194 |   |
| Corporate                                                 |       | 27,268        |       | 1,633                |       | (449       | )          | 28,452 |   |
| Foreign government                                        |       | 1,981         |       | 326                  |       | (6         | )          | 2,301 |   |
| Residential mortgage-backed securities (“RMBS”) |       | 5,548         |       | 139                  |       | (719       | )          | 4,968 |   |
| Commercial mortgage-backed securities (“CMBS”)  |       | 2,588         |       | 45                   |       | (598       | )          | 2,035 |   |
| Asset-backed securities (“ABS”)                 |       | 2,747         |       | 61                   |       | (469       | )          | 2,339 |   |
| Redeemable preferred stock                                |       | 15            |       | —               |       | —     |       | 15 |   |
| Total fixed income securities                             |       | $             | 48,700     |                 | $          | 2,716      |       | $ | (2,545 | ) | $ | 48,871 |   |
|                                                      |       |          |       |                 |       |       |       |   |   |
| **At December 31, 2009**                             |       |          |       |                 |       |       |       |   |   |
| U.S. government and agencies                              |       | $             | 3,426      |                 | $          | 168        |       | $ | (13 | ) | $ | 3,581 |   |
| Municipal                                                 |       | 5,578         |       | 50                   |       | (519       | )          | 5,109 |   |
| Corporate                                                 |       | 27,314        |       | 1,015                |       | (790       | )          | 27,539 |   |
| Foreign government                                        |       | 1,906         |       | 258                  |       | (11        | )          | 2,153 |   |
| RMBS                                                      |       | 5,596         |       | 76                   |       | (1,006     | )          | 4,666 |   |
| CMBS                                                      |       | 3,390         |       | 30                   |       | (952       | )          | 2,468 |   |
| ABS                                                       |       | 2,616         |       | 48                   |       | (537       | )          | 2,127 |   |
| Redeemable preferred stock                                |       | 16            |       | —               |       | (1         | )          | 15 |   |
| Total fixed income securities                             |       | $             | 49,842     |                 | $          | 1,645      |       | $ | (3,829 | ) | $ | 47,658 |   |

 

6

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Scheduled maturities**

 

Thescheduled maturities for fixed income securities are as follows at June 30,2010:

 
| **($ in millions)**               | ** ** | **Amortized  cost** | ** ** | **Fair  value** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------|------------|
| Due in one year or less                |       | $                   | 1,507      |            | $          | 1,526 |   |
| Due after one year through five years  |       | 13,351              |       | 13,909          |       |
| Due after five years through ten years |       | 10,848              |       | 11,704          |       |
| Due after ten years                    |       | 14,699              |       | 14,425          |       |
|                                   |       | 40,405              |       | 41,564          |       |
| RMBS and ABS                           |       | 8,295               |       | 7,307           |       |
| Total                                  |       | $                   | 48,700     |            | $          | 48,871 |   |

 

Actualmaturities may differ from those scheduled as a result of prepayments by theissuers.  Because of the potential forprepayment on RMBS and ABS, they are not categorized by contractualmaturity.  CMBS are categorized bycontractual maturity because they generally are not subject to prepayment risk.

 

**Net investment income**

 

Netinvestment income is as follows:

 
| ** **                        | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| **($ in millions)**          | ** ** | **2010**                                    | ** ** | **2009**                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities           |       | $                                           | 629        |                                      | $          | 639 |   | $ | 1,264 |   | $ | 1,320 |   |
| Mortgage loans                    |       | 98                                          |       | 129                                       |       | 199 |   | 263 |   |
| Equity securities                 |       | 1                                           |       | 1                                         |       | 2 |   | 2 |   |
| Limited partnership interests     |       | 4                                           |       | 2                                         |       | 7 |   | 4 |   |
| Short-term investments            |       | 1                                           |       | 3                                         |       | 2 |   | 10 |   |
| Other                             |       | (5                                          | )          | (10                                       | )          | (13 | ) | (16 | ) |
| Investment income, before expense |       | 728                                         |       | 764                                       |       | 1,461 |   | 1,583 |   |
| Investment expense                |       | (28                                         | )          | (23                                       | )          | (54 | ) | (45 | ) |
| Net investment income             |       | $                                           | 700        |                                      | $          | 741 |   | $ | 1,407 |   | $ | 1,538 |   |

 

**Realized capital gains and losses**

 

Realizedcapital gains and losses by security type are as follows:

 
| ** **                        | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| **($ in millions)**          | ** ** | **2010**                                    | ** ** | **2009**                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities           |       | $                                           | (176       | )                                         | $          | 4 |   | $ | (267 | ) | $ | 148 |   |
| Mortgage loans                    |       | (28                                         | )          | (16                                       | )          | (53 | ) | (48 | ) |
| Equity securities                 |       | 20                                          |       | 1                                         |       | 20 |   | (24 | ) |
| Limited partnership interests     |       | 9                                           |       | (53                                       | )          | (6 | ) | (224 | ) |
| Derivatives                       |       | (177                                        | )          | 221                                       |       | (212 | ) | 290 |   |
| Other                             |       | —                                      |       | (35                                       | )          | 5 |   | (58 | ) |
| Realized capital gains and losses |       | $                                           | (352       | )                                         | $          | 122 |   | $ | (513 | ) | $ | 84 |   |

 

7

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Realizedcapital gains and losses by transaction type are as follows:

 
| ** **                             | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| **($ in millions)**               | ** ** | **2010**                                    | ** ** | **2009**                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Impairment write-downs                 |       | $                                           | (141       | )                                         | $          | (203 | ) | $ | (283 | ) | $ | (555 | ) |
| Change in intent write-downs           |       | (57                                         | )          | (25                                       | )          | (80 | ) | (57 | ) |
| Net OTTI losses recognized in earnings |       | (198                                        | )          | (228                                      | )          | (363 | ) | (612 | ) |
| Sales                                  |       | 17                                          |       | 163                                       |       | 60 |   | 521 |   |
| Valuation of derivative instruments    |       | (149                                        | )          | 179                                       |       | (203 | ) | 262 |   |
| Settlements of derivative instruments  |       | (30                                         | )          | 41                                        |       | (11 | ) | 23 |   |
| EMA limited partnership income         |       | 8                                           |       | (33                                       | )          | 4 |   | (110 | ) |
| Realized capital gains and losses      |       | $                                           | (352       | )                                         | $          | 122 |   | $ | (513 | ) | $ | 84 |   |

 

Grossgains of $71 million and $223 million and gross losses of $94 million and $47million were realized on sales of fixed income securities during the threemonths ended June 30, 2010 and 2009, respectively.  Gross gains of $166 million and $629 millionand gross losses of $143 million and $115 million were realized on sales offixed income securities during the six months ended June 30, 2010 and2009, respectively.

 

8

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                              | ** ** | **Three months ended********June 30, 2010**                | ** ** | **Six months ended********June 30, 2010**                | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **($ in millions)**                | ** ** | **Gross**                                                       | ** ** | **Included  in OCI**                                          | ** ** | **Net** | ** ** | **Gross** | ** ** | **Included  in OCI** | ** ** | **Net** | ** ** |
| Fixed income securities:                |       |                                                            |       |                                                          |       |   |   |   |   |   |   |   |   |
| Municipal                               |       | $                                                               | (28        | )                                                             | $          | — |   | $ | (28 | ) | $ | (48 | ) | $ | — |   | $ | (48 | ) |
| Corporate                               |       | (2                                                              | )          | —                                                        |       | (2 | ) | (42 | ) | 2 |   | (40 | ) |
| RMBS                                    |       | (89                                                             | )          | 2                                                             |       | (87 | ) | (149 | ) | 15 |   | (134 | ) |
| CMBS                                    |       | (17                                                             | )          | (11                                                           | )          | (28 | ) | (43 | ) | (11 | ) | (54 | ) |
| ABS                                     |       | (5                                                              | )          | (15                                                           | )          | (20 | ) | (8 | ) | (16 | ) | (24 | ) |
| Total fixed income securities           |       | (141                                                            | )          | (24                                                           | )          | (165 | ) | (290 | ) | (10 | ) | (300 | ) |
| Mortgage loans                          |       | (28                                                             | )          | —                                                        |       | (28 | ) | (47 | ) | — |   | (47 | ) |
| Limited partnership interests           |       | (5                                                              | )          | —                                                        |       | (5 | ) | (16 | ) | — |   | (16 | ) |
| Other-than-temporary  impairment losses |       | $                                                               | (174       | )                                                             | $          | (24 | ) | $ | (198 | ) | $ | (353 | ) | $ | (10 | ) | $ | (363 | ) |
| ** **                              | ** ** | ** **                                                      | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Three months ended********June 30, 2009** | ** ** | **Six months ended********June 30, 2009** | ** ** |
| ** **                              | ** ** | **Gross**                                                       | ** ** | **Included  in OCI**                                     | ** ** | **Net** | ** ** | **Gross** | ** ** | **Included  in OCI** | ** ** | **Net** | ** ** |
| Fixed income securities:                |       |                                                            |       |                                                          |       |   |   |   |   |   |   |   |   |
| Municipal                               |       | $                                                               | (16        | )                                                             | $          | — |   | $ | (16 | ) | $ | (16 | ) | $ | — |   | $ | (16 | ) |
| Corporate                               |       | (37                                                             | )          | (9                                                            | )          | (46 | ) | (70 | ) | (9 | ) | (79 | ) |
| Foreign government                      |       | —                                                          |       | —                                                        |       | — |   | (17 | ) | — |   | (17 | ) |
| RMBS                                    |       | (148                                                            | )          | 104                                                           |       | (44 | ) | (168 | ) | 104 |   | (64 | ) |
| CMBS                                    |       | (44                                                             | )          | —                                                        |       | (44 | ) | (53 | ) | — |   | (53 | ) |
| ABS                                     |       | (37                                                             | )          | 9                                                             |       | (28 | ) | (167 | ) | 9 |   | (158 | ) |
| Total fixed income securities           |       | (282                                                            | )          | 104                                                           |       | (178 | ) | (491 | ) | 104 |   | (387 | ) |
| Mortgage loans                          |       | (15                                                             | )          | —                                                        |       | (15 | ) | (49 | ) | — |   | (49 | ) |
| Equity securities                       |       | (1                                                              | )          | —                                                        |       | (1 | ) | (26 | ) | — |   | (26 | ) |
| Limited partnership interests           |       | (21                                                             | )          | —                                                        |       | (21 | ) | (115 | ) | — |   | (115 | ) |
| Other                                   |       | (13                                                             | )          | —                                                        |       | (13 | ) | (35 | ) | — |   | (35 | ) |
| Other-than-temporary  impairment losses |       | $                                                               | (332       | )                                                             | $          | 104 |   | $ | (228 | ) | $ | (716 | ) | $ | 104 |   | $ | (612 | ) |

 

The total amount of other-than-temporary impairment losses included inaccumulated other comprehensive income for fixed income securities, which werenot included in earnings, are presented in the following table.  The amount excludes $180 million and $136million as of June 30, 2010 and December 31, 2009, respectively, ofnet unrealized gains related to changes in valuation of the fixed income securitiessubsequent to the impairment measurement date.

 
| **($ in  millions)** | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Corporate                 |       | $                       | (18        | )                           | $          | (18 | ) |
| RMBS                      |       | (314                    | )          | (323                        | )          |
| CMBS                      |       | (94                     | )          | (127                        | )          |
| ABS                       |       | (73                     | )          | (90                         | )          |
| Total                     |       | $                       | (499       | )                           | $          | (558 | ) |

 

9

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Rollforwardsof the cumulative credit losses recognized in earnings for fixed incomesecurities held as of the end of the period are as follows:

 
| ** **                                                                                                                                                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**                                                                                                                                 | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Beginning balance                                                                                                                                         |       | $                                     | (833       | )                                   | $          | — |   | $ | (808 | ) | $ | — |   |
| Beginning balance of cumulative credit loss for  securities held at April 1, 2009                                                                    |       | —                                |       | (1,059                              | )          | — |   | (1,059 | ) |
| Additional credit loss for securities previously  other-than-temporarily impaired                                                                         |       | (75                                   | )          | (39                                 | )          | (122 | ) | (39 | ) |
| Additional credit loss for securities not  previously other-than-temporarily impaired                                                                     |       | (34                                   | )          | (119                                | )          | (105 | ) | (119 | ) |
| Reduction in credit loss for securities disposed  or collected                                                                                            |       | 75                                    |       | 24                                  |       | 168 |   | 24 |   |
| Reduction in credit loss for securities  other-than-temporarily impaired to fair value                                                                    |       | 1                                     |       | —                              |       | 1 |   | — |   |
| 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 |       | 2                                     |       | —                              |       | 2 |   | — |   |
| Ending balance                                                                                                                                            |       | $                                     | (864       | )                                   | $          | (1,193 | ) | $ | (864 | ) | $ | (1,193 | ) |

 

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, currentconditions, and reasonable and supportable assumptions and forecasts, areconsidered when developing the estimate of cash flows expected to becollected.  That information generallyincludes, but is not limited to, the remaining payment terms of the security,prepayment speeds, foreign exchange rates, the financial condition of the issueor issuer(s), expected defaults, expected recoveries, the value of underlyingcollateral and current subordination levels, vintage, geographic concentration,available reserves or escrows, third party guarantees and other creditenhancements.  Additionally, otherinformation, such as industry analyst reports and forecasts, sector creditratings, financial condition of the bond insurer for insured fixed incomesecurities, and other market data relevant to the realizability of contractualcash flows, may also be considered.  Theestimated fair value of collateral may be used to estimate recovery value ifthe Company determines that the security is dependent on the liquidation ofcollateral for ultimate settlement.  Ifthe estimated recovery value is less than the amortized cost of the security, acredit loss exists and an other-than-temporary impairment for the differencebetween the estimated recovery value and amortized cost is recorded inearnings.  The portion of the unrealizedloss related to factors 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.

 

10

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Unrealizednet capital gains and losses**

 

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

 
| ** **                                         | ** ** | **Fair**  | ** ** | **Gross unrealized** | ** ** | **Unrealized net** | ** ** |
|----------------------------------------------------|------------|-----------|------------|----------------------|------------|--------------------|------------|
| **($ in  millions)**                          | ** ** | **value** | ** ** | **Gains**            | ** ** | **Losses**         | ** ** | **gains (losses)** | ** ** |
| **At June 30, 2010**                          |       |      |       |                 |       |               |       |   |   |
| Fixed income securities (1)                        |       | $         | 48,871     |                 | $          | 2,716              |       | $ | (2,545 | ) | $ | 171 |   |
| Equity securities                                  |       | 172       |       | 19                   |       | (8                 | )          | 11 |   |
| Short-term investments                             |       | 903       |       | —               |       | —             |       | — |   |
| Derivative instruments (2)                         |       | 7         |       | 10                   |       | (3                 | )          | 7 |   |
| Unrealized net capital gains and losses, pre-tax   |       |      |       |                 |       |               |       | 189 |   |
| Amounts recognized for:                            |       |      |       |                 |       |               |       |   |   |
| Insurance reserves (3)                             |       |      |       |                 |       |               |       | (292 | ) |
| DAC and DSI (4)                                    |       |      |       |                 |       |               |       | 406 |   |
| Amounts recognized                                 |       |      |       |                 |       |               |       | 114 |   |
| Deferred income taxes                              |       |      |       |                 |       |               |       | (111 | ) |
| Unrealized net capital gains and losses, after-tax |       |      |       |                 |       |               |       | $ | 192 |   |
|                                                    |            |           |            |                      |            |                    |            |  |  |  |  |  |  |

 

----

| (1)    |   | Unrealized  net capital gains and losses for fixed income securities as of June 30,  2010 comprises $(319) million related to unrealized net capital losses on  fixed income securities with OTTI and $490 million related to other  unrealized net capital gains and losses.                                                                                                                                                                                                                                                                                                                                  |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (2)    |   | Included  in the fair value of derivative securities are $5 million classified as  assets and $(2) million classified as liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (3)    |   | The  insurance reserves adjustment represents the amount by which the reserve  balance would increase if the net unrealized gains in the applicable product  portfolios were realized and reinvested at current lower interest rates,  resulting in a premium deficiency. Although the Company evaluates premium  deficiencies on the combined performance of life insurance and immediate  annuities with life contingencies, the adjustment primarily relates to  structured settlement annuities with life contingencies, in addition to  annuity buy-outs and certain payout annuities with life contingencies. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (4)    |   | The  DAC and DSI adjustment balance represents the amount by which the  amortization of DAC and DSI would increase or decrease if the unrealized  gains or losses in the respective product portfolios were realized.                                                                                                                                                                                                                                                                                                                                                                                               |

 
| ** **                                         | ** ** | **Fair**  | ** ** | **Gross unrealized** | ** ** | **Unrealized net** | ** ** |
|----------------------------------------------------|------------|-----------|------------|----------------------|------------|--------------------|------------|
| ** **                                         | ** ** | **value** | ** ** | **Gains**            | ** ** | **Losses**         | ** ** | **gains (losses)** | ** ** |
| **At December 31, 2009**                      |       |      |       |                 |       |               |       |   |   |
| Fixed income securities (1)                        |       | $         | 47,658     |                 | $          | 1,645              |       | $ | (3,829 | ) | $ | (2,184 | ) |
| Equity securities                                  |       | 183       |       | 31                   |       | (7                 | )          | 24 |   |
| Short-term investments                             |       | 1,669     |       | —               |       | —             |       | — |   |
| Derivative instruments (2)                         |       | (20       | )          | 2                    |       | (20                | )          | (18 | ) |
| Unrealized net capital gains and losses, pre-tax   |       |      |       |                 |       |               |       | (2,178 | ) |
| Amounts recognized for:                            |       |      |       |                 |       |               |       |   |   |
| Insurance reserves                                 |       |      |       |                 |       |               |       | — |   |
| DAC and DSI                                        |       |      |       |                 |       |               |       | 990 |   |
| Amounts recognized                                 |       |      |       |                 |       |               |       | 990 |   |
| Deferred income taxes                              |       |      |       |                 |       |               |       | 411 |   |
| Unrealized net capital gains and losses, after-tax |       |      |       |                 |       |               |       | $ | (777 | ) |
|                                                    |            |           |            |                      |            |                    |            |  |  |  |  |  |  |

 

----

| (1)    |   | Unrealized  net capital gains and losses for fixed income securities as of  December 31, 2009 comprises $(422) million related to net unrealized  capital losses on fixed income securities with OTTI and $(1,762) million  related to other unrealized net capital gains and losses. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                       |
| (2)    |   | Included in the fair value of derivative  securities are $(2) million classified as assets and $18 million  classified as liabilities.                                                                                                                                                |

 

11

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

** **

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

 

Thechange in unrealized net capital gains and losses for the six months ended June 30,2010 is as follows:

 
| **($ in millions)**                             | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| Fixed income securities                              |       | $          | 2,355      |   |
| Equity securities                                    |       | (13        | )          |
| Derivative instruments                               |       | 25         |       |
| Total                                                |       | 2,367      |       |
|                                                 |       |       |       |
| Amounts recognized for:                              |       |       |       |
| Insurance reserves                                   |       | (292       | )          |
| DAC and DSI                                          |       | (584       | )          |
| Decrease in amounts recognized                       |       | (876       | )          |
| Deferred income taxes                                |       | (522       | )          |
| Increase in unrealized net capital gains and  losses |       | $          | 969        |   |

 

**Portfolio monitoring**

 

TheCompany has a comprehensive portfolio monitoring process to identify andevaluate each fixed income and equity security whose carrying value may beother-than-temporarily impaired*.*

 

Foreach fixed income security in an unrealized loss position, the Company assesseswhether management with the appropriate authority**hasmade a decision to sell or whether it is more likely than not the Company willbe required to sell the security before recovery of the amortized cost basisfor reasons such as liquidity, contractual or regulatory purposes.  If a security meets either of these criteria,the security’s decline in fair value is other than temporary and is recorded inearnings.

 

Ifthe Company has not made the decision to sell the fixed income security and itis not more likely than not the Company will be required to sell the fixedincome security before recovery of its amortized cost basis, the Companyevaluates if it expects to receive cash flows sufficient to recover the entireamortized cost basis of the security by comparing the estimated recovery value,calculated by discounting the best estimate of future cash flows at thesecurity’s original or current effective rate, as appropriate, to the amortizedcost of the security.  If the Companydoes not expect to receive cash flows sufficient to recover the entireamortized cost basis of the fixed income security, the credit loss component ofthe impairment is recorded in earnings, with the remaining amount of theunrealized loss related to other factors recognized in OCI.

 

Forequity securities, the Company considers various factors, including whether theCompany has the intent and ability to hold the equity security for a period oftime sufficient to recover its cost basis. Where the Company lacks the intent and ability to hold to recovery, orbelieves the recovery period is extended, the equity security’s decline in fairvalue is considered other than temporary and is recorded in earnings.  For equity securities managed by a thirdparty, the Company has contractually retained its decision making authority asit pertains to selling equity securities that are in an unrealized lossposition.

 

TheCompany’s portfolio monitoring process includes a quarterly review of allsecurities through a screening process which identifies instances where thefair value compared to amortized cost (for fixed income securities) and cost(for equity securities) is below established thresholds.  The screening process also includes themonitoring of other criteria such as ratings, ratings downgrades and paymentdefaults.  The securities identified, inaddition to other securities for which the Company may have a concern, areevaluated for potential other-than-temporary impairment using all reasonablyavailable information relevant to the collectability or recovery of thesecurity.  Inherent in the Company’sevaluation of other-than-temporary impairment for these fixed income and equitysecurities are assumptions and estimates about the financial condition of theissue or issuer and its future earnings potential.  Some of the factors considered in evaluatingwhether a decline in fair value is other than temporary are: 1) the financialcondition, near-term and long-term prospects of the issue or issuer, includingrelevant industry specific market conditions and trends, geographic locationand implications of rating agency actions and offering prices; 2) the specificreasons that a security is in a significant unrealized loss position, includingoverall market conditions which could affect liquidity; and 3) the length oftime and extent to which the fair value has been less than amortized cost orcost.

 

12

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table summarizes the gross unrealized losses and fair value of fixedincome and equity securities by the length of time that individual securitieshave been in a continuous unrealized loss position.

 
| ** **                                     | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**      | ** ** |
|------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                     | ** ** | **Number**              | ** ** | **Fair**              | ** ** | **Unrealized** | ** ** | **Number** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **unrealized** | ** ** |
| **($ in  millions)**                      | ** ** | **of issues**           | ** ** | **value**             | ** ** | **losses**     | ** ** | **of issues** | ** ** | **value** | ** ** | **losses** | ** ** | **losses** | ** ** |
| **At June 30, 2010**                      | ** ** | ** **              | ** ** | ** **            | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fixed income securities                        | ** ** | ** **              | ** ** | ** **            | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Municipal                                      |       | 20                      |       | $                     | 237        |           | $          | (4 | ) | 234 |   | $ | 1,601 |   | $ | (300 | ) | $ | (304 | ) |
| Corporate                                      |       | 194                     |       | 1,917                 |       | (80            | )          | 230 |   | 3,094 |   | (369 | ) | (449 | ) |
| Foreign government                             |       | 6                       |       | 108                   |       | (6             | )          | 2 |   | 20 |   | — |   | (6 | ) |
| RMBS                                           |       | 53                      |       | 354                   |       | (6             | )          | 294 |   | 1,565 |   | (713 | ) | (719 | ) |
| CMBS                                           |       | 6                       |       | 60                    |       | (2             | )          | 173 |   | 1,167 |   | (596 | ) | (598 | ) |
| ABS                                            |       | 32                      |       | 293                   |       | (18            | )          | 143 |   | 1,230 |   | (451 | ) | (469 | ) |
| Redeemable preferred stock                     |       | 2                       |       | 14                    |       | —         |       | — |   | — |   | — |   | — |   |
| Total fixed income securities (1)              |       | 313                     |       | 2,983                 |       | (116           | )          | 1,076 |   | 8,677 |   | (2,429 | ) | (2,545 | ) |
| Equity securities                              |       | 7                       |       | 56                    |       | (6             | )          | 1 |   | 16 |   | (2 | ) | (8 | ) |
| Total fixed income and equity securities       |       | 320                     |       | $                     | 3,039      |           | $          | (122 | ) | 1,077 |   | $ | 8,693 |   | $ | (2,431 | ) | $ | (2,553 | ) |
|                                           |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |
| Investment grade fixed income securities       |       | 214                     |       | $                     | 2,529      |           | $          | (107 | ) | 782 |   | $ | 6,965 |   | $ | (1,372 | ) | $ | (1,479 | ) |
| Below investment grade fixed income securities |       | 99                      |       | 454                   |       | (9             | )          | 294 |   | 1,712 |   | (1,057 | ) | (1,066 | ) |
| Total fixed income securities                  |       | 313                     |       | $                     | 2,983      |           | $          | (116 | ) | 1,076 |   | $ | 8,677 |   | $ | (2,429 | ) | $ | (2,545 | ) |
|                                           |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |
| **At December 31, 2009**                  | ** ** | ** **              | ** ** | ** **            | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fixed income securities                        | ** ** | ** **              | ** ** | ** **            | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. government and agencies                   |       | 27                      |       | $                     | 1,952      |           | $          | (13 | ) | — |   | $ | — |   | $ | — |   | $ | (13 | ) |
| Municipal                                      |       | 144                     |       | 1,634                 |       | (62            | )          | 280 |   | 1,912 |   | (457 | ) | (519 | ) |
| Corporate                                      |       | 300                     |       | 3,979                 |       | (131           | )          | 398 |   | 5,155 |   | (659 | ) | (790 | ) |
| Foreign government                             |       | 10                      |       | 360                   |       | (11            | )          | 1 |   | 1 |   | — |   | (11 | ) |
| RMBS                                           |       | 162                     |       | 604                   |       | (14            | )          | 310 |   | 1,727 |   | (992 | ) | (1,006 | ) |
| CMBS                                           |       | 19                      |       | 186                   |       | (3             | )          | 257 |   | 1,796 |   | (949 | ) | (952 | ) |
| ABS                                            |       | 21                      |       | 203                   |       | (19            | )          | 163 |   | 1,363 |   | (518 | ) | (537 | ) |
| Redeemable preferred stock                     |       | 1                       |       | —                |       | —         |       | 1 |   | 13 |   | (1 | ) | (1 | ) |
| Total fixed income securities (1)              |       | 684                     |       | 8,918                 |       | (253           | )          | 1,410 |   | 11,967 |   | (3,576 | ) | (3,829 | ) |
| Equity securities                              |       | 7                       |       | 11                    |       | (2             | )          | 1 |   | 13 |   | (5 | ) | (7 | ) |
| Total fixed income and equity securities       |       | 691                     |       | $                     | 8,929      |           | $          | (255 | ) | 1,411 |   | $ | 11,980 |   | $ | (3,581 | ) | $ | (3,836 | ) |
|                                           |       |                    |       |                  |       |           |       |   |   |   |   |   |   |   |   |
| Investment grade fixed income securities       |       | 650                     |       | $                     | 8,667      |           | $          | (191 | ) | 1,119 |   | $ | 10,260 |   | $ | (2,467 | ) | $ | (2,658 | ) |
| Below investment grade fixed income securities |       | 34                      |       | 251                   |       | (62            | )          | 291 |   | 1,707 |   | (1,109 | ) | (1,171 | ) |
| Total fixed income securities                  |       | 684                     |       | $                     | 8,918      |           | $          | (253 | ) | 1,410 |   | $ | 11,967 |   | $ | (3,576 | ) | $ | (3,829 | ) |

 

----

| (1) | Gross  unrealized losses resulting from factors other than credit on fixed income  securities with other-than-temporary impairments for which the Company has  recorded a credit loss in earnings total $4 million for the less than 12  month category and $389 million for the 12 months or greater category as of  June 30, 2010 and $16 million for the less than 12 month category and  $468 million for the 12 months or greater category as of December 31,  2009. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Asof June 30, 2010, $584 million of unrealized losses are related tosecurities with an unrealized loss position less than 20% of amortized cost orcost, the degree of which suggests that these securities do not pose a highrisk of being other-than-temporarily impaired. Of the $584 million, $494 million are related to unrealized losses oninvestment grade fixed income securities. Investment grade is defined as a security having a rating of Aaa, Aa, Aor Baa from Moody’s, a rating of AAA, AA, A or BBB from S&P, Fitch,Dominion or Realpoint, a rating of aaa, aa, a or bbb from A.M. Best, or acomparable internal rating if an externally provided rating is notavailable.  Unrealized losses oninvestment grade securities are principally related to rising interest rates orwidening credit spreads since the securities were acquired.

 

Asof June 30, 2010, the remaining $1.97 billion of unrealized losses arerelated to securities in unrealized loss positions greater than or equal to 20%of amortized cost or cost.  Investmentgrade securities comprising $985 million of these unrealized losses wereevaluated based on factors such as discounted cash flows and the financialcondition and near-term and long-term prospects of the issue or issuer and weredetermined to have adequate resources to fulfill contractual obligations, suchas recent financings or bank loans, cash flows from operations, collateral orthe position of a subsidiary with respect to its parent’s bankruptcy.  Of the $1.97 billion, $984 million arerelated to below investment grade fixed income securities.  Of these amounts, $921 million of the belowinvestment grade fixed income securities had been in an unrealized lossposition for a period of twelve or more consecutive months as of June 30,2010.  Unrealized losses on below investmentgrade securities are principally related to RMBS, CMBS and ABS and were theresult of wider credit spreads resulting from larger risk premiums 

 

13

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

sincethe time of initial purchase, largely due to macroeconomic conditions andcredit market deterioration, including the impact of declining residential andcommercial real estate valuations.

 

RMBS,CMBS and ABS securities in an unrealized loss position were evaluated based ondiscounted cash flows and credit ratings, as well as the performance of theunderlying collateral relative to the securities’ positions in the respectivesecuritization trusts.  The evaluationfor RMBS and ABS in an unrealized loss position also takes into considerationcredit enhancements from bond insurers, where applicable.  Municipal bonds in an unrealized lossposition were evaluated based on the quality of the underlying security, takinginto consideration credit enhancements from bond insurers, whereapplicable.  Unrealized losses on equitysecurities are primarily related to equity market fluctuations.

 

Asof June 30, 2010, the Company has not made a decision to sell and it isnot more likely than not the Company will be required to sell fixed incomesecurities with unrealized losses before recovery of the amortized costbasis.  As of June 30, 2010, theCompany had the intent and ability to hold the equity securities withunrealized losses for a period of time sufficient for them to recover.

 

**Limitedpartnership impairment**

 

Asof June 30, 2010 and December 31, 2009, the carrying value of equitymethod limited partnership interests totaled $474 million and $495 million,respectively.  The Company recognizes animpairment loss for equity method investments when evidence demonstrates thatit is other-than-temporarily impaired. Evidence of a loss in value that is other than temporary may include theabsence of an ability to recover the carrying amount of the investment or theinability of the investee to sustain a level of earnings that would justify thecarrying amount of the investment.  TheCompany had write-downs of $1 million for the three months ended June 30,2010 and had no write-downs for the three months ended June 30, 2009related to equity method limited partnership interests.  The Company had write-downs of $1 million and$5 million for the six months ended June 30, 2010 and 2009, respectively,related to equity-method limited partnership interests.

 

Asof June 30, 2010 and December 31, 2009, the carrying value for costmethod limited partnership interests was $590 million and $533 million,respectively.  To determine if another-than-temporary impairment has occurred, the Company evaluates whether animpairment 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 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, as well as investments thatare performing below expectations, for further impairment consideration.  If a cost method limited partnership is deemedother-than-temporarily impaired, the carrying value is written down to fairvalue, generally estimated to be equivalent to the reported net asset value ofthe underlying funds.  The Company hadwrite-downs of $4 million and $21 million for the three months ended June 30,2010 and 2009, respectively, and write-downs of $15 million and $110 millionfor the six months ended June 30, 2010 and 2009, respectively, related tocost method investments that were other-than-temporarily impaired.

 

**5.  Fair Value of Assets andLiabilities**

 

Fairvalue is defined as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date.  The hierarchyfor inputs used in determining fair value maximizes the use of observableinputs and minimizes the use of unobservable inputs by requiring thatobservable inputs be used when available. Assets and liabilities recorded on the Condensed Consolidated Statementsof Financial Position at fair value are categorized in the fair value hierarchybased on the observability of inputs to the valuation techniques as follows:

 

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

 

*Level 2:***    **Assets andliabilities whose values are based on the following:

 

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

 

14

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

(c)  Valuation models whose inputs areobservable, directly or indirectly, for substantially the full term of theasset or liability.

 

*Level 3:**    *Assets andliabilities whose values are based on prices or valuation techniques thatrequire inputs that are both unobservable and significant to the overall fairvalue measurement.  Unobservable inputsreflect the Company’s estimates of the assumptions that market participantswould use in valuing the assets and liabilities.

 

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

 

The Company has two types of situations whereinvestments are classified as Level 3 in the fair value hierarchy.  The first is where quotes continue to bereceived from independent third-party valuation service providers and allsignificant inputs are market observable; however, there has been a significantdecrease in the volume and level of activity for the asset when compared tonormal market activity such that the degree of market observability hasdeclined to a point where categorization as a Level 3 measurement is consideredappropriate.  The indicators consideredin determining whether a significant decrease in the volume and level ofactivity for a specific asset has occurred include the level of new issuancesin the primary market, trading volume in the secondary market, the level ofcredit spreads over historical levels, applicable bid-ask spreads, and priceconsensus among market participants and sources.

 

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

 

Certainassets are not carried at fair value on a recurring basis, includinginvestments such as mortgage loans, limited partnership interests, bank loansand policy loans.  Accordingly, suchinvestments are only included in the fair value hierarchy disclosure when theinvestment is subject to remeasurement at fair value after initial recognitionand the resulting remeasurement is reflected in the condensed consolidatedfinancial statements.  In addition,equity options embedded in fixed income securities are not disclosed in thehierarchy with free-standing derivatives as the embedded derivatives are presentedwith the host contracts in fixed income securities.  As of June 30, 2010, 76.3% of totalassets are measured at fair value and 0.9% of total liabilities are measured atfair value.

 

Indetermining fair value, the Company principally uses the market approach whichgenerally utilizes market transaction data for the same or similarinstruments.  To a lesser extent, theCompany uses the income approach which involves determining fair values fromdiscounted cash flow methodologies.  Forthe majority of Level 2 and Level 3 valuations, a combination of the market andincome approaches is used.

 

*Summary of significant valuation techniques for assets and liabilitiesmeasured at fair value on a recurring basis*

 

Level1 measurements

 

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

 

·                  Equity securities:  Comprise actively traded, exchange-listedU.S. and international equity securities. Valuation is based on unadjustedquoted prices for identical assets in active markets that the Company canaccess.

 

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

 

15

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

Level2 measurements

 

·                  Fixed income securities:

 

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

 

*Municipal:*  The primaryinputs to the valuation include quoted prices for identical or similar assetsin markets that are not active, contractual cash flows, benchmark yields andcredit spreads.

 

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

 

*Foreign government: *The primaryinputs to the valuation include quoted prices for identical or similar assetsin markets that are not active, contractual cash flows, benchmark yields andcredit spreads.

 

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

 

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

 

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

 

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

 

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

 

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

 

OTCderivatives, including interest rate swaps, foreign currency swaps, foreignexchange forward contracts, and certain credit default swaps, are valued usingmodels that rely on inputs such as interest rate yield curves, currency rates,and counterparty credit spreads that are observable for substantially the fullterm of the contract.  The valuationtechniques underlying the models are widely accepted in the financial servicesindustry and do not involve significant judgment.

 

·                  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.  The valuation techniques are widely acceptedin the financial services industry and do not include significant judgment.

 

16

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Level3 measurements

 

·                  Fixed income securities:

 

*Municipal: *ARS primarilybacked by student loans that have become illiquid due to failures in theauction market are valued using a discounted cash flow model that is widelyaccepted in the financial services industry and uses significant non-marketobservable inputs, including estimates of future coupon rates if auctionfailures continue, maturity assumptions and illiquidity premium.  Also included are municipal bonds that arenot rated by third party credit rating agencies but are rated by the NAIC, inaddition to other high-yield municipal bonds. The primary inputs to the valuation of these municipal bonds includequoted prices for identical or similar assets in markets that exhibit lessliquidity relative to those markets supporting Level 2 fair value measurements,contractual cash flows, benchmark yields and credit spreads.

 

*Corporate, including privately placed:*  Primarily valued based on non-binding brokerquotes.  Also included are equity-indexednotes which are valued using a discounted cash flow model that is widely accepted in the financial servicesindustry and uses significantnon-market observable inputs,such as volatility.  Other inputsinclude an interest rate curve, as well as published credit spreads for similarassets that incorporate the credit quality and industry sector of the issuer.

 

*RMBS - Subprime residential mortgage-backed securities (“Subprime”) andAlt-A:*  The primary inputs to thevaluation include quoted prices for identical or similar assets in markets thatexhibit less liquidity relative to those markets supporting Level 2 fair valuemeasurements, contractual cash flows, benchmark yields, prepayment speeds,collateral performance and credit spreads. Also included are Subprime and Alt-A securities that are valued based onnon-binding broker quotes.  Due to thereduced availability of actual market prices or relevant observable inputs as aresult of the decrease in liquidity that has been experienced in the market forthese securities, Subprime and certain Alt-A securities are categorized asLevel 3.

 

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

 

*CMBS:*  The primaryinputs to the valuation include quoted prices for identical or similar assetsin markets that exhibit less liquidity relative to those markets supportingLevel 2 fair value measurements, contractual cash flows, benchmark yields,collateral performance and credit spreads. Also included are CMBS that are valued based on non-binding brokerquotes.  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 CMBS are categorized as Level 3.

 

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

 

*ABS - student loans and other:*  The primary inputs to the valuation includequoted prices for identical or similar assets in markets that exhibit lessliquidity relative to those markets supporting Level 2 fair value measurements,contractual cash flows, benchmark yields, prepayment speeds, collateralperformance and credit spreads.  Alsoincluded are ABS that are valued based on non-binding broker quotes.  Due to the reduced availability of actualmarket prices or relevant observable inputs as a result of the decrease inliquidity that has been experienced in the market for these securities, certainABS are categorized as Level 3.

 

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

 

·                  Contractholderfunds:  Derivatives embedded in certainannuity contracts are valued internally using models widely accepted in thefinancial services industry that determinea single best estimate of fair value for the embedded derivatives within ablock of contractholder liabilities.  Themodels use stochastically determined cash flows based on the contractualelements of embedded derivatives and other applicable 

 

17

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

market data. These are categorized as Level 3 as a result of the significance of non-market observable inputs.

 

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

 

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

 

Thefollowing table summarizes the Company’s assets and liabilities measured atfair value on a recurring and non-recurring basis as of June 30, 2010:

 
| **($ in  millions)**                 | ** ** | **Quoted prices  in active  markets for  identical assets  (Level 1)** | ** ** | **Significant  other  observable  inputs  (Level 2)** | ** ** | **Significant  unobservable  inputs  (Level 3)** | ** ** | **Counterparty  and cash  collateral  netting** | ** ** | **Balance as of  June 30,  2010** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------|------------|
| **Assets**                                | ** ** | ** **                                                             | ** ** | ** **                                            | ** ** | ** **                                       | ** ** | ** **                                      | ** ** | ** **                             | ** ** |
| Fixed income securities:                  |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                   |       |
| U.S. government and agencies              |       | $                                                                      | 839        |                                                  | $          | 2,728                                            |       | $                                               | —     |                                   |       |   | $ | 3,567 |   |
| Municipal                                 |       | —                                                                 |       | 4,591                                                 |       | 603                                              |       |                                            |       | 5,194                                  |       |
| Corporate                                 |       | —                                                                 |       | 26,434                                                |       | 2,018                                            |       |                                            |       | 28,452                                 |       |
| Foreign government                        |       | —                                                                 |       | 2,301                                                 |       | —                                           |       |                                            |       | 2,301                                  |       |
| RMBS                                      |       | —                                                                 |       | 3,606                                                 |       | 1,362                                            |       |                                            |       | 4,968                                  |       |
| CMBS                                      |       | —                                                                 |       | 1,243                                                 |       | 792                                              |       |                                            |       | 2,035                                  |       |
| ABS                                       |       | —                                                                 |       | 459                                                   |       | 1,880                                            |       |                                            |       | 2,339                                  |       |
| Redeemable preferred stock                |       | —                                                                 |       | 14                                                    |       | 1                                                |       |                                            |       | 15                                     |       |
| Total fixed income securities             |       | 839                                                                    |       | 41,376                                                |       | 6,656                                            |       |                                            |       | 48,871                                 |       |
| Equity securities                         |       | 110                                                                    |       | 33                                                    |       | 29                                               |       |                                            |       | 172                                    |       |
| Short-term investments                    |       | 95                                                                     |       | 808                                                   |       | —                                           |       |                                            |       | 903                                    |       |
| Other investments:                        |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                   |       |
| Free-standing derivatives                 |       | —                                                                 |       | 364                                                   |       | 7                                                |       | $                                               | (185       | )                                      | 186        |   |
| Separate account assets                   |       | 8,003                                                                  |       | —                                                |       | —                                           |       |                                            |       | 8,003                                  |       |
| Other assets                              |       | —                                                                 |       | —                                                |       | 2                                                |       |                                            |       | 2                                      |       |
| **Total recurring basis assets**          |       | 9,047                                                                  |       | 42,581                                                |       | 6,694                                            |       | (185                                            | )          | 58,137                                 |       |
| Non-recurring basis (1)                   |       | —                                                                 |       | —                                                |       | 84                                               |       |                                            |       | 84                                     |       |
| **Total assets at fair value**            |       | $                                                                      | 9,047      |                                                  | $          | 42,581                                           |       | $                                               | 6,778      |                                   | $          | (185 | ) | $ | 58,221 |   |
| % of total assets at fair value           |       | 15.5                                                                   | %          | 73.1                                                  | %          | 11.7                                             | %          | (0.3                                            | )%         | 100.0                                  | %          |
|                                      |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                   |       |
| **Liabilities**                           |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                   |       |
| Contractholder funds:                     |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                   |       |
| Derivatives embedded in annuity contracts |       | $                                                                      | —     |                                                  | $          | (106                                             | )          | $                                               | (119       | )                                      |       |   | $ | (225 | ) |
| Other liabilities:                        |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                   |       |
| Free-standing derivatives                 |       | (1                                                                     | )          | (463                                                  | )          | (115                                             | )          | $                                               | 185        |                                   | (394       | ) |
| **Total liabilities at fair value**       |       | $                                                                      | (1         | )                                                     | $          | (569                                             | )          | $                                               | (234       | )                                      | $          | 185 |   | $ | (619 | ) |
| % of total liabilities at fair value      |       | 0.2                                                                    | %          | 91.9                                                  | %          | 37.8                                             | %          | (29.9                                           | )%         | 100.0                                  | %          |

 

----

(1)         Includes $78 million ofmortgage loans and $6 million of limited partnership interests written-down tofair value in connection with recognizing other-than-temporary impairments.

 

18

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table summarizes the Company’s assets and liabilities measured atfair value on a recurring and non-recurring basis as of December 31, 2009:

 
| **($ in  millions)**                 | ** ** | **Quoted prices  in active  markets for  identical assets  (Level 1)** | ** ** | **Significant  other  observable  inputs  (Level 2)** | ** ** | **Significant  unobservable  inputs  (Level 3)** | ** ** | **Counterparty  and cash  collateral  netting** | ** ** | **Balance as of  December 31,  2009** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------|------------|
| **Assets**                                | ** ** | ** **                                                             | ** ** | ** **                                            | ** ** | ** **                                       | ** ** | ** **                                      | ** ** | ** **                                 | ** ** |
| Fixed income securities:                  |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                       |       |
| U.S. government and agencies              |       | $                                                                      | 1,596      |                                                  | $          | 1,985                                            |       | $                                               | —     |                                       |       |   | $ | 3,581 |   |
| Municipal                                 |       | —                                                                 |       | 4,363                                                 |       | 746                                              |       |                                            |       | 5,109                                      |       |
| Corporate                                 |       | —                                                                 |       | 25,519                                                |       | 2,020                                            |       |                                            |       | 27,539                                     |       |
| Foreign government                        |       | —                                                                 |       | 2,133                                                 |       | 20                                               |       |                                            |       | 2,153                                      |       |
| RMBS                                      |       | —                                                                 |       | 3,614                                                 |       | 1,052                                            |       |                                            |       | 4,666                                      |       |
| CMBS                                      |       | —                                                                 |       | 1,146                                                 |       | 1,322                                            |       |                                            |       | 2,468                                      |       |
| ABS                                       |       | —                                                                 |       | 417                                                   |       | 1,710                                            |       |                                            |       | 2,127                                      |       |
| Redeemable preferred stock                |       | —                                                                 |       | 14                                                    |       | 1                                                |       |                                            |       | 15                                         |       |
| Total fixed income securities             |       | 1,596                                                                  |       | 39,191                                                |       | 6,871                                            |       |                                            |       | 47,658                                     |       |
| Equity securities                         |       | 129                                                                    |       | 27                                                    |       | 27                                               |       |                                            |       | 183                                        |       |
| Short-term investments                    |       | 133                                                                    |       | 1,536                                                 |       | —                                           |       |                                            |       | 1,669                                      |       |
| Other investments:                        |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                       |       |
| Free-standing derivatives                 |       | —                                                                 |       | 808                                                   |       | 32                                               |       | $                                               | (411       | )                                          | 429        |   |
| Separate account assets                   |       | 9,072                                                                  |       | —                                                |       | —                                           |       |                                            |       | 9,072                                      |       |
| Other assets                              |       | —                                                                 |       | —                                                |       | 2                                                |       |                                            |       | 2                                          |       |
| **Total recurring basis assets**          |       | 10,930                                                                 |       | 41,562                                                |       | 6,932                                            |       | (411                                            | )          | 59,013                                     |       |
| Non-recurring basis (1)                   |       | —                                                                 |       | —                                                |       | 219                                              |       |                                            |       | 219                                        |       |
| **Total assets at fair value**            |       | $                                                                      | 10,930     |                                                  | $          | 41,562                                           |       | $                                               | 7,151      |                                       | $          | (411 | ) | $ | 59,232 |   |
| % of total assets at fair value           |       | 18.4                                                                   | %          | 70.2                                                  | %          | 12.1                                             | %          | (0.7                                            | )%         | 100.0                                      | %          |
|                                      |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                       |       |
| **Liabilities**                           |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                       |       |
| Contractholder funds:                     |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                       |       |
| Derivatives embedded in annuity contracts |       | $                                                                      | —     |                                                  | $          | (217                                             | )          | $                                               | (110       | )                                          |       |   | $ | (327 | ) |
| Other liabilities:                        |       |                                                                   |       |                                                  |       |                                             |       |                                            |       |                                       |       |
| Free-standing derivatives                 |       | (1                                                                     | )          | (556                                                  | )          | (85                                              | )          | $                                               | 243        |                                       | (399       | ) |
| **Total liabilities at fair value**       |       | $                                                                      | (1         | )                                                     | $          | (773                                             | )          | $                                               | (195       | )                                          | $          | 243 |   | $ | (726 | ) |
| % of total liabilities at fair value      |       | 0.1                                                                    | %          | 106.5                                                 | %          | 26.9                                             | %          | (33.5                                           | )%         | 100.0                                      | %          |

 

----

(1)         Includes $205 million ofmortgage loans and $14 million of limited partnership interests written-down tofair value in connection with recognizing other-than-temporary impairments.

 

19

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table presents the rollforward of Level 3 assets and liabilities heldat fair value on a recurring basis during the three months ended June 30,2010.

 
| ** **                                   | ** ** | ** **                                        | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                            | ** ** | ** **                                   | ** ** |
|----------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------|------------|
| **($ in millions)**                | ** ** | **Balance as of  March 31,  2010** | ** ** | **Net  income (1)**                                                                     | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  sales, issuances  and settlements,  net** | ** ** | **Transfers  into Level 3** | ** ** | **Transfers out  of Level 3** | ** ** | **Balance as of  June 30,  2010** | ** ** |
| **Assets**                                   |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Fixed  income securities:                    |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Municipal                                    |       | $                                                 | 681        |                                                                                         | $          | (5                                                      | )          | $                                                                 | 3          |                                  | $          | (68                                          | )          | $ | — |   | $ | (8 | ) | $ | 603 |   |
| Corporate                                    |       | 1,967                                             |       | (6                                                                                           | )          | 29                                                      |       | (5                                                                | )          | 169                                   |       | (136                                         | )          | 2,018 |   |
| RMBS                                         |       | 1,387                                             |       | (88                                                                                          | )          | 139                                                     |       | (70                                                               | )          | —                                |       | (6                                           | )          | 1,362 |   |
| CMBS                                         |       | 1,033                                             |       | (74                                                                                          | )          | 192                                                     |       | (155                                                              | )          | —                                |       | (204                                         | )          | 792 |   |
| ABS                                          |       | 1,900                                             |       | 11                                                                                           |       | (9                                                      | )          | 55                                                                |       | —                                |       | (77                                          | )          | 1,880 |   |
| Redeemable  preferred stock                  |       | 1                                                 |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                |       | —                                       |       | 1 |   |
| Total  fixed income   securities             |       | 6,969                                             |       | (162                                                                                         | )          | 354                                                     |       | (243                                                              | )          | 169                                   |       | (431                                         | )          | 6,656 |   |
| Equity  securities                           |       | 31                                                |       | —                                                                                       |       | (1                                                      | )          | (1                                                                | )          | —                                |       | —                                       |       | 29 |   |
| Other  investments:                          |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Free-standing  derivatives, net              |       | (70                                               | )          | (41                                                                                          | )          | —                                                  |       | 3                                                                 |       | —                                |       | —                                       |       | (108 | )(2) |
| Other  assets                                |       | 2                                                 |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                |       | —                                       |       | 2 |   |
| **Total recurring****Level 3 assets**        |       | $                                                 | 6,932      |                                                                                         | $          | (203                                                    | )          | $                                                                 | 353        |                                  | $          | (241                                         | )          | $ | 169 |   | $ | (431 | ) | $ | 6,579 |   |
|                                         |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| **Liabilities**                              |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Contractholder  funds:                       |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Derivatives  embedded in   annuity contracts |       | $                                                 | (90        | )                                                                                            | $          | (30                                                     | )          | $                                                                 | —     |                                  | $          | 1                                            |       | $ | — |   | $ | — |   | $ | (119 | ) |
| **Total recurring****Level 3 liabilities**   |       | $                                                 | (90        | )                                                                                            | $          | (30                                                     | )          | $                                                                 | —     |                                  | $          | 1                                            |       | $ | — |   | $ | — |   | $ | (119 | ) |

 

----

| (1)    |   | The  effect to net income totals $(233) million and is reported in the Condensed  Consolidated Statements of Operations as follows: $(217) million in realized  capital gains and losses, $18 million in net investment income, $4 million in  interest credited to contractholder funds and $30 million in contract  benefits. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                            |
| (2)    |   | Comprises  $7 million of assets and $115 million of liabilities.                                                                                                                                                                                                                                                                |

 

20

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table presents the rollforward of Level 3 assets and liabilities heldat fair value on a recurring basis during the six months ended June 30,2010.

 
| ** **                                 | ** ** | ** **                                           | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                            | ** ** | ** **                                   | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------|------------|
| **($ in millions)**              | ** ** | **Balance as of  December 31,  2009** | ** ** | **Net  income (1)**                                                                     | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  sales, issuances  and settlements,  net** | ** ** | **Transfers  into Level 3** | ** ** | **Transfers out  of Level 3** | ** ** | **Balance as of  June 30,  2010** | ** ** |
| **Assets**                                 |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Fixed  income securities:                  |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Municipal                                  |       | $                                                    | 746        |                                                                                         | $          | (10                                                     | )          | $                                                                 | 10         |                                  | $          | (116                                         | )          | $ | — |   | $ | (27 | ) | $ | 603 |   |
| Corporate                                  |       | 2,020                                                |       | (22                                                                                          | )          | 120                                                     |       | (61                                                               | )          | 172                                   |       | (211                                         | )          | 2,018 |   |
| Foreign  government                        |       | 20                                                   |       | —                                                                                       |       | —                                                  |       | (20                                                               | )          | —                                |       | —                                       |       | — |   |
| RMBS                                       |       | 1,052                                                |       | (128                                                                                         | )          | 248                                                     |       | 196                                                               |       | —                                |       | (6                                           | )          | 1,362 |   |
| CMBS                                       |       | 1,322                                                |       | (108                                                                                         | )          | 301                                                     |       | (334                                                              | )          | 24                                    |       | (413                                         | )          | 792 |   |
| ABS                                        |       | 1,710                                                |       | 16                                                                                           |       | 77                                                      |       | 154                                                               |       | —                                |       | (77                                          | )          | 1,880 |   |
| Redeemable  preferred stock                |       | 1                                                    |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                |       | —                                       |       | 1 |   |
| Total  fixed income securities             |       | 6,871                                                |       | (252                                                                                         | )          | 756                                                     |       | (181                                                              | )          | 196                                   |       | (734                                         | )          | 6,656 |   |
| Equity  securities                         |       | 27                                                   |       | —                                                                                       |       | 1                                                       |       | 1                                                                 |       | —                                |       | —                                       |       | 29 |   |
| Other  investments:                        |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Free-standing  derivatives, net            |       | (53                                                  | )          | (65                                                                                          | )          | —                                                  |       | 10                                                                |       | —                                |       | —                                       |       | (108 | )(2) |
| Other  assets                              |       | 2                                                    |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                |       | —                                       |       | 2 |   |
| **Total recurring****Level 3 assets**      |       | $                                                    | 6,847      |                                                                                         | $          | (317                                                    | )          | $                                                                 | 757        |                                  | $          | (170                                         | )          | $ | 196 |   | $ | (734 | ) | $ | 6,579 |   |
|                                       |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| **Liabilities**                            |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Contractholder  funds:                     |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Derivatives  embedded in annuity contracts |       | $                                                    | (110       | )                                                                                            | $          | (12                                                     | )          | $                                                                 | —     |                                  | $          | 3                                            |       | $ | — |   | $ | — |   | $ | (119 | ) |
| **Total recurring****Level 3 liabilities** |       | $                                                    | (110       | )                                                                                            | $          | (12                                                     | )          | $                                                                 | —     |                                  | $          | 3                                            |       | $ | — |   | $ | — |   | $ | (119 | ) |

 

----

(1)          The effect to net incometotals $(329) million and is reported in the Condensed Consolidated Statementsof Operations as follows: $(361) million in realized capital gains and losses,$47 million in net investment income, $3 million in interest credited tocontractholder funds and $12 million in contract benefits.

(2)          Comprises $7 million ofassets and $115 million of liabilities.

 

Transfersbetween level categorizations may occur due to changes in the availability ofmarket observable inputs, which generally are caused by changes in marketconditions such as liquidity, trading volume or bid-ask spreads.  Transfers between level categorizations mayalso occur due to changes in the valuation source.  For example, in situations where a fair valuequote is not provided by the Company’s independent third-party valuationservice provider and as a result the price is stale or has been replaced with abroker quote, the security is transferred into Level 3.  Transfers in and out of level categorizationsare reported as having occurred at the beginning of the quarter in which thetransfer occurred.  Therefore, for alltransfers into Level 3, all realized and changes in unrealized gains and lossesin the quarter of transfer are reflected in the Level 3 rollforward table.

 

Therewere no transfers between Level 1 and Level 2 during the three and six monthsended June 30, 2010.

 

Duringthe three and six months ended June 30, 2010, certain CMBS and ABS weretransferred into Level 2 from Level 3 as a result of increased liquidity in themarket and the availability of market observable quoted prices for similarassets.  When transferring these securities into Level 2, the Company did notchange the source of fair value estimates or modify the estimates received fromindependent third-party valuation service providers or the internal valuationapproach.  Accordingly, for securitiesincluded within this group, there was no change in fair value in conjunctionwith the transfer resulting in a realized or unrealized gain or loss.

 

Transfers into Level 3 during the three and six months ended June 30,2010, including those related to Corporate fixed income securities, includedsituations where a fair value quote was not provided by the Company’sindependent third-party valuation service provider and as a result the pricewas stale or had been replaced with a broker quote resulting in the securitybeing classified as Level 3.  Transfersout of Level 3 during the three and six months ended June 30, 2010,including those related to Corporate fixed income securities, includedsituations where a broker quote was used in the prior period and a fair valuequote became available from the Company’s independent third-party valuationservice provider.  A quote utilizing thenew pricing source was not available as of 

 

21

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

theprior period, and any gains or losses related to the change in valuation sourcefor individual securities were not significant.

 

Thefollowing table provides the total gains and (losses) included in net incomeduring the period for Level 3 assets and liabilities still held at June 30,2010.

 
| **($ in millions)**             | ** ** | **Three months ended  June 30, 2010** | ** ** | **Six months ended  June 30, 2010** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Assets**                                |       |                                                      |       |                                                    |       |
| Fixed income securities:                  |       |                                                      |       |                                                    |       |
| Municipal                                 |       | $                                                         | (4         | )                                                       | $          | (8 | ) |
| Corporate                                 |       | (9                                                        | )          | (39                                                     | )          |
| RMBS                                      |       | (83                                                       | )          | (121                                                    | )          |
| CMBS                                      |       | (19                                                       | )          | (43                                                     | )          |
| ABS                                       |       | 11                                                        |       | 11                                                      |       |
| Total fixed income securities             |       | (104                                                      | )          | (200                                                    | )          |
| Other investments:                        |       |                                                      |       |                                                    |       |
| Free-standing derivatives, net            |       | (39                                                       | )          | (57                                                     | )          |
| **Total recurring Level 3 assets**        |       | $                                                         | (143       | )                                                       | $          | (257 | ) |
|                                      |       |                                                      |       |                                                    |       |
| **Liabilities**                           |       |                                                      |       |                                                    |       |
| Contractholder funds:                     |       |                                                      |       |                                                    |       |
| Derivatives embedded in annuity contracts |       | $                                                         | (30        | )                                                       | $          | (12 | ) |
| **Total recurring Level 3  liabilities**  |       | $                                                         | (30        | )                                                       | $          | (12 | ) |

 

Theamounts in the table above represent gains and losses included in net incomeduring the period presented for the period of time that the asset or liabilitywas determined to be in Level 3.  Thesegains and losses total $(173) million for the three months ended June 30,2010 and are reported in the Condensed Consolidated Statements of Operations asfollows: $(155) million in realized capital gains and losses,$17 million in net investment income, $5 million in interest credited tocontractholder funds and $30 million in contract benefits.  These gains and losses total$(269) million for the six months ended June 30, 2010 and arereported in the Condensed Consolidated Statements of Operations as follows:$(282) million in realized capital gains and losses, $30 million innet investment income, $5 million in interest credited to contractholder fundsand $12 million in contract benefits.

 

22

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table presents the rollforward of Level 3 assets and liabilities heldat fair value on a recurring basis during the three months ended June 30,2009.

 
| ** **                                 | ** ** | ** **                                        | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                                                          | ** ** | **Total  gains (losses)  included in net  income for  financial** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| **($ in millions)**                   | ** ** | **Balance as of  March 31,  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  June 30,  2009**                                      | ** ** | **instruments  still held at  June 30,  2009 (3)** | ** ** |
| **Assets**                                 |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Fixed  income securities:                  |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Municipal                                  |       | $                                                 | 633        |                                                                                         | $          | —                                                  |       | $                                                                 | 26         |                                                                | $          | (6                                                                                    | )          | $ | 34 |   | $ | 687 |   | $ | — |   |
| Corporate                                  |       | 9,496                                             |       | (5                                                                                           | )          | 568                                                     |       | (548                                                              | )          | (7                                                                  | )          | 9,504                                                                                 |       | (18 | ) |
| RMBS                                       |       | 1,550                                             |       | (40                                                                                          | )          | 97                                                      |       | (34                                                               | )          | (162                                                                | )          | 1,411                                                                                 |       | (41 | ) |
| CMBS                                       |       | 719                                               |       | (72                                                                                          | )          | 255                                                     |       | (2                                                                | )          | (13                                                                 | )          | 887                                                                                   |       | (72 | ) |
| ABS                                        |       | 1,056                                             |       | (26                                                                                          | )          | 242                                                     |       | (15                                                               | )          | —                                                              |       | 1,257                                                                                 |       | (27 | ) |
| Redeemable  preferred stock                |       | 1                                                 |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                              |       | 1                                                                                     |       | — |   |
| Total  fixed income securities             |       | 13,455                                            |       | (143                                                                                         | )          | 1,188                                                   |       | (605                                                              | )          | (148                                                                | )          | 13,747                                                                                |       | (158 | ) |
| Equity  securities                         |       | 26                                                |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                              |       | 26                                                                                    |       | — |   |
| Other  investments:                        |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Free-standing  derivatives, net            |       | (152                                              | )          | 47                                                                                           |       | —                                                  |       | 6                                                                 |       | —                                                              |       | (99                                                                                   | )(2)       | 52 |   |
| Other  assets                              |       | 3                                                 |       | (1                                                                                           | )          | —                                                  |       | —                                                            |       | —                                                              |       | 2                                                                                     |       | (1 | ) |
| **Total recurring****Level 3 assets**      |       | $                                                 | 13,332     |                                                                                         | $          | (97                                                     | )          | $                                                                 | 1,188      |                                                                | $          | (599                                                                                  | )          | $ | (148 | ) | $ | 13,676 |   | $ | (107 | ) |
|                                       |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| **Liabilities**                            |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Contractholder  funds:                     |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Derivatives  embedded in annuity contracts |       | $                                                 | (291       | )                                                                                            | $          | 131                                                     |       | $                                                                 | —     |                                                                | $          | 5                                                                                     |       | $ | — |   | $ | (155 | ) | $ | 131 |   |
| **Total recurring****Level 3 liabilities** |       | $                                                 | (291       | )                                                                                            | $          | 131                                                     |       | $                                                                 | —     |                                                                | $          | 5                                                                                     |       | $ | — |   | $ | (155 | ) | $ | 131 |   |

 

----

(1)          The effect to net income totals $34 million and isreported in the Condensed Consolidated Statements of Operations as follows:$(110) million in realized capital gains and losses, $13 million in netinvestment income and $(131) million in contract benefits.

(2)          Comprises $30 million of assets and $129 million ofliabilities.

(3)          The amounts represent gains and losses included innet income for the period of time that the asset or liability was determined tobe in Level 3.  These gains and lossestotal $24 million and are reported in the Condensed Consolidated Statements ofOperations as follows: $(122) million in realized capital gains and losses, $14million in net investment income, $(1) million in interest credited tocontractholder funds, and $(131) million in contract benefits.

 

23

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table presents the rollforward of Level 3 assets and liabilities heldat fair value on a recurring basis during the six months ended June 30,2009.

 
| ** **                                 | ** ** | ** **                                           | ** ** | **Total realized and unrealized gains  (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                                                          | ** ** | **Total  gains (losses)  included in net  income for  financial** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| **($ in millions)**                   | ** ** | **Balance as of  December 31,  2008** | ** ** | **Net income (1)**                                                                 | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  sales, issuances  and  settlements, net** | ** ** | **Net  transfers in  and/or (out)  of Level 3** | ** ** | **Balance as of  June 30,  2009**                                      | ** ** | **instruments  still held at  June 30,  2009 (3)** | ** ** |
| **Assets**                                 |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Fixed  income securities:                  |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Municipal                                  |       | $                                                    | 703        |                                                                                         | $          | —                                                  |       | $                                                                 | 7          |                                                                | $          | (13                                                                                   | )          | $ | (10 | ) | $ | 687 |   | $ | — |   |
| Corporate                                  |       | 9,867                                                |       | (57                                                                                          | )          | 624                                                     |       | (872                                                              | )          | (58                                                                 | )          | 9,504                                                                                 |       | (68 | ) |
| RMBS                                       |       | 1,811                                                |       | (34                                                                                          | )          | (122                                                    | )          | (82                                                               | )          | (162                                                                | )          | 1,411                                                                                 |       | (39 | ) |
| CMBS                                       |       | 410                                                  |       | (104                                                                                         | )          | 173                                                     |       | (17                                                               | )          | 425                                                                 |       | 887                                                                                   |       | (94 | ) |
| ABS                                        |       | 1,341                                                |       | (155                                                                                         | )          | 246                                                     |       | (129                                                              | )          | (46                                                                 | )          | 1,257                                                                                 |       | (152 | ) |
| Redeemable  preferred stock                |       | 1                                                    |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                              |       | 1                                                                                     |       | — |   |
| Total  fixed income securities             |       | 14,133                                               |       | (350                                                                                         | )          | 928                                                     |       | (1,113                                                            | )          | 149                                                                 |       | 13,747                                                                                |       | (353 | ) |
| Equity  securities                         |       | 27                                                   |       | —                                                                                       |       | (1                                                      | )          | —                                                            |       | —                                                              |       | 26                                                                                    |       | — |   |
| Other  investments:                        |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Free-standing  derivatives, net            |       | (93                                                  | )          | 38                                                                                           |       | —                                                  |       | (44                                                               | )          | —                                                              |       | (99                                                                                   | )(2)       | 44 |   |
| Other  assets                              |       | 1                                                    |       | 1                                                                                            |       | —                                                  |       | —                                                            |       | —                                                              |       | 2                                                                                     |       | 1 |   |
| **Total recurring****Level 3 assets**      |       | $                                                    | 14,068     |                                                                                         | $          | (311                                                    | )          | $                                                                 | 927        |                                                                | $          | (1,157                                                                                | )          | $ | 149 |   | $ | 13,676 |   | $ | (308 | ) |
|                                       |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| **Liabilities**                            |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Contractholder  funds:                     |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Derivatives  embedded in annuity contracts |       | $                                                    | (265       | )                                                                                            | $          | 105                                                     |       | $                                                                 | —     |                                                                | $          | 5                                                                                     |       | $ | — |   | $ | (155 | ) | $ | 105 |   |
| **Total recurring****Level 3 liabilities** |       | $                                                    | (265       | )                                                                                            | $          | 105                                                     |       | $                                                                 | —     |                                                                | $          | 5                                                                                     |       | $ | — |   | $ | (155 | ) | $ | 105 |   |

 

----

(1)          The effect to net income totals $(206) million andis reported in the Condensed Consolidated Statements of Operations as follows:$(359) million in realized capital gains and losses, $49 million in netinvestment income, $1 million in interest credited to contractholder funds, and$(105) million in contract benefits.

(2)          Comprises $30 million of assets and $129 million ofliabilities.

(3)          The amounts represent gains and losses included innet income for the period of time that the asset or liability was determined tobe in Level 3.  These gains and lossestotal $(203) million and are reported in the Condensed Consolidated Statementsof Operations as follows: $(357) million in realized capital gains andlosses, $48 million in net investment income, $(1) million in interestcredited to contractholder funds, and $(105) million in contract benefits.

 

Presentedbelow are the carrying values and fair value estimates of financial instrumentsnot carried at fair value.

 

**Financial assets**

 
| ** **                                  | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|---------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| **($ in  millions)**                   | ** ** | **Carrying  value**    | ** ** | **Fair  value**            | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** |
| Mortgage loans                              |       | $                      | 7,039      |                       | $          | 6,043 |   | $ | 7,780 |   | $ | 6,220 |   |
| Limited partnership  interests - cost basis |       | 590                    |       | 608                        |       | 533 |   | 521 |   |
| Bank loans                                  |       | 328                    |       | 304                        |       | 359 |   | 329 |   |
| Notes due from related  party               |       | 275                    |       | 245                        |       | 275 |   | 233 |   |
|                                             |            |                        |            |                            |            |  |  |  |  |  |  |  |  |

 

Thefair value of mortgage loans is based on discounted contractual cash flows or,if the loans are impaired due to credit reasons, the fair value of collateralless costs to sell.  Risk adjusteddiscount rates are selected using current rates at which similar loans would bemade 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 fair value of notes due from related party is based on discountedcash flow calculations using current interest rates for instruments withcomparable terms.

 

24

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Financial liabilities**

 
| ** **                                    | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| **($ in  millions)**                     | ** ** | **Carrying  value**    | ** ** | **Fair  value**            | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** |
| Contractholder funds on  investment contracts |       | $                      | 36,409     |                       | $          | 35,480 |   | $ | 39,824 |   | $ | 38,196 |   |
| Notes due to related  parties                 |       | 681                    |       | 641                        |       | 675 |   | 611 |   |
| Liability for collateral                      |       | 442                    |       | 442                        |       | 617 |   | 617 |   |
|                                               |            |                        |            |                            |            |  |  |  |  |  |  |  |  |

 

Thefair value of contractholder funds on investment contracts is based on theterms of the underlying contracts utilizing prevailing market rates for similarcontracts adjusted for the Company’s own credit risk.  Deferred annuities included in contractholderfunds are valued using discounted cash flow models which incorporate marketvalue margins, which are based on the cost of holding economic capital, and theCompany’s own credit risk.  Immediateannuities without life contingencies and fixed rate funding agreements arevalued at the present value of future benefits using market implied interestrates which include the Company’s own credit risk.

 

Thefair value of notes due to related parties is based on discounted cash flowcalculations using current interest rates for instruments with comparable termsand considers the Company’s own credit risk. The liability for collateral is valued at carrying value due to itsshort-term nature.

 

**6.  Derivative FinancialInstruments**

 

TheCompany primarily uses derivatives for risk management and assetreplication.  In addition, the Companyhas derivatives embedded in non-derivative “host” contracts that are requiredto be separated from the host contracts and accounted for at fair value.  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.

 

TheCompany uses derivatives to partially mitigate potential adverse impacts fromincreases in credit spreads.  Creditdefault swaps are typically used to mitigate the credit risk within the Company’sfixed income portfolio.  The Company usesforeign currency swaps primarily to reduce the foreign currency risk associatedwith issuing foreign currency denominated funding agreements and holdingforeign currency denominated investments.

 

Asset-liabilitymanagement is a risk management strategy that is principally employed tobalance the respective interest-rate sensitivities of the Company’s assets andliabilities.  Depending upon theattributes of the assets acquired and liabilities issued, derivativeinstruments such as interest rate swaps, caps, floors, swaptions and futuresare acquired to change the interest rate characteristics of existing assets andliabilities to ensure the relationship is maintained within specified rangesand to reduce exposure to rising or falling interest rates.  The Company uses financial futures andinterest rate swaps to hedge anticipated asset purchases and liabilityissuances and futures and options for hedging the Company’s equity exposurecontained in equity indexed annuity product contracts that offer equity returnsto contractholders.  In addition, theCompany uses interest rate swaps to hedge interest rate risk inherent infunding agreements.

 

Whenderivatives meet specific criteria, they may be designated as accounting hedgesand accounted for as fair value, cash flow, foreign currency fair value orforeign currency cash flow hedges.  TheCompany designates certain of its interest rate and foreign currency swapcontracts and certain investment risk transfer reinsurance agreements as fairvalue hedges when the hedging instrument is highly effective in offsetting therisk of changes in the fair value of the hedged item.  The Company designates certain of its foreigncurrency swap contracts as cash flow hedges when the hedging instrument ishighly effective in offsetting the exposure of variations in cash flows for thehedged risk that could affect net income. Amounts are reclassified to net investment income or realized capitalgains and losses as the hedged item affects net income.

 

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

 

25

----

 

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

creditdefault swap and one or more highly rated fixed income securities tosynthetically replicate the economic characteristics of one or more cash marketsecurities.

 

TheCompany’s primary embedded derivatives are conversion options in fixed incomesecurities, which provide the Company with the right to convert the instrumentinto a predetermined number of shares of common stock; equity options inannuity product contracts, which provide equity returns to contractholders; andequity-indexed notes containing equity call options, which provide a couponpayout that is determined using one or more equity-based indices.

 

Thenotional amounts specified in the contracts are used to calculate the exchangeof 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.

 

Fairvalue, which is equal to the carrying value, is the estimated amount that theCompany would receive or pay to terminate the derivative contracts at the reportingdate.  The carrying value amounts for OTCderivatives are further adjusted for the effects, if any, of legallyenforceable master netting agreements and are presented on a net basis, bycounterparty agreement, in the Condensed Consolidated Statements of FinancialPosition.  For certain exchange tradedderivatives, the exchange requires margin deposits as well as daily cashsettlements of margin accounts.  As of June 30,2010, the Company pledged $16 million of securities and cash in the form ofmargin deposits.

 

Thenet impact to pre-tax income for derivatives includes valuation and settlementsof derivatives.  For those derivativeswhich qualify for fair value hedge accounting, net income includes the changesin the fair value of the hedged risk, and therefore reflects any hedgingineffectiveness.  For cash flow hedges,gains and losses amortized from accumulated other comprehensive income arereported in net income.  For embeddedderivatives in convertible fixed income securities and equity-indexed notes,net income includes the change in fair value of the embedded derivative andaccretion income related to the host instrument.  For non-hedge derivatives, net incomeincludes changes in fair value and accrued periodic settlements.

 

26

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table provides a summary of the volume and fair value positions ofderivative instruments as well as their reporting location in the CondensedConsolidated Statements of Financial Position at June 30, 2010.

 
| ** **                                                                    | ** ** | **Asset derivatives**           | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                    | ** ** | ** **                           | ** ** | **Volume (1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **($ in millions, except number of contracts)** | ** ** | **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                    |       | $ | 39 |   | n/a |   | $ | (3 | ) | $ | — |   | $ | (3 | ) |
| Foreign  currency swap agreements                                             |       | Other investments                    |       | 41 |   | n/a |   | 5 |   | 5 |   | — |   |
| Total                                                                         |       |                                 |       | $ | 80 |   | n/a |   | $ | 2 |   | $ | 5 |   | $ | (3 | ) |
|                                                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as accounting****hedging instruments**           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest  rate swap agreements                                                |       | Other investments                    |       | $ | 573 |   | n/a |   | $ | 45 |   | $ | 49 |   | $ | (4 | ) |
| Interest  rate cap and floor agreements                                       |       | Other investments                    |       | 61 |   | n/a |   | 1 |   | 1 |   | — |   |
| Financial  futures contracts and options                                      |       | Other investments                    |       | n/a |   | 1,235 |   | — |   | — |   | — |   |
| **Equity and index contracts**                                                |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Options,  futures and warrants (2)                                            |       | Other investments                    |       | 73 |   | 21,900 |   | 134 |   | 134 |   | — |   |
| Options,  futures and warrants                                                |       | Other assets                         |       | n/a |   | 30 |   | — |   | — |   | — |   |
| **Foreign currency contracts**                                                |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Foreign  currency swap agreements                                             |       | Other investments                    |       | 40 |   | n/a |   | 3 |   | 3 |   | — |   |
| **Embedded derivative financial instruments**                                 |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Conversion  options in fixed income securities                                |       | Fixed income  securities             |       | 322 |   | n/a |   | 76 |   | 76 |   | — |   |
| Equity-indexed  call options in fixed income securities                       |       | Fixed income  securities             |       | 425 |   | n/a |   | 57 |   | 57 |   | — |   |
| **Credit default contracts**                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Credit  Default Swaps - Buying Protection                                     |       | Other investments                    |       | 41 |   | n/a |   | 1 |   | 1 |   | — |   |
| **Other contracts**                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Other  contracts                                                              |       | Other investments                    |       | 13 |   | n/a |   | — |   | — |   | — |   |
| Other  contracts                                                              |       | Other assets                         |       | 6 |   | n/a |   | 2 |   | 2 |   | — |   |
| Total                                                                         |       |                                 |       | $ | 1,554 |   | 23,165 |   | $ | 319 |   | $ | 323 |   | $ | (4 | ) |
|                                                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivative assets**                                                   |       |                                 |       | $ | 1,634 |   | 23,165 |   | $ | 321 |   | $ | 328 |   | $ | (7 | ) |

 

----

(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 ofcontracts presented in the table, the Company held 837,100 stock warrants.  Stock warrants can be converted to cash uponsale of those instruments or exercised for shares of common stock.

 

27

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **                                                        | ** ** | **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 |       | $ | 3,832 |   | n/a |   | $ | (240 | ) | $ | 14 |   | $ | (254 | ) |
| Interest  rate swap agreements                                    |       | Contractholder  funds                          |       | — |   | n/a |   | 3 |   | 3 |   | — |   |
| Foreign  currency swap agreements                                 |       | Other liabilities &  accrued expenses |       | 161 |   | n/a |   | 2 |   | 5 |   | (3 | ) |
| Foreign  currency and interest rate swap agreements               |       | Other liabilities &  accrued expenses |       | 435 |   | n/a |   | 27 |   | 27 |   | — |   |
| Foreign  currency and interest rate swap agreements               |       | Contractholder  funds                          |       | — |   | n/a |   | 12 |   | 12 |   | — |   |
| Total                                                             |       |                                           |       | $ | 4,428 |   | n/a |   | $ | (196 | ) | $ | 61 |   | $ | (257 | ) |
|                                                              |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as accounting hedging  instruments** |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                       |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest  rate swap agreements                                    |       | Other  liabilities & accrued expenses |       | $ | 5,297 |   | n/a |   | $ | (45 | ) | $ | 93 |   | $ | (138 | ) |
| Interest  rate swaption agreements                                |       | Other liabilities &  accrued expenses |       | 750 |   | n/a |   | 4 |   | 4 |   | — |   |
| Interest  rate cap and floor agreements                           |       | Other liabilities &  accrued expenses |       | 3,563 |   | n/a |   | (32 | ) | 1 |   | (33 | ) |
| Financial  futures contracts and options                          |       | Other liabilities &  accrued expenses |       | n/a |   | 1,947 |   | — |   | — |   | — |   |
| **Equity and index contracts**                                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Options  and futures                                              |       | Other liabilities &  accrued expenses |       | 48 |   | 22,855 |   | (48 | ) | — |   | (48 | ) |
| **Foreign currency contracts**                                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Foreign  currency swap agreements                                 |       | Other liabilities &  accrued expenses |       | 50 |   | n/a |   | 8 |   | 8 |   | — |   |
| **Embedded derivative financial****instruments**                  |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Guaranteed  accumulation benefits                                 |       | Contractholder  funds                          |       | 1,015 |   | n/a |   | (75 | ) | — |   | (75 | ) |
| Guaranteed  withdrawal benefits                                   |       | Contractholder  funds                          |       | 721 |   | n/a |   | (40 | ) | — |   | (40 | ) |
| Equity-indexed  options in life and annuity product contracts     |       | Contractholder  funds                          |       | 4,236 |   | n/a |   | (106 | ) | — |   | (106 | ) |
| Other  embedded derivative financial instruments                  |       | Contractholder  funds                          |       | 85 |   | n/a |   | (4 | ) | — |   | (4 | ) |
| **Credit default contracts**                                      |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Credit  Default Swaps - Buying Protection                         |       | Other liabilities &  accrued expenses |       | 523 |   | n/a |   | 2 |   | 10 |   | (8 | ) |
| Credit  Default Swaps - Selling Protection                        |       | Other liabilities &  accrued expenses |       | 479 |   | n/a |   | (87 | ) | 1 |   | (88 | ) |
| Total                                                             |       |                                           |       | $ | 16,767 |   | 24,802 |   | $ | (423 | ) | $ | 117 |   | $ | (540 | ) |
|                                                              |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivative liabilities**                                  |       |                                           |       | $ | 21,195 |   | 24,802 |   | $ | (619 | ) | $ | 178 |   | $ | (797 | ) |
|                                                              |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivatives**                                             |       |                                           |       | $ | 22,829 |   | 47,967 |   | $ | (298 | ) |   |   |   |   |

 

----

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

 

28

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table provides a summary of the volume and fair value positions ofderivative instruments as well as their reporting location in the ConsolidatedStatements of Financial Position at December 31, 2009.

 
| ** **                                                                    | ** ** | **Asset derivatives**           | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                    | ** ** | ** **                           | ** ** | **Volume (1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **($ in millions, except number of contracts)** | ** ** | **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                    |       | $ | 45 |   | n/a |   | $ | (3 | ) | $ | — |   | $ | (3 | ) |
| Foreign currency swap agreements                                              |       | Other investments                    |       | 23 |   | n/a |   | (2 | ) | — |   | (2 | ) |
| Total                                                                         |       |                                 |       | $ | 68 |   | n/a |   | $ | (5 | ) | $ | — |   | $ | (5 | ) |
|                                                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting****hedging instruments**          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                                 |       | Other investments                    |       | $ | 1,106 |   | n/a |   | $ | 57 |   | $ | 61 |   | $ | (4 | ) |
| Interest rate cap and floor agreements                                        |       | Other investments                    |       | 52 |   | n/a |   | 2 |   | 2 |   | — |   |
| Financial futures contracts and options                                       |       | Other assets                         |       | n/a |   | 404 |   | — |   | — |   | — |   |
| **Equity and index contracts**                                                |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Options, futures and warrants (2)                                             |       | Other investments                    |       | 62 |   | 19,850 |   | 385 |   | 385 |   | — |   |
| Options, futures and warrants                                                 |       | Other assets                         |       | n/a |   | 102 |   | — |   | — |   | — |   |
| **Foreign currency contracts**                                                |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency swap agreements                                              |       | Other investments                    |       | 53 |   | n/a |   | 1 |   | 1 |   | — |   |
| **Embedded derivative financial  instruments**                                |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Conversion options in fixed income securities                                 |       | Fixed income securities              |       | 315 |   | n/a |   | 117 |   | 117 |   | — |   |
| Equity-indexed call options in fixed income  securities                       |       | Fixed income securities              |       | 475 |   | n/a |   | 89 |   | 89 |   | — |   |
| **Credit default contracts**                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Credit Default Swaps - Buying Protection                                      |       | Other investments                    |       | 83 |   | n/a |   | (3 | ) | 2 |   | (5 | ) |
| Credit Default Swaps - Selling Protection                                     |       | Other investments                    |       | 14 |   | n/a |   | — |   | — |   | — |   |
| **Other contracts**                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Other contracts                                                               |       | Other investments                    |       | 75 |   | n/a |   | — |   | — |   | — |   |
| Other contracts                                                               |       | Other assets                         |       | 6 |   | n/a |   | 2 |   | 2 |   | — |   |
| Total                                                                         |       |                                 |       | $ | 2,241 |   | 20,356 |   | $ | 650 |   | $ | 659 |   | $ | (9 | ) |
|                                                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivative assets**                                                   |       |                                 |       | $ | 2,309 |   | 20,356 |   | $ | 645 |   | $ | 659 |   | $ | (14 | ) |

 

----

(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 ofcontracts presented in the table, the Company held 837,100 stock warrants.  Stock warrants can be converted to cash uponsale of those instruments or exercised for shares of common stock.

 

29

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **                                                        | ** ** | **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 |       | $ | 2,443 |   | n/a |   | $ | (230 | ) | $ | — |   | $ | (230 | ) |
| Foreign  currency swap agreements                                 |       | Other  liabilities & accrued expenses |       | 179 |   | n/a |   | (18 | ) | 3 |   | (21 | ) |
| Foreign  currency and interest rate swap agreements               |       | Other  liabilities & accrued expenses |       | 870 |   | n/a |   | 231 |   | 231 |   | — |   |
| Foreign  currency and interest rate swap agreements               |       | Contractholder  funds                          |       | — |   | n/a |   | 44 |   | 44 |   | — |   |
| Total                                                             |       |                                           |       | $ | 3,492 |   | n/a |   | $ | 27 |   | $ | 278 |   | $ | (251 | ) |
|                                                              |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as accounting hedging  instruments** |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                       |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest  rate swap agreements                                    |       | Other  liabilities & accrued expenses |       | $ | 6,087 |   | n/a |   | $ | 32 |   | $ | 69 |   | $ | (37 | ) |
| Interest  rate swaption agreements                                |       | Other  liabilities & accrued expenses |       | 1,000 |   | n/a |   | 15 |   | 15 |   | — |   |
| Interest  rate cap and floor agreements                           |       | Other  liabilities & accrued expenses |       | 3,896 |   | n/a |   | (16 | ) | 9 |   | (25 | ) |
| **Equity and index contracts**                                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Options,  futures and warrants                                    |       | Other  liabilities & accrued expenses |       | 45 |   | 19,946 |   | (213 | ) | 3 |   | (216 | ) |
| **Foreign currency contracts**                                    |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Foreign  currency swap agreements                                 |       | Other  liabilities & accrued expenses |       | 54 |   | n/a |   | 3 |   | 3 |   | — |   |
| Foreign  currency forwards and options                            |       | Other  liabilities & accrued expenses |       | 185 |   | n/a |   | 2 |   | 2 |   | — |   |
| **Embedded derivative financial****instruments**                  |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Guaranteed  accumulation benefits                                 |       | Contractholder  funds                          |       | 1,113 |   | n/a |   | (66 | ) | — |   | (66 | ) |
| Guaranteed  withdrawal benefits                                   |       | Contractholder  funds                          |       | 810 |   | n/a |   | (41 | ) | — |   | (41 | ) |
| Equity-indexed  options in life and annuity product contracts     |       | Contractholder  funds                          |       | 4,321 |   | n/a |   | (217 | ) | — |   | (217 | ) |
| Other  embedded derivative financial instruments                  |       | Contractholder  funds                          |       | 85 |   | n/a |   | (3 | ) | — |   | (3 | ) |
| **Credit default contracts**                                      |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Credit  Default Swaps - Buying Protection                         |       | Other  liabilities & accrued expenses |       | 550 |   | n/a |   | (29 | ) | 4 |   | (33 | ) |
| Credit  Default Swaps - Selling Protection                        |       | Other  liabilities & accrued expenses |       | 1,070 |   | n/a |   | (60 | ) | 6 |   | (66 | ) |
| Total                                                             |       |                                           |       | $ | 19,216 |   | 19,946 |   | $ | (593 | ) | $ | 111 |   | $ | (704 | ) |
|                                                              |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivative liabilities**                                  |       |                                           |       | $ | 22,708 |   | 19,946 |   | $ | (566 | ) | $ | 389 |   | $ | (955 | ) |
|                                                              |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivatives**                                             |       |                                           |       | $ | 25,017 |   | 40,302 |   | $ | 79 |   |   |   |   |   |

 

----

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

 

The following table provides a summary of theimpacts of the Company’s foreign currency contracts in cash flow hedgingrelationships in the Condensed Consolidated Statements of Operations and theCondensed Consolidated Statements of Financial Position.  Amortization of net gains from accumulatedother comprehensive income related to cash flow hedges is expected to be $1million during the next twelve months.

 
| ** **                                                                                | ** ** | **Three months  ended June 30,** | ** ** | **Six months********ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| **($ in  millions)**                                                                 | ** ** | **2010**                              | ** ** | **2009**                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Effective portion**                                                                     |       |                                  |       |                                      |       |   |   |   |   |
| Gain (loss) recognized in OCI on derivatives during  the period                           |       | $                                     | 22         |                                      | $          | (28 | ) | $ | 28 |   | $ | (24 | ) |
| Gain (loss) recognized in OCI on derivatives  during the term of the hedging relationship |       | 7                                     |       | (11                                       | )          | 7 |   | (11 | ) |
| Gain reclassified from AOCI into income (net  investment income)                          |       | —                                |       | —                                    |       | 1 |   | 1 |   |
| Gain reclassified from AOCI into income (realized  capital gains and losses)              |       | 2                                     |       | 1                                         |       | 2 |   | 1 |   |
| **Ineffective portion and amount  excluded from effectiveness**                           |       |                                  |       |                                      |       |   |   |   |   |
| Gain recognized in income on derivatives (realized  capital gains and losses)             |       | —                                |       | —                                    |       | — |   | — |   |
|                                                                                           |            |                                       |            |                                           |            |  |  |  |  |  |  |  |  |

 

30

----

 

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing tables present gains and losses from valuation, settlements and hedgeineffectiveness reported on derivatives used in fair value hedgingrelationships and derivatives not designated as accounting hedging instrumentsin the Condensed Consolidated Statements of Operations.

 
| ** **                                                        | ** ** | **Three months ended June 30, 2010** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **($ in millions)**                                     | ** ** | **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                                           |       | $                                                             | (72        | ) | $ | 2 |   | $ | — |   | $ | 13 |   | $ | (57 | ) |
| Foreign currency and interest rate contracts                      |       | —                                                        |       | (1 | ) | — |   | (16 | ) | (17 | ) |
| Subtotal                                                          |       | (72                                                           | )          | 1 |   | — |   | (3 | ) | (74 | ) |
|                                                              |       |                                                          |       |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |       | —                                                        |       | (115 | ) | — |   | — |   | (115 | ) |
| Equity and index contracts                                        |       | —                                                        |       | — |   | — |   | (70 | ) | (70 | ) |
| Embedded derivative financial instruments                         |       | —                                                        |       | (51 | ) | (28 | ) | 112 |   | 33 |   |
| Credit default contracts                                          |       | —                                                        |       | (14 | ) | — |   | — |   | (14 | ) |
| Other contracts                                                   |       | —                                                        |       | — |   | — |   | 2 |   | 2 |   |
| Subtotal                                                          |       | —                                                        |       | (180 | ) | (28 | ) | 44 |   | (164 | ) |
| Total                                                             |       | $                                                             | (72        | ) | $ | (179 | ) | $ | (28 | ) | $ | 41 |   | $ | (238 | ) |

 
| ** **                                                        | ** ** | **Six months ended June 30, 2010** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **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                                           |       | $                                                           | (113       | ) | $ | 2 |   | $ | — |   | $ | 12 |   | $ | (99 | ) |
| Foreign currency and interest rate contracts                      |       | —                                                      |       | (1 | ) | — |   | (40 | ) | (41 | ) |
| Subtotal                                                          |       | (113                                                        | )          | 1 |   | — |   | (28 | ) | (140 | ) |
|                                                              |       |                                                        |       |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |       | —                                                      |       | (147 | ) | — |   | — |   | (147 | ) |
| Equity and index contracts                                        |       | —                                                      |       | — |   | — |   | (36 | ) | (36 | ) |
| Embedded derivative financial instruments                         |       | —                                                      |       | (56 | ) | (8 | ) | 110 |   | 46 |   |
| Foreign currency contracts                                        |       | —                                                      |       | 4 |   | — |   | — |   | 4 |   |
| Credit default contracts                                          |       | —                                                      |       | (16 | ) | — |   | — |   | (16 | ) |
| Other contracts                                                   |       | —                                                      |       | — |   | — |   | 2 |   | 2 |   |
| Subtotal                                                          |       | —                                                      |       | (215 | ) | (8 | ) | 76 |   | (147 | ) |
| Total                                                             |       | $                                                           | (113       | ) | $ | (214 | ) | $ | (8 | ) | $ | 48 |   | $ | (287 | ) |

 

31

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **                                                        | ** ** | **Three months ended June 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                                           |       | $                                                             | 71         |   | $ | 6 |   | $ | — |   | $ | (1 | ) | $ | 76 |   |
| Foreign currency and interest rate contracts                      |       | —                                                        |       | (2 | ) | — |   | 90 |   | 88 |   |
| Subtotal                                                          |       | 71                                                            |       | 4 |   | — |   | 89 |   | 164 |   |
|                                                              |       |                                                          |       |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |       | —                                                        |       | 218 |   | — |   | — |   | 218 |   |
| Equity and index contracts                                        |       | —                                                        |       | (3 | ) | — |   | 32 |   | 29 |   |
| Embedded derivative financial instruments                         |       | —                                                        |       | 25 |   | 133 |   | (68 | ) | 90 |   |
| Foreign currency contracts                                        |       | —                                                        |       | (1 | ) | — |   | — |   | (1 | ) |
| Credit default contracts                                          |       | —                                                        |       | (23 | ) | — |   | — |   | (23 | ) |
| Other contracts                                                   |       | —                                                        |       | — |   | — |   | (4 | ) | (4 | ) |
| Subtotal                                                          |       | —                                                        |       | 216 |   | 133 |   | (40 | ) | 309 |   |
| Total                                                             |       | $                                                             | 71         |   | $ | 220 |   | $ | 133 |   | $ | 49 |   | $ | 473 |   |

 
| ** **                                                        | ** ** | **Six months ended June 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                                           |       | $                                                           | 78         |   | $ | 10 |   | $ | — |   | $ | (13 | ) | $ | 75 |   |
| Foreign currency and interest rate contracts                      |       | —                                                      |       | (3 | ) | — |   | 60 |   | 57 |   |
| Subtotal                                                          |       | 78                                                          |       | 7 |   | — |   | 47 |   | 132 |   |
|                                                              |       |                                                        |       |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |       | —                                                      |       | 274 |   | — |   | — |   | 274 |   |
| Equity and index contracts                                        |       | —                                                      |       | — |   | — |   | 9 |   | 9 |   |
| Embedded derivative financial instruments                         |       | —                                                      |       | 2 |   | 110 |   | (85 | ) | 27 |   |
| Credit default contracts                                          |       | —                                                      |       | 6 |   | — |   | — |   | 6 |   |
| Other contracts                                                   |       | —                                                      |       | — |   | — |   | (1 | ) | (1 | ) |
| Subtotal                                                          |       | —                                                      |       | 282 |   | 110 |   | (77 | ) | 315 |   |
| Total                                                             |       | $                                                           | 78         |   | $ | 289 |   | $ | 110 |   | $ | (30 | ) | $ | 447 |   |

 

Thefollowing tables provide a summary of the changes in fair value of the Company’sfair value hedging relationships in the Condensed Consolidated Statements ofOperations.

 

**($ inmillions)**

 
| ** **                                                                                                           | ** ** | **Three months ended June 30, 2010** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **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                                                                            |       | $                                                             | 9          |   | $ | (24 | ) | $ | 15 |   | $ | — |   |
| Net investment income                                                                                                |       | (43                                                           | )          | — |   | — |   | 43 |   |
| Realized capital gains and losses                                                                                    |       | 2                                                             |       | (1 | ) | — |   | — |   |
| Total                                                                                                                |       | $                                                             | (32        | ) | $ | (25 | ) | $ | 15 |   | $ | 43 |   |

 

32

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **                                                                                                           | ** ** | **Six months ended June 30, 2010** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **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                                                                            |       | $                                                           | 8          |   | $ | (57 | ) | $ | 49 |   | $ | — |   |
| Net investment income                                                                                                |       | (56                                                         | )          | — |   | — |   | 56 |   |
| Realized capital gains and losses                                                                                    |       | 2                                                           |       | (1 | ) | — |   | — |   |
| Total                                                                                                                |       | $                                                           | (46        | ) | $ | (58 | ) | $ | 49 |   | $ | 56 |   |

 
| ** **                                                                                                           | ** ** | **Three months ended June 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                                                                            |       | $                                                             | —     |   | $ | 79 |   | $ | (79 | ) | $ | — |   |
| Net investment income                                                                                                |       | 105                                                           |       | — |   | — |   | (105 | ) |
| Realized capital gains and losses                                                                                    |       | 6                                                             |       | (2 | ) | — |   | — |   |
| Total                                                                                                                |       | $                                                             | 111        |   | $ | 77 |   | $ | (79 | ) | $ | (105 | ) |

 
| ** **                                                                                                           | ** ** | **Six months ended June 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        | ) | $ | 44 |   | $ | (18 | ) | $ | — |   |
| Net investment income                                                                                                |       | 145                                                         |       | — |   | — |   | (145 | ) |
| Realized capital gains and losses                                                                                    |       | 10                                                          |       | (3 | ) | — |   | — |   |
| Total                                                                                                                |       | $                                                           | 129        |   | $ | 41 |   | $ | (18 | ) | $ | (145 | ) |

 

TheCompany manages its exposure to credit risk by utilizing highly ratedcounterparties, establishing risk control limits, executing legally enforceablemaster netting agreements (“MNAs”) and obtaining collateral whereappropriate.  The Company uses MNAs forOTC derivative transactions, including interest rate swap, foreign currencyswap, interest rate cap, interest rate floor, credit default swap, forward andcertain option agreements (including swaptions).  These agreements permit either party to netpayments due for transactions covered by the agreements.  Under the provisions of the agreements,collateral is either pledged or obtained when certain predetermined exposurelimits are exceeded.  As of June 30,2010, counterparties pledged $9 million in securities to the Company, and theCompany pledged $302 million in securities to counterparties which includes$263 million of collateral posted under MNAs for contracts containingcredit-risk-contingent provisions that are in a liability position and $39million of collateral posted under MNAs for contracts without credit-risk-contingentliabilities.  The Company has notincurred any losses on derivative financial instruments due to counterpartynonperformance.  Other derivativesincluding futures and certain option contracts are traded on organizedexchanges, which require margin deposits and guarantee the execution of trades,thereby mitigating any potential credit risk associated with transactionsexecuted on organized exchanges.

 

Counterpartycredit exposure represents the Company’s potential loss if all of the counterpartiesconcurrently fail to perform under the contractual terms of the contracts andall collateral, if any, becomes worthless. This exposure is measured by the fair value of OTC derivative contractswith a positive fair value at the reporting date reduced by the effect, if any,of legally enforceable master netting agreements.

 

33

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

**($ in millions)**

 
| ** **          | ** ** | **June 30, 2010**           | ** ** | **December 31, 2009** | ** ** |
|---------------------|------------|---------------------------------------|------------|---------------------------------|------------|
| **Rating (1)** | ** ** | **Number of  counter-  parties** | ** ** | **Notional  amount**            | ** ** | **Credit  exposure (2)** | ** ** | **Exposure,  net of  collateral (2)** | ** ** | **Number of  counter-  parties** | ** ** | **Notional  amount** | ** ** | **Credit  exposure (2)** | ** ** | **Exposure,  net of  collateral (2)** | ** ** |
| AA-                 |       | 1                                     |       | $                               | 672        |   | $ | 21 |   | $ | 12 |   | — |   | $ | — |   | $ | — |   | $ | — |   |
| A+                  |       | 1                                     |       | 15                              |       | — |   | — |   | 3 |   | 6,666 |   | 151 |   | 18 |   |
| A                   |       | 2                                     |       | 94                              |       | — |   | — |   | 2 |   | 1,041 |   | 48 |   | 17 |   |
| A-                  |       | 1                                     |       | 89                              |       | 30 |   | 30 |   | 1 |   | 145 |   | 23 |   | 23 |   |
| Total               |       | 5                                     |       | $                               | 870        |   | $ | 51 |   | $ | 42 |   | 6 |   | $ | 7,852 |   | $ | 222 |   | $ | 58 |   |

 

----

(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.

 

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

 

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

 

Thefollowing summarizes the fair value of derivative instruments with termination,cross-default or collateral credit-risk-contingent features that are in aliability position, as well as the fair value of assets and collateral that arenetted against the liability in accordance with provisions within legallyenforceable MNAs.

 
| **($ in millions)**                                                                                                               | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Gross liability fair  value of contracts containing credit-risk-contingent features                                                    |       | $                       | 499        |                        | $          | 386 |   |
| Gross asset fair value  of contracts containing credit-risk-contingent features and subject to MNAs                                    |       | (182                    | )          | (233                        | )          |
| Collateral posted under  MNAs for contracts containing credit-risk-contingent features                                                 |       | (263                    | )          | (122                        | )          |
| Maximum amount of  additional exposure for contracts with credit-risk-contingent features if all  features were triggered concurrently |       | $                       | 54         |                        | $          | 31 |   |

 

**Credit derivatives - selling protection**

 

Credit default swaps (“CDS”) are utilizedfor selling credit protection against a specified credit event.  A credit default swap is a derivativeinstrument, representing an agreement between two parties to exchange thecredit risk of a specified entity (or a group of entities), or an index basedon the credit risk of a group of entities (all commonly referred to as the “referenceentity” or a portfolio of “reference entities”), for a periodic premium.  In selling protection, CDS are used toreplicate fixed income securities and to complement the cash market when creditexposure to certain issuers is not available or when the derivative alternativeis less expensive than the cash market alternative.  CDS typically have a five-year term.

 

34

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table shows the CDS notional amounts by credit rating and fair valueof protection sold as of June 30, 2010:

 
| ** **                       | ** ** | **Notional amount** | ** ** | ** ** | ** ** |
|----------------------------------|------------|--------------------------|------------|------------|------------|
| **($ in millions)**    | ** ** | **AAA**                  | ** ** | **AA**     | ** ** | **A** | ** ** | **BBB** | ** ** | **BB and  lower** | ** ** | **Total** | ** ** | **Fair  value** | ** ** |
| **Single name**                  |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment grade corporate debt  |       | $                        | —     |       | $          | 40 |   | $ | 75 |   | $ | 36 |   | $ | 15 |   | $ | 166 |   | $ | (5 | ) |
| High yield debt                  |       | —                   |       | —     |       | — |   | — |   | 8 |   | 8 |   | — |   |
| Municipal                        |       | —                   |       | 25         |       | — |   | — |   | — |   | 25 |   | (8 | ) |
| Subtotal                         |       | —                   |       | 65         |       | 75 |   | 36 |   | 23 |   | 199 |   | (13 | ) |
| **Baskets**                      |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |
| **Tranche**                      |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment grade  corporate debt |       | —                   |       | —     |       | — |   | — |   | 65 |   | 65 |   | (35 | ) |
| **First-to-default**             |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment grade corporate debt  |       | —                   |       | —     |       | — |   | 15 |   | — |   | 15 |   | — |   |
| Municipal                        |       | —                   |       | —     |       | 100 |   | — |   | — |   | 100 |   | (38 | ) |
| Subtotal                         |       | —                   |       | —     |       | 100 |   | 15 |   | 65 |   | 180 |   | (73 | ) |
| **Index**                        |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment grade corporate debt  |       | 1                        |       | 2          |       | 26 |   | 66 |   | 5 |   | 100 |   | (1 | ) |
| **Total**                        |       | $                        | 1          |       | $          | 67 |   | $ | 201 |   | $ | 117 |   | $ | 93 |   | $ | 479 |   | $ | (87 | ) |

 

Thefollowing table shows the CDS notional amounts by credit rating and fair valueof protection sold as of December 31, 2009:

 
| ** **                       | ** ** | **Notional amount** | ** ** | ** ** | ** ** |
|----------------------------------|------------|---------------------|------------|------------|------------|
| **($ in millions)**         | ** ** | **AA**              | ** ** | **A**      | ** ** | **BBB** | ** ** | **BB and  lower** | ** ** | **Total** | ** ** | **Fair  value** | ** ** |
| **Single name**                  |       |                |       |       |       |   |   |   |   |   |   |   |   |
| Investment grade  corporate debt |       | $                   | 50         |       | $          | 65 |   | $ | 41 |   | $ | 15 |   | $ | 171 |   | $ | (5 | ) |
| High yield debt                  |       | —              |       | —     |       | — |   | 8 |   | 8 |   | — |   |
| Municipal                        |       | 25                  |       | —     |       | — |   | — |   | 25 |   | (4 | ) |
| Subtotal                         |       | 75                  |       | 65         |       | 41 |   | 23 |   | 204 |   | (9 | ) |
| **Baskets**                      |       |                |       |       |       |   |   |   |   |   |   |   |   |
| **Tranche**                      |       |                |       |       |       |   |   |   |   |   |   |   |   |
| Investment grade  corporate debt |       | —              |       | —     |       | — |   | 65 |   | 65 |   | (27 | ) |
| **First-to-default**             |       |                |       |       |       |   |   |   |   |   |   |   |   |
| Investment grade  corporate debt |       | —              |       | 45         |       | 15 |   | — |   | 60 |   | — |   |
| Municipal                        |       | 20                  |       | 135        |       | — |   | — |   | 155 |   | (28 | ) |
| Subtotal                         |       | 20                  |       | 180        |       | 15 |   | 65 |   | 280 |   | (55 | ) |
| **Index**                        |       |                |       |       |       |   |   |   |   |   |   |   |   |
| Investment grade  corporate debt |       | 14                  |       | 159        |       | 408 |   | 19 |   | 600 |   | 4 |   |
| **Total**                        |       | $                   | 109        |       | $          | 404 |   | $ | 464 |   | $ | 107 |   | $ | 1,084 |   | $ | (60 | ) |

 

Inselling protection with CDS, the Company sells credit protection on anidentified single name, a basket of names in a first-to-default (“FTD”)structure or a specific tranche of a basket, or credit derivative index (“CDX”)that is generally investment grade, and in return receives periodic premiumsthrough expiration or termination of the agreement.  With single name CDS, this premium or creditspread generally corresponds to the difference between

 

35

----

 

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

theyield on the referenced entity’s public fixed maturity cash instruments andswap rates, at the time the agreement is executed.  With a FTD basket or a tranche of a basket,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 onmultiple (generally 125) reference entities. Credit events are typically defined as bankruptcy, failure to pay, orrestructuring, 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.  When a credit event occurs in a tranche of abasket, there is no immediate impact to the Company until cumulative losses inthe basket exceed the contractual subordination.  To date, realized losses have not exceeded thesubordination.  For CDX index, thereference entity’s name incurring the credit event is removed from the indexwhile the contract continues until expiration. The maximum payout on a CDS is the contract notional amount.  A physical settlement may afford the Companywith recovery rights as the new owner of the asset.

 

TheCompany monitors risk associated with credit derivatives through individualname 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:

 
| ** **                                        | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**                     | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Premiums and contract charges**                 |       |                                            |       |                                          |       |   |   |   |   |
| Direct                                            |       | $                                               | 566        |                                          | $          | 555 |   | $ | 1,117 |   | $ | 1,100 |   |
| Assumed                                           |       |                                            |       |                                          |       |   |   |   |   |
| Affiliate                                         |       | 26                                              |       | 25                                            |       | 53 |   | 50 |   |
| Non-affiliate                                     |       | 6                                               |       | 6                                             |       | 11 |   | 11 |   |
| Ceded—non-affiliate                          |       | (196                                            | )          | (195                                          | )          | (380 | ) | (390 | ) |
|                                              |       |                                            |       |                                          |       |   |   |   |   |
| Premiums and contract charges, net of reinsurance |       | $                                               | 402        |                                          | $          | 391 |   | $ | 801 |   | $ | 771 |   |

 

The effects of reinsurance on contract benefits are as follows:

 
| ** **                            | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**         | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Contract benefits**                 |       |                                            |       |                                          |       |   |   |   |   |
| Direct                                |       | $                                               | 590        |                                          | $          | 480 |   | $ | 1,058 |   | $ | 1,239 |   |
| Assumed                               |       |                                            |       |                                          |       |   |   |   |   |
| Affiliate                             |       | 18                                              |       | 18                                            |       | 35 |   | 33 |   |
| Non-affiliate                         |       | 8                                               |       | 6                                             |       | 12 |   | 14 |   |
| Ceded—non-affiliate              |       | (210                                            | )          | (147                                          | )          | (335 | ) | (595 | ) |
|                                  |       |                                            |       |                                          |       |   |   |   |   |
| Contract benefits, net of reinsurance |       | $                                               | 406        |                                          | $          | 357 |   | $ | 770 |   | $ | 691 |   |

 

36

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The effects of reinsurance on interest credited to contractholder fundsare as follows:

 
| ** **                                                     | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Interest credited to  contractholder funds**                 |       |                                            |       |                                          |       |   |   |   |   |
| Direct                                                         |       | $                                               | 441        |                                          | $          | 551 |   | $ | 895 |   | $ | 1,117 |   |
| Assumed                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Affiliate                                                      |       | 3                                               |       | 2                                             |       | 5 |   | 5 |   |
| Non-affiliate                                                  |       | 4                                               |       | 3                                             |       | 7 |   | 6 |   |
| Ceded—non-affiliate                                       |       | (9                                              | )          | (8                                            | )          | (16 | ) | (15 | ) |
|                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Interest credited to contractholder funds, net of  reinsurance |       | $                                               | 439        |                                          | $          | 548 |   | $ | 891 |   | $ | 1,113 |   |

 

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

 

**Guaranty funds**

 

Understate insurance guaranty fund laws, insurers doing business in a state can beassessed, up to prescribed limits, for certain obligations of insolventinsurance 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 met itsstate of domicile’s statutory definition of insolvency and the amount of theloss is reasonably estimable.  In most states,the definition is met with a declaration of financial insolvency by a court ofcompetent jurisdiction.  In certainstates there must also be a final order of liquidation.

 

The New York Liquidation Bureau (the “Bureau”) haspublicly reported that Executive Life Insurance Company of New York (“ExecutiveLife”) is currently under its jurisdiction as part of a 1992 court-orderedrehabilitation plan. However, Executive Life does not have a liquidity problemat this time, and an order of liquidation has not been sought by theBureau.  The current publicly availableestimated shortfall from the Bureau is $1.27 billion.

 

IfExecutive Life were to be declared insolvent in the future, the Company mayhave 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 from insurancecompanies.  New York law currentlycontains an aggregate limit on guaranty funds under the Life InsuranceCorporation of New York of $500 million, of which approximately $40 million hasbeen used.  Under current law, theCompany may be allowed to recoup a portion of the amount of any additionalguaranty fund assessment in periods subsequent to the recognition of theassessment by offsetting future premium taxes. The Company’s average market share for New York, based on assessablepremiums, was approximately 3.1% in 2009.

 

**Guarantees**

 

TheCompany owns certain fixed income securities that obligate the Company toexchange credit risk or to forfeit principal due, depending on the nature oroccurrence of specified credit events for the referenced entities.  In the event all such specified credit eventswere to occur, the Company’s maximum amount at risk on these fixed incomesecurities, as measured by the amount of the aggregate initial investment, was$111 million at June 30, 2010.  Theobligations associated with these fixed income securities expire at variousdates on or before March 26, 2014.

 

Relatedto the disposal through reinsurance of substantially all of the Company’svariable annuity business to The Prudential Insurance Company of America, asubsidiary of Prudential Financial, Inc. (collectively “Prudential”) in2006, the Company and the Corporation have agreed to indemnify Prudential forcertain pre-closing contingent liabilities (including extra-contractualliabilities of the Company and liabilities specifically excluded from thetransaction) that the Company has agreed to retain.  In addition, the Company and the Corporationwill each 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 

 

37

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

benefitguarantees.  Management does not believethis agreement will have a material adverse effect on results of operations,cash flows or financial position of the Company.

 

Inthe normal course of business, the Company provides standard indemnificationsto contractual counterparties in connection with numerous transactions,including acquisitions and divestitures. The types of indemnifications typically provided includeindemnifications for breaches of representations and warranties, taxes andcertain 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 June 30, 2010.

 

**Regulation and Compliance**

 

The Company is subject to changing social, economicand regulatory conditions.  From time totime, regulatory authorities or legislative bodies seek to impose additionalregulations regarding agent and broker compensation, regulate the nature of andamount of investments, and otherwise expand overall regulation of insuranceproducts and the insurance industry.  TheCompany has established procedures and policies to facilitate compliance withlaws and regulations, to foster prudent business operations, and to supportfinancial reporting.  The Companyroutinely reviews its practices to validate compliance with laws andregulations and with internal procedures and policies.  As a result of these reviews, from time totime the Company may decide to modify some of its procedures and policies.  Such modifications, and the reviews that ledto them, may be accompanied by payments being made and costs beingincurred.  The ultimate changes andeventual effects of these actions on the Company’s business, if any, areuncertain.

 

**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 matters raisedifficult and complicated factual and legal issues and are subject to manyuncertainties 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 mattersmay be affected 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, plaintiffsseek a variety of remedies including equitable relief in the form of injunctiveand other remedies and monetary relief in the form of contractual andextra-contractual damages.  In some cases,the monetary damages sought include punitive damages.  Often specific information about the reliefsought, such as the amount of damages, is not available because plaintiffs havenot requested specific relief in their pleadings.  In the Company’s experience, when specificmonetary demands are made in pleadings, they bear little relation to theultimate loss, if any, to the Company.

 

38

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

·      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.

 

AICis defending certain matters relating to its agency program reorganizationannounced in 1999.  These matters are invarious stages of development.

 

·   These matters include a lawsuit filed in 2001 by theU.S. Equal Employment Opportunity Commission (“EEOC”) alleging retaliationunder federal civil rights laws (the “EEOC I” suit) and a class action filed in2001 by former employee agents alleging retaliation and age discriminationunder the Age Discrimination in Employment Act (“ADEA”), breach of contract andERISA violations (the “Romero I” suit). In 2004, in the consolidated EEOC I and Romero I litigation, the trialcourt issued a memorandum and order that, among other things, certified classesof agents, including a mandatory class of agents who had signed a release, forpurposes of effecting the court’s declaratory judgment that the release isvoidable at the option of the release signer. The court also ordered that an agent who voids the release must returnto AIC “any and all benefits received by the [agent] in exchange for signingthe release.”  The court also statedthat, “on the undisputed facts of record, there is no basis for claims of agediscrimination.”  The EEOC and plaintiffsasked the court to clarify and/or reconsider its memorandum and order and in January 2007,the judge denied their request.  In June 2007,the court granted AIC’s motions for summary judgment.  Following plaintiffs’ filing of a notice ofappeal, the U.S. Court of Appeals for the Third Circuit (“Third Circuit”)issued an order in December 2007 stating that the notice of appeal was nottaken from a final order within the meaning of the federal law and thus notappealable at this time.  In March 2008,the Third Circuit decided that the appeal should not summarily be dismissed andthat the question of whether the matter is appealable at this time will beaddressed by the Third Circuit along with the merits of the appeal.  In July 2009, the Third Circuit vacatedthe decision which granted AIC’s summary judgment motions, remanded the casesto the trial court for additional discovery, and directed that the cases bereassigned to another trial court judge. In January 2010, the cases were assigned to a new judge for furtherproceedings in the trial court.

 

·   A putative nationwide class action has also beenfiled by former employee agents alleging various violations of ERISA, includinga worker classification issue.  Theseplaintiffs are challenging certain amendments to the Agents Pension Plan andare seeking to have exclusive agent independent contractors treated asemployees for benefit purposes.  Thismatter was dismissed with prejudice by the trial court, was the subject offurther proceedings on appeal, and was reversed and remanded to the trial courtin 2005.  In June 2007, the courtgranted AIC’s motion to dismiss the case. Following plaintiffs’ filing of a notice of appeal, the Third Circuitissued an order in December 2007 stating that the notice of appeal was nottaken from a final order within the meaning of the federal law and thus notappealable at this time.  In March 2008,the Third Circuit decided that the appeal should not summarily be dismissed andthat the question of whether the 

 

39

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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 motion to dismiss the case, remanded the case to the trial court foradditional discovery, and directed that the case be reassigned to another trialcourt judge.  In January 2010, thecase was assigned to a new judge for further proceedings in the trial court.

 

Inthese agency program reorganization matters, plaintiffs seek compensatory andpunitive damages, and equitable relief. AIC has been vigorously defending these lawsuits and other mattersrelated to its agency program reorganization.

 

***Other Matters***

 

Variousother legal, governmental, and regulatory actions, including state marketconduct exams, and other governmental and regulatory inquiries are currentlypending that involve the Company and specific aspects of its conduct ofbusiness.  Like other members of theinsurance industry, the Company is the target of a number of class actionlawsuits and other types of proceedings, some of which involve claims forsubstantial or indeterminate amounts. These actions are based on a variety of issues and target a range of theCompany’s practices.  The outcome ofthese disputes is currently unpredictable.

 

Oneor more of these matters could have an adverse effect on the Company’soperating 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 in this “Other Matters” subsection, in excess of amountscurrently reserved, if any, as they are resolved over time is not likely tohave a material effect on the operating results, cash flows or financialposition of the Company.

 

**9.****             ****IncomeTaxes**

 

Areconciliation of the statutory federal income tax rate to the effective incometax rate on income from operations for the six months ended June 30 is asfollows:

 
| **($ in  millions)**                     | ** ** | **2010** | ** ** | **2009** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| Statutory federal income tax rate - benefit   |       | $        | (82        | )        | (35.0      | )% | $ | (110 | ) | (35.0 | )% |
| Dividends received deduction                  |       | (6       | )          | (2.6     | )          | (6 | ) | (1.9 | ) |
| Other                                         |       | (1       | )          | (0.4     | )          | 1 |   | 0.3 |   |
| Valuation allowance                           |       | —   |       | —   |       | 137 |   | 43.6 |   |
| Effective income tax rate - (benefit) expense |       | $        | (89        | )        | (38.0      | )% | $ | 22 |   | 7.0 | % |

 

Income tax expense for the six months ended June 30,2009 included expense of $142 million attributable to an increase in thevaluation allowance relating to the deferred tax asset on capital losses.

 

**10.****      ****Other Comprehensive Income**

 

Thecomponents of other comprehensive income on a pre-tax and after-tax basis areas follows:

 
| ** **                                                                             | ** ** | **Three months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| **($ in millions)**                                                          | ** ** | **Pre-tax**                                         | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
| Unrealized holding gains and losses arising during  the period, net of related offsets |       | $                                                   | 522        |   | $ | (182 | ) | $ | 340 |   | $ | 2,625 |   | $ | (1,021 | ) | $ | 1,604 |   |
| Less: reclassification adjustment of realized  capital gains and losses                |       | (156                                                | )          | 55 |   | (101 | ) | (49 | ) | 17 |   | (32 | ) |
| Unrealized net capital gains and losses                                                |       | 678                                                 |       | (237 | ) | 441 |   | 2,674 |   | (1,038 | ) | 1,636 |   |
| Other comprehensive income                                                             |       | $                                                   | 678        |   | $ | (237 | ) | 441 |   | $ | 2,674 |   | $ | (1,038 | ) | 1,636 |   |
| Net loss                                                                               |       |                                                |       |   |   | (127 | ) |   |   |   |   | — |   |
| Comprehensive income                                                                   |       |                                                |       |   |   | $ | 314 |   |   |   |   |   | $ | 1,636 |   |

 

40

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **                                                                             | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2010**                                          | ** ** | **2009** | ** ** |
| ** **                                                                             | ** ** | **Pre-tax**                                       | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
| Unrealized holding gains and losses arising during  the period, net of related offsets |       | $                                                 | 1,244      |   | $ | (436 | ) | $ | 808 |   | $ | 2,471 |   | $ | (964 | ) | $ | 1,507 |   |
| Less: reclassification adjustment of realized  capital gains and losses                |       | (247                                              | )          | 86 |   | (161 | ) | (102 | ) | 36 |   | (66 | ) |
| Unrealized net capital gains and losses                                                |       | 1,491                                             |       | (522 | ) | 969 |   | 2,573 |   | (1,000 | ) | 1,573 |   |
| Other comprehensive income                                                             |       | $                                                 | 1,491      |   | $ | (522 | ) | 969 |   | $ | 2,573 |   | $ | (1,000 | ) | 1,573 |   |
| Net loss                                                                               |       |                                              |       |   |   | (145 | ) |   |   |   |   | (336 | ) |
| Comprehensive income                                                                   |       |                                              |       |   |   | $ | 824 |   |   |   |   |   | $ | 1,237 |   |

 

41

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholder of

AllstateLife Insurance Company

Northbrook, IL60062

 

Wehave reviewed the accompanying condensed consolidated statement of financialposition of Allstate Life Insurance Company and subsidiaries (the “Company”),an affiliate of The Allstate Corporation, as of June 30, 2010, and therelated condensed consolidated statements of operations for the three-month andsix-month periods ended June 30, 2010 and 2009, and the condensedconsolidated statements of cash flows for the six-month periods ended June 30,2010 and 2009.  These interim financialstatements are the responsibility 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.

 

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 ofDecember 31, 2009, and the related consolidated statements of operationsand comprehensive income, shareholder’s equity, and cash flows for the yearthen ended (not presented herein); and in our report dated March 12, 2010,which report includes an explanatory paragraph relating to a change in theCompany’s recognition and presentation for other-than-temporary impairments ofdebt securities in 2009, we expressed an unqualified opinion on thoseconsolidated financial statements.  Inour opinion, the information set forth in the accompanying condensedconsolidated statement of financial position as of December 31, 2009 isfairly stated, in all material respects, in relation to the consolidatedstatement of financial position from which it has been derived.

 

 

/s/Deloitte & Touche LLP

 

Chicago, Illinois

August 9,2010

 

42

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**Item2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS FOR THE THREE-MONTH AND SIX-MONTH PERIODSENDED JUNE 30, 2010 AND 2009**

** **

**OVERVIEW**

 

Thefollowing discussion highlights significant factors influencing theconsolidated financial position and results of operations of Allstate LifeInsurance Company (referred to in this document as “we”, “our”, “us”, or the “Company”).  It should be read in conjunction with thecondensed consolidated financial 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 2009.  We operate as a single segmententity based on the manner in which we use financial information to evaluatebusiness performance and to determine the allocation of resources.

 

**OPERATIONS HIGHLIGHTS**

 

·                  Netloss was $127 million and $145 million in the second quarter and first sixmonths of 2010, respectively, compared to breaking even (no net income or loss)and a net loss of $336 million in the second quarter and first six months of2009, respectively.

·                  Premiums and contractcharges on underwritten products, including traditional and interest-sensitivelife insurance and accident and health insurance, increased 4.3% or $15 millionand 5.9% or $40 million in the second quarter and first six months of 2010,respectively, compared to the same periods in the prior year.

·                  Netrealized capital losses totaled $352 million and $513 million in the second quarterand first six months of 2010, respectively, compared to net realized capitalgains of $122 million and $84 million in the second quarter and first six monthof 2009, respectively.

·                  Investments as of June 30,2010 totaled $59.72 billion, reflecting a decrease in carrying value of $499million from $60.22 billion as of December 31, 2009.  Net investment income decreased 5.5% to $700million in the second quarter and 8.5% to $1.41 billion in the first six monthsof 2010 from $741 million and $1.54 billion in the second quarter and first sixmonths of 2009, respectively.

·                  Contractholder funds as of June 30,2010 totaled $47.70 billion, reflecting a decrease of $3.15 billion from $50.85billion as of December 31, 2009.

 

**OPERATIONS**

 

**Summary analysis** Summarized financial data is presented in the following table.

 
| ** **                                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**                 | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Revenues**                              |       |                                  |       |                                |       |   |   |   |   |
| Premiums                                  |       | $                                     | 154        |                                | $          | 154 |   | $ | 307 |   | $ | 306 |   |
| Contract charges                          |       | 248                                   |       | 237                                 |       | 494 |   | 465 |   |
| Net investment income                     |       | 700                                   |       | 741                                 |       | 1,407 |   | 1,538 |   |
| Realized capital gains and losses         |       | (352                                  | )          | 122                                 |       | (513 | ) | 84 |   |
| Total revenues                            |       | 750                                   |       | 1,254                               |       | 1,695 |   | 2,393 |   |
|                                      |       |                                  |       |                                |       |   |   |   |   |
| **Costs and expenses**                    |       |                                  |       |                                |       |   |   |   |   |
| Contract benefits                         |       | (406                                  | )          | (357                                | )          | (770 | ) | (691 | ) |
| Interest credited to contractholder funds |       | (439                                  | )          | (548                                | )          | (891 | ) | (1,113 | ) |
| Amortization of DAC                       |       | (14                                   | )          | (268                                | )          | (81 | ) | (697 | ) |
| Operating costs and expenses              |       | (83                                   | )          | (81                                 | )          | (169 | ) | (170 | ) |
| Restructuring and related charges         |       | 1                                     |       | (2                                  | )          | 1 |   | (19 | ) |
| Interest expense                          |       | (11                                   | )          | (10                                 | )          | (22 | ) | (21 | ) |
| Total costs and expenses                  |       | (952                                  | )          | (1,266                              | )          | (1,932 | ) | (2,711 | ) |
|                                      |       |                                  |       |                                |       |   |   |   |   |
| Gain on disposition of operations         |       | 2                                     |       | 1                                   |       | 3 |   | 4 |   |
| Income tax benefit (expense)              |       | 73                                    |       | 11                                  |       | 89 |   | (22 | ) |
| Net loss                                  |       | $                                     | (127       | )                                   | $          | — |   | $ | (145 | ) | $ | (336 | ) |
|                                      |       |                                  |       |                                |       |   |   |   |   |
| Investments at June 30               |       |                                  |       |                                |       | $ | 59,718 |   | $ | 57,957 |   |

 

43

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*Net loss* in the second quarter of 2010 was $127 millioncompared to breaking even (no net income or loss) in the same period of2009.  The unfavorable change of $127million was primarily due to net realized capital losses in the current yearperiod compared to net realized capital gains in the prior year period andhigher contract benefits, partiallyoffset by lower amortization of DAC and interest credited to contractholderfunds.

 

Netloss in the first six months of 2010 was $145 million compared to a net loss of$336 million in the first six months of 2009. The improvement of $191 million was primarily due to lower amortizationof DAC and interest credited to contractholder funds, partially offset by netrealized capital losses in the current year period compared to net realizedcapital gains in the prior year period, decreased net investment income andhigher contract benefits.  Additionally,the first six months of 2009 included expense of $142 million attributable toan increase in the valuation allowance relating to the deferred tax asset oncapital losses.

 

**Analysis of revenues **Total revenuesdecreased 40.2% or $504 million in the second quarter of 2010 and 29.2% or $698million in the first six months of 2010 compared to the same periods of 2009 dueto net realized capital losses in the current year periods compared to netrealized capital gains in the prior year periods and lower net investmentincome, partially offset by increased contract charges.

 

*Premiums*representrevenues generated from traditional life insurance, immediate annuities withlife contingencies, and accident and health and 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.

 

The following table summarizes premiums and contract charges byproduct.

 
| ** **                                  | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**                   | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Premiums**                                |       |                                  |       |                                |       |   |   |   |   |
| Traditional life  insurance                 |       | $                                     | 100        |                                | $          | 97 |   | $ | 202 |   | $ | 193 |   |
| Immediate annuities with life contingencies |       | 31                                    |       | 34                                  |       | 58 |   | 68 |   |
| Accident and health                         |       | 23                                    |       | 23                                  |       | 47 |   | 45 |   |
| **Total premiums**                          |       | 154                                   |       | 154                                 |       | 307 |   | 306 |   |
|                                        |       |                                  |       |                                |       |   |   |   |   |
| **Contract charges**                        |       |                                  |       |                                |       |   |   |   |   |
| Interest-sensitive life  insurance          |       | 238                                   |       | 226                                 |       | 471 |   | 442 |   |
| Fixed annuities                             |       | 10                                    |       | 11                                  |       | 23 |   | 23 |   |
| **Total contract charges**(1)               |       | 248                                   |       | 237                                 |       | 494 |   | 465 |   |
|                                        |       |                                  |       |                                |       |   |   |   |   |
| **Total premiums and contract  charges**    |       | $                                     | 402        |                                | $          | 391 |   | $ | 801 |   | $ | 771 |   |

 

----

| (1) |   | Total  contract charges for the second quarter of 2010 and 2009 include contract  charges related to the cost of insurance totaling $157 million and $147  million, respectively. Total contract charges for the first six months of  2010 and 2009 include contract charges related to the cost of insurance  totaling $310 million and $297 million, respectively. |   |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|

 

Total premiums were consistent in the second quarter and first sixmonths of 2010, respectively, compared to the same periods of 2009 as highersales of traditional life insurance products were offset by lower sales ofimmediate annuities with life contingencies.

 

Total contract charges increased 4.6% and 6.2% in the second quarterand first six months of 2010, respectively, compared to the same periods of2009 primarily due to higher contract charges on interest-sensitive lifeinsurance products resulting from a shift in the mix of policies in force.

 

44

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*Contractholder funds*represent interest-bearingliabilities arising from the sale of individual and institutional products,such as interest-sensitive life insurance, fixed annuities and fundingagreements.  The balance ofcontractholder funds is equal to the cumulative deposits received and interestcredited to the contractholder less cumulative contract maturities, benefits,surrenders, withdrawals and contract charges for mortality or administrativeexpenses.  The following table shows thechanges in contractholder funds.

 
| ** **                                                     | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in millions)**                                       | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Contractholder funds, beginning  balance**                   |       | $                                     | 49,281     |                                | $          | 54,876 |   | $ | 50,850 |   | $ | 56,780 |   |
|                                                           |       |                                  |       |                                |       |   |   |   |   |
| **Deposits**                                                   |       |                                  |       |                                |       |   |   |   |   |
| Fixed annuities                                                |       | 236                                   |       | 635                                 |       | 527 |   | 1,270 |   |
| Interest-sensitive life insurance                              |       | 369                                   |       | 337                                 |       | 742 |   | 659 |   |
| Other                                                          |       | —                                |       | —                              |       | 1 |   | — |   |
| Total deposits                                                 |       | 605                                   |       | 972                                 |       | 1,270 |   | 1,929 |   |
|                                                           |       |                                  |       |                                |       |   |   |   |   |
| **Interest credited**                                          |       | 438                                   |       | 502                                 |       | 889 |   | 1,020 |   |
|                                                           |       |                                  |       |                                |       |   |   |   |   |
| **Maturities, benefits, withdrawals  and other adjustments**   |       |                                  |       |                                |       |   |   |   |   |
| Maturities and retirements of institutional  products          |       | (827                                  | )          | (2,552                              | )          | (1,781 | ) | (4,503 | ) |
| Benefits                                                       |       | (390                                  | )          | (394                                | )          | (781 | ) | (825 | ) |
| Surrenders and partial withdrawals                             |       | (1,109                                | )          | (918                                | )          | (2,103 | ) | (1,839 | ) |
| Contract charges                                               |       | (228                                  | )          | (213                                | )          | (454 | ) | (419 | ) |
| Net transfers from separate accounts                           |       | 3                                     |       | 2                                   |       | 5 |   | 6 |   |
| Fair value hedge adjustments for institutional  products       |       | (74                                   | )          | 78                                  |       | (197 | ) | 30 |   |
| Other adjustments (1)                                          |       | (2                                    | )          | (55                                 | )          | (1 | ) | 119 |   |
| Total maturities, benefits, withdrawals and other  adjustments |       | (2,627                                | )          | (4,052                              | )          | (5,312 | ) | (7,431 | ) |
| **Contractholder funds, ending  balance**                      |       | $                                     | 47,697     |                                | $          | 52,298 |   | $ | 47,697 |   | $ | 52,298 |   |

 

----

(1) The table above illustrates the changes incontractholder funds, which are presented gross of reinsurance recoverables onthe Condensed Consolidated Statements of Financial Position.  The table above is intended to supplement ourdiscussion and analysis of revenues, which are presented net of reinsurance onthe 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 3.2% and 6.2% in the second quarter and first six months of2010, respectively, compared to a decrease of 4.7% and 7.9% in the secondquarter and first six months of 2009, respectively.  Average contractholder funds decreased 9.5%and 9.7% in the second quarter and first six months of 2010, respectively,compared to the same periods of 2009.

 

Contractholderdeposits decreased 37.8% and 34.2% in the second quarter and first six monthsof 2010, respectively, compared to the same periods of 2009 primarily due tolower deposits on fixed annuities. Deposits on fixed annuities decreased 62.8% and 58.5% in the second quarterand first six months of 2010, respectively, compared to the same periods of2009 due to our strategic decision to discontinue distributing fixed annuitiesthrough banks and broker-dealers and our goal to reduce our concentration inspread based products.

 

Maturitiesand retirements of institutional products decreased 67.6% to $827 million inthe second quarter of 2010 and 60.4% to $1.78 billion in the first six monthsof 2010 from $2.55 billion and $4.50 billion in the second quarter and firstsix months of 2009, respectively.  Thesedeclines were primarily due to the redemption in the second quarter of 2009 of$1.39 billion of institutional product liabilities in conjunction with cashtender offers.  In addition, the secondquarter and first six months of 2009 included the retirement of $80 million and$1.44 billion, respectively, of extendible institutional market obligations,all of which were retired during 2009.

 

Surrenders and partial withdrawals on deferred fixed annuities andinterest-sensitive life insurance products increased 20.8% to $1.11 billion inthe second quarter of 2010 and 14.4% to $2.10 billion in the first six monthsof 2010 from $918 million and $1.84 billion in the second quarter and first sixmonths of 2009, respectively, due to higher surrenders and partial withdrawalson fixed annuities.  The annualizedsurrender and partial withdrawal rate on deferred fixed annuities andinterest-sensitive life insurance products, based on the beginning of periodcontractholder funds, was 10.3% in the first six months of 2010 compared to8.7% in the first six months of 2009.

 

45

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**Analysis of costs and expenses**  Total costs and expenses decreased 24.8% or$314 million in the second quarter of 2010 and 28.7% or $779 million in thefirst six months of 2010 compared to the same periods of 2009 due primarily tolower amortization of DAC and interest credited to contractholder funds,partially offset by higher contract benefits.

 

*Contract benefits* increased 13.7% or $49 million in the secondquarter of 2010 and 11.4% or $79 million in the first six months of 2010compared to the same periods of 2009. The increase in both periods reflects higher contract benefits on interest-sensitivelife insurance, partially offset by lower contract benefits on immediateannuities.  The increase in contractbenefits on interest-sensitive life insurance in both periods was due to there-estimation of reserves for certain secondary guarantees on universal lifeinsurance policies and unfavorable mortality experience.  The decrease in contract benefits onimmediate annuities in both periods was primarily due to the re-estimation ofreserves for benefits payable to certain annuitants to reflect currentcontractholder information.

 

The reserve re-estimations utilized more refined policy levelinformation and assumptions in the second quarter of 2010.  The increase in reserves for certainsecondary guarantees on universal life insurance policies resulted in a chargeto contract benefits of $68 million and a related reduction in amortization ofDAC of $50 million.  The decrease inreserves for immediate annuities resulted in a credit to contract benefits of$26 million.  The net impact was anincrease to income of $8 million, pre-tax.

 

We analyze our mortality and morbidity results using the differencebetween premiums and contract charges earned for the cost of insurance andcontract benefits excluding the portion related to the implied interest onimmediate annuities with life contingencies (“benefit spread”).  This implied interest totaled $139 millionand $278 million in the second quarter and first six months of 2010,respectively, compared to $140 million and $279 million in the second quarterand first six months of 2009, respectively.

 

The benefit spread by product group is disclosed in the followingtable.

 
| ** **                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)** | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Life insurance            |       | $                                     | 21         |                                | $          | 93 |   | $ | 104 |   | $ | 194 |   |
| Accident and health       |       | 7                                     |       | 6                                   |       | 15 |   | 14 |   |
| Annuities                 |       | 16                                    |       | (15                                 | )          | 6 |   | (17 | ) |
| Total benefit spread      |       | $                                     | 44         |                                | $          | 84 |   | $ | 125 |   | $ | 191 |   |

 

Benefit spread decreased 47.6% or $40 million in the second quarter of2010 and 34.6% or $66 million in the first six months of 2010 compared to thesame periods of 2009 primarily due to re-estimates of reserves that increasedcontract benefits for interest-sensitive life insurance and decreased contractbenefits for immediate annuities and unfavorable mortality experience oninterest-sensitive life insurance.

 

*Interest credited to contractholder funds* decreased19.9% or $109 million in the second quarter of 2010 and 19.9% or $222 millionin the first six months of 2010 compared to the same periods of 2009 primarilydue to lower average contractholder funds, management actions to reduceinterest crediting rates on deferred fixed annuities, and lower amortization ofdeferred sales inducement costs (“DSI”).

 

Amortization of DSI in the second quarter and first six months of 2010was $6 million and $11 million, respectively, compared to $53 million and $110million in the second quarter and first six months of 2009, respectively.  The decline in amortization of DSI in bothperiods was primarily due to lower amortization relating to realized capitalgains and losses and, for the first six months of 2010, a reduction inamortization acceleration for changes in assumptions.  Amortization of DSI relating to realizedcapital gains and losses declined $41 million and $45 million in the second quarterand first six months of 2010, respectively, compared to the same periods in theprior year.  Amortization accelerationfor changes in assumptions declined $38 million in the first six months of 2010compared to the same period in the prior year.

 

In order to analyze the impact of net investment income and interestcredited to contractholders on net income, we monitor the difference betweennet investment income and the sum of interest credited to contractholder fundsand the implied interest on immediate annuities with life contingencies, whichis included as a component of contract benefits on the Condensed ConsolidatedStatements of Operations (“investment spread”).

 

46

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The investment spread by product group is shown in the following table.

 
| ** **                                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**                                | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Annuities and institutional products                     |       | $                                     | 54         |                                | $          | 3 |   | $ | 104 |   | $ | 37 |   |
| Life insurance                                           |       | 7                                     |       | 5                                   |       | 14 |   | 2 |   |
| Accident and health                                      |       | 2                                     |       | 2                                   |       | 4 |   | 4 |   |
| Net investment income on investments supporting  capital |       | 59                                    |       | 43                                  |       | 116 |   | 103 |   |
| Total investment spread                                  |       | $                                     | 122        |                                | $          | 53 |   | $ | 238 |   | $ | 146 |   |

 

Investment spread increased 130.2% or $69 million in the second quarterof 2010 and 63.0% or $92 million in the first six months of 2010 compared tothe same periods of 2009 as lower net investment income was more than offset bydecreased interest credited to contractholder funds, which includes loweramortization of DSI.  Excludingamortization of DSI, investment spread increased $22 million or 20.8% in thesecond quarter of 2010 and decreased $7 million or 2.7% in the first six monthsof 2010 compared to the same periods in the prior year.

 

Tofurther analyze investment spreads, the following tables summarize the weightedaverage investment yield on assets supporting product liabilities and capital,interest crediting rates and investment spreads.

 
| ** **                                                           | ** ** | **Three months ended June 30,**   | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                           | ** ** | **Weighted average  investment yield** | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
| ** **                                                           | ** ** | **2010**                               | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.4                                    | %          | 5.4 | % | 4.5 | % | 4.5 | % | 0.9 | % | 0.9 | % |
| Deferred fixed annuities and institutional  products                 |       | 4.5                                    |       | 4.5 |   | 3.2 |   | 3.5 |   | 1.3 |   | 1.0 |   |
| Immediate fixed annuities with and without life  contingencies       |       | 6.5                                    |       | 6.3 |   | 6.4 |   | 6.5 |   | 0.1 |   | (0.2 | ) |
| Investments supporting capital, traditional life  and other products |       | 3.8                                    |       | 2.6 |   | N/A |   | N/A |   | N/A |   | N/A |   |

 
| ** **                                                           | ** ** | **Six months ended June 30,**     | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                           | ** ** | **Weighted average  investment yield** | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
| ** **                                                           | ** ** | **2010**                               | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.5                                    | %          | 5.4 | % | 4.5 | % | 4.6 | % | 1.0 | % | 0.8 | % |
| Deferred fixed annuities and institutional  products                 |       | 4.4                                    |       | 4.6 |   | 3.3 |   | 3.4 |   | 1.1 |   | 1.2 |   |
| Immediate fixed annuities with and without life  contingencies       |       | 6.5                                    |       | 6.3 |   | 6.4 |   | 6.5 |   | 0.1 |   | (0.2 | ) |
| Investments supporting capital, traditional life  and other products |       | 3.8                                    |       | 3.3 |   | N/A |   | N/A |   | N/A |   | N/A |   |

 

47

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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.

 
| ** **                                                       | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------|------------|-------------------|------------|
| **($ in  millions)**                                        | ** ** | **2010**          | ** ** | **2009** | ** ** |
| Immediate fixed annuities with life contingencies                |       | $                 | 8,567      |   | $ | 8,402 |   |
| Other life contingent contracts and other                        |       | 4,218             |       | 3,806 |   |
| Reserve for life-contingent contract benefits                    |       | $                 | 12,785     |   | $ | 12,208 |   |
|                                                             |       |              |       |   |   |
| Interest-sensitive life insurance                                |       | $                 | 9,902      |   | $ | 9,477 |   |
| Deferred fixed annuities                                         |       | 30,680            |       | 33,382 |   |
| Immediate fixed annuities without life  contingencies            |       | 3,838             |       | 3,876 |   |
| Institutional products                                           |       | 2,650             |       | 4,570 |   |
| Market value adjustments related to fair value  hedges and other |       | 627               |       | 993 |   |
| Contractholder funds                                             |       | $                 | 47,697     |   | $ | 52,298 |   |

 

*Amortization of DAC* decreased 94.8% or $254million in the second quarter of 2010 and 88.4% or $616 million in the firstsix months of 2010 compared to the same periods of 2009.  The components of amortization of DAC aresummarized in the following table.

 
| ** **                                                                                                        | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**                                                                                         | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Amortization of DAC before amortization relating  to realized capital gains and losses and changes in assumptions |       | $                                     | (19        | )                                   | $          | (109 | ) | $ | (96 | ) | $ | (233 | ) |
| Accretion (amortization) relating to realized  capital gains and losses (1)                                       |       | 5                                     |       | (159                                | )          | 2 |   | (186 | ) |
| Amortization deceleration (acceleration) for  changes in assumptions (“DAC unlocking”)                  |       | —                                |       | —                              |       | 13 |   | (278 | ) |
| Total amortization of DAC                                                                                         |       | $                                     | (14        | )                                   | (268       | ) | $ | (81 | ) | $ | (697 | ) |
|                                                                                                                   |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

----

(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.

 

Thedecreases of $254 million and $616 million in the second quarter and first sixmonths of 2010, respectively, compared to the same periods of 2009 wereprimarily due to a favorable change in amortization/accretion relating torealized capital gains and losses, lower amortization resulting from decreasedbenefit spread on interest-sensitive life insurance due to the re-estimation ofreserves, a lower amortization rate on fixed annuities and, for the first sixmonths of 2010, a favorable change in amortization acceleration/decelerationfor changes in assumptions.

 

Duringthe first quarter of 2010, we completed our annual comprehensive review of theprofitability of our products to determine DAC balances for ourinterest-sensitive life, fixed annuities and other investment contracts, whichcovers assumptions for investment returns, including capital gains and losses,interest crediting rates to policyholders, the effect of any hedges,persistency, mortality and expenses in all product lines.  In the first quarter of 2010, the reviewresulted in a deceleration of DAC amortization (credit to income) of $13million.  Amortization deceleration of$45 million related to variable life insurance and was primarily due toappreciation in the underlying separate account valuations.  Amortization acceleration of $31 millionrelated to interest-sensitive life insurance and was primarily due to anincrease in projected realized capital losses and lower projected renewalpremium (which is also expected to reduce persistency), partially offset bylower expenses.

 

Inthe first quarter of 2009, our annual comprehensive review resulted in theacceleration of DAC amortization (charge to income) of $278 million.  $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 was amortization deceleration (creditto income) for interest-sensitive life insurance of $29 million.  The principal assumption impacting fixedannuity amortization acceleration was an increase in the level of expectedrealized capital losses in 2009 and 2010. For interest-sensitive life insurance, the amortization deceleration wasdue to a favorable change in our mortality assumptions, partially offset byincreased expected capital losses.

 

48

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* *

*Operating costs and expenses* increased 2.5%and decreased 0.6% in the second quarter and first six months of 2010,respectively, compared to the same periods of 2009.  The following table summarizes operatingcosts and expenses.

 
| ** **                         | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**          | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Non-deferrable acquisition costs   |       | $                                     | 20         |                                | $          | 22 |   | $ | 42 |   | $ | 44 |   |
| Other operating costs and expenses |       | 63                                    |       | 59                                  |       | 127 |   | 126 |   |
| Total operating costs and expenses |       | $                                     | 83         |                                | $          | 81 |   | $ | 169 |   | $ | 170 |   |
|                               |       |                                  |       |                                |       |   |   |   |   |
| Restructuring and related charges  |       | $                                     | (1         | )                                   | $          | 2 |   | $ | (1 | ) | $ | 19 |   |

 

Non-deferrable acquisitioncosts decreased 9.1% or $2 million and 4.5% or $2 million in the second quarterand first six months of 2010, respectively, compared to the same periods of2009 primarily due to decreased expenses associated with non-deferrable agent compensation.  Other operating costs and expenses increased6.8% or $4 million and 0.8% or $1 million in the second quarter and first sixmonths of 2010, respectively, compared to the same periods of 2009 due primarilyto increases in the net cost of employee benefits due to unfavorable investmentresults.  In the first six months of2010, the increase in the net cost of employee benefits was partially offset byour expense reduction actions, which resulted in lower employee, professionalservices and sales support expenses.

 

*Income tax benefit* of $73 million and $89million was recognized for the second quarter and first six months of 2010,respectively, compared to an income tax benefit of $11 million in the secondquarter of 2009 and expense of $22 million in the first six months of2009.  Income tax expense for the firstsix months of 2009 included expense of $142 million attributable to an increasein the valuation allowance relating to the deferred tax asset on capitallosses.

 

**INVESTMENTS HIGHLIGHTS**

 

·                  Investments as of June 30, 2010 totaled$59.72 billion, a decrease of 0.8% from $60.22 billion as of December 31,2009.

·                Unrealized netcapital gains totaled $189 million as of June 30, 2010, improving fromunrealized net capital losses of $2.18 billion as of December 31, 2009.

·                  Net investment income was $700 million in thesecond quarter of 2010, a decrease of 5.5% from $741 million in the secondquarter of 2009, and $1.41 billion in the first six months of 2010, a decreaseof 8.5% from $1.54 billion in the first six months of 2009.

·                  Net realized capital losses were $352 millionin the second quarter of 2010 compared to net realized capital gains of $122million in the second quarter of 2009. Net realized capital losses were $513 million in the first six months of2010 compared to net realized capital gains of $84 million in the first sixmonths of 2009.

·                  During the first six months of 2010, ourfixed income and mortgage loan portfolio generated $3.24 billion of cash flowsfrom interest and maturities.

 

**INVESTMENTS**

 

We continue to focus our strategic risk mitigation efforts towardsmanaging interest rate, credit and real estate investment risks, while ourreturn optimization efforts focus on investing in new opportunities to generateincome and capital appreciation.  As aresult, during the first six months of 2010 we took the following actions:

 

·                  Reduced ourcommercial real estate exposure by 13.0% or $1.53 billion of amortized costprimarily through targeted dispositions and principal repayments fromborrowers.

·                  Reduced ourmunicipal bond exposure by 4.6% or $258 million of amortized cost primarilythrough targeted dispositions, calls and scheduled maturities.

·                  We continue tomonitor fixed income and equity securities in our portfolio which are exposedto certain economies under stress in the European Union, particularly Ireland, Italy,Portugal and Spain.  The total marketvalue of our investments in these four countries is $816 million, with netunrealized capital losses of $1 million. As of June 30, 2010, we did not hold any investments inGreece.  Our total sovereign debtexposure is $3 million, all of which relates to Italy.  Of the remaining $813 million of theseinvestments, $804 million are corporate fixed income securities and $9 millionare equity securities.

 

49

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The composition of the investment portfolio at June 30, 2010 ispresented in the table below.

 
| **($ in millions)**          | ** ** | **Investments** | ** ** | **Percent  to total** | ** ** |
|-----------------------------------|------------|-----------------|------------|-----------------------|------------|
| Fixed income securities (1)       |       | $               | 48,871     |                  | 81.8       | % |
| Mortgage loans                    |       | 7,039           |       | 11.8                  |       |
| Equity securities (2)             |       | 172             |       | 0.3                   |       |
| Limited partnership interests (3) |       | 1,064           |       | 1.8                   |       |
| Short-term (4)                    |       | 903             |       | 1.5                   |       |
| Policy loans                      |       | 825             |       | 1.4                   |       |
| Other                             |       | 844             |       | 1.4                   |       |
| Total                             |       | $               | 59,718     |                  | 100.0      | % |

 

----

| (1) |   | Fixed  income securities are carried at fair value. Amortized cost basis for these  securities was $48.70 billion. |   |
|-----|--------|--------------------------------------------------------------------------------------------------------------------|--------|
| (2) |   | Equity  securities are carried at fair value. Cost basis for these securities was  $161 million.                   |   |
| (3) |   | We  have commitments to invest in additional limited partnership interests  totaling $721 million.                 |   |
| (4) |   | Short-term  investments are carried at fair value. Amortized cost basis for these  investments was $903 million.   |   |

 

Total investments decreased to $59.72 billion at June 30, 2010,from $60.22 billion at December 31, 2009, primarily due to net reductionsin contractholder obligations of $3.15 billion, partially offset by highervaluations for fixed income securities. Valuations of fixed income securities are typically driven by acombination of changes in risk-free interest rates and credit spreads over therelevant period.  Risk-free interestrates are typically defined as the yield on U.S. Treasury securities, whereascredit spread is the additional yield on fixed income securities above therisk-free rate that market participants require to compensate them for assumingcredit, liquidity and/or prepayment risks. The increase in valuation for fixed income securities for the six monthsended June 30, 2010 was mainly due to declining risk-free interest rates,partially offset by widening credit spreads in certain sectors.

 

**Fixed income securities** by type are listed in thetable below.

 
| **($ in  millions)**                                   | ** ** | **Fair value at  June 30, 2010** | ** ** | **Percent to  total  investments** | ** ** | **Fair value at  December 31, 2009** | ** ** | **Percent to  total  investments** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|------------------------------------------------|------------|------------------------------------|------------|
| U.S. government and  agencies                               |       | $                                     | 3,567      |                               | 6.0        | %                                              | $          | 3,581                              |       | 5.9 | % |
| Municipal                                                   |       | 5,194                                 |       | 8.7                                |       | 5,109                                          |       | 8.5                                |       |
| Corporate                                                   |       | 28,452                                |       | 47.6                               |       | 27,539                                         |       | 45.7                               |       |
| Foreign government                                          |       | 2,301                                 |       | 3.9                                |       | 2,153                                          |       | 3.6                                |       |
| Residential  mortgage-backed securities  (“RMBS”) |       | 4,968                                 |       | 8.3                                |       | 4,666                                          |       | 7.8                                |       |
| Commercial  mortgage-backed securities (“CMBS”)   |       | 2,035                                 |       | 3.4                                |       | 2,468                                          |       | 4.1                                |       |
| Asset-backed securities  (“ABS”)                  |       | 2,339                                 |       | 3.9                                |       | 2,127                                          |       | 3.5                                |       |
| Redeemable preferred  stock                                 |       | 15                                    |       | —                             |       | 15                                             |       | —                             |       |
| Total fixed income  securities                              |       | $                                     | 48,871     |                               | 81.8       | %                                              | $          | 47,658                             |       | 79.1 | % |

 

At June 30, 2010, 93.2% of the fixed income securities portfoliowas rated investment grade, which is defined as a security having a rating ofAaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB from Standard andPoor’s (“S&P”), Fitch, Dominion, or Realpoint, a rating of aaa, aa, a orbbb from A.M. Best, or a comparable internal rating, if an externally providedrating is not available.

 

50

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The following table summarizes the fair value and unrealized netcapital gains and losses for fixed income securities by credit rating as of June 30,2010.

 
| ** **                                                                       | ** ** | **Aaa**         | ** ** | **Aa**                      | ** ** | **A**           | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------|------------|-----------------------------|------------|-----------------|------------|
| **($ in  millions)**                                                        | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
|                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| U.S. government and agencies                                                     |       | $               | 3,567      |                        | $          | 334             |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Municipal                                                                        |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Tax exempt                                                                       |       | —          |       | —                      |       | 30              |       | 2 |   | 1 |   | — |   |
| Taxable                                                                          |       | 144             |       | 7                           |       | 2,540           |       | 66 |   | 1,302 |   | (27 | ) |
| Auction rate securities (“ARS”)                                        |       | 415             |       | (22                         | )          | 27              |       | (4 | ) | 39 |   | (7 | ) |
|                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Corporate                                                                        |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Public                                                                           |       | 957             |       | 32                          |       | 1,742           |       | 92 |   | 4,948 |   | 373 |   |
| Privately placed                                                                 |       | 791             |       | 42                          |       | 1,466           |       | 79 |   | 3,158 |   | 180 |   |
| Hybrid                                                                           |       | 33              |       | 3                           |       | 33              |       | 6 |   | 499 |   | (94 | ) |
|                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Foreign government                                                               |       | 1,444           |       | 260                         |       | 149             |       | 5 |   | 375 |   | 39 |   |
|                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| RMBS                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| U.S. government sponsored entities (“U.S. Agency”)                     |       | 2,550           |       | 123                         |       | —          |       | — |   | — |   | — |   |
| Prime residential mortgage-backed securities  (“Prime”)                |       | 445             |       | (7                          | )          | 81              |       | (8 | ) | 172 |   | (3 | ) |
| Alt-A residential mortgage-backed securities  (“Alt-A”)                |       | 35              |       | (1                          | )          | 51              |       | (8 | ) | 107 |   | (6 | ) |
| Subprime residential mortgage-backed securities  (“Subprime”)          |       | 55              |       | (3                          | )          | 245             |       | (97 | ) | 126 |   | (45 | ) |
|                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| CMBS                                                                             |       | 1,245           |       | (10                         | )          | 230             |       | (44 | ) | 265 |   | (125 | ) |
|                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| ABS                                                                              |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Collateralized debt obligations (“CDO”)                                |       | 8               |       | (1                          | )          | 468             |       | (21 | ) | 428 |   | (94 | ) |
| Consumer and other asset-backed securities  (“Consumer and other ABS”) |       | 282             |       | 5                           |       | 158             |       | — |   | 174 |   | (7 | ) |
|                                                                             |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Redeemable preferred stock                                                       |       | —          |       | —                      |       | —          |       | — |   | — |   | — |   |
| Total fixed income securities                                                    |       | $               | 11,971     |                        | $          | 762             |       | $ | 7,220 |   | $ | 68 |   | $ | 11,594 |   | $ | 184 |   |

 
| ** **                    | ** ** | **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  |       | $               | —     |                        | $          | —          |       | $ | — |   | $ | — |   | $ | 3,567 |   | $ | 334 |   |
|                          |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Municipal                     |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Tax exempt                    |       | 31              |       | 2                           |       | —          |       | — |   | 62 |   | 4 |   |
| Taxable                       |       | 546             |       | (80                         | )          | 75              |       | (55 | ) | 4,607 |   | (89 | ) |
| ARS                           |       | 32              |       | (5                          | )          | 12              |       | (3 | ) | 525 |   | (41 | ) |
|                          |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Corporate                     |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Public                        |       | 6,763           |       | 421                         |       | 679             |       | (17 | ) | 15,089 |   | 901 |   |
| Privately placed              |       | 5,927           |       | 172                         |       | 875             |       | 9 |   | 12,217 |   | 482 |   |
| Hybrid                        |       | 449             |       | (100                        | )          | 132             |       | (14 | ) | 1,146 |   | (199 | ) |
|                          |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Foreign government            |       | 327             |       | 15                          |       | 6               |       | 1 |   | 2,301 |   | 320 |   |
|                          |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| RMBS                          |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| U.S. Agency                   |       | —          |       | —                      |       | —          |       | — |   | 2,550 |   | 123 |   |
| Prime                         |       | 8               |       | —                      |       | 245             |       | (12 | ) | 951 |   | (30 | ) |
| Alt-A                         |       | 31              |       | (7                          | )          | 227             |       | (70 | ) | 451 |   | (92 | ) |
| Subprime                      |       | 48              |       | (15                         | )          | 542             |       | (421 | ) | 1,016 |   | (581 | ) |
|                          |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| CMBS                          |       | 173             |       | (181                        | )          | 122             |       | (193 | ) | 2,035 |   | (553 | ) |
|                          |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| ABS                           |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| CDO                           |       | 238             |       | (97                         | )          | 388             |       | (181 | ) | 1,530 |   | (394 | ) |
| Consumer and other ABS        |       | 175             |       | (7                          | )          | 20              |       | (5 | ) | 809 |   | (14 | ) |
|                          |       |            |       |                        |       |            |       |   |   |   |   |   |   |
| Redeemable preferred stock    |       | 14              |       | —                      |       | 1               |       | — |   | 15 |   | — |   |
| Total fixed income securities |       | $               | 14,762     |                        | $          | 118             |       | $ | 3,324 |   | $ | (961 | ) | $ | 48,871 |   | $ | 171 |   |

 

51

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*Municipal Bonds,* including tax exempt, taxable and ARSsecurities, totaled $5.19 billion as of June 30, 2010 with an unrealizednet capital loss of $126 million. Taxable municipal bonds have an unrealized net capital loss of $89million resulting primarily from wider credit spreads than at initial purchase,which is largely due to the deterioration of state and municipal marketconditions which continue to persist in 2010, as well as issuer-specificconditions.

 

Included in our municipal bond holdings at June 30, 2010 are $57million of municipal securities which are not rated by third party creditrating agencies, but are rated by the National Association of InsuranceCommissioners (“NAIC”) and are also internally rated.  These holdings include $7 million of belowinvestment grade municipal bonds that provide the opportunity to achieveincremental returns.  Our initialinvestment decisions and ongoing monitoring procedures for these securities arebased on a thorough due diligence process which includes, but is not limitedto, an assessment of the credit quality, sector, structure, and liquidity risksof each issue.

 

As of June 30, 2010, 37.7% or $1.96 billion of our municipal bondportfolio is insured by six bond insurers and 39.1% of these securities have acredit rating of Aaa or Aa.  61.0% of ourinsured municipal bond portfolio was insured by National Public FinanceGuarantee Corporation, Inc., 19.9% by Assured Guaranty MunicipalCorporation, 14.8% by Ambac Assurance Corporation and 1.9% by SyncoraHoldings.  Given the effects of theeconomic crisis on bond insurers in recent years, the value inherent in thisinsurance has declined.  We believe the fair value of our insuredmunicipal bond portfolio substantially reflects the decline in the value of theinsurance, and further related valuation declines, if any, are not expected tobe material.  While the valuation of these holdings may be temporarilyimpacted by negative market developments, we expect to receive all of thecontractual cash flows because our practices for acquiring and monitoringmunicipal bonds are predominantly based on the underlying credit quality of theprimary obligor.

 

*Corporate bonds,* including publicly traded, privately placedand hybrid securities, totaled $28.45 billion as of June 30, 2010 with anunrealized net capital gain of $1.18 billion. Privately placed securities primarily consist of corporate issued seniordebt securities that are in unregistered form or are directly negotiated with theborrower.  49.6% of the privately placedcorporate securities in our portfolio are rated by an independent rating agencyand substantially all are rated by the NAIC.

 

The following table shows details of our hybrid securities as of June 30,2010.

 
| ** **                      | ** ** | **Public**      | ** ** | **Privately placed**        | ** ** | **Total**       | ** ** |
|---------------------------------|------------|-----------------|------------|-----------------------------|------------|-----------------|------------|
| **($ in  millions)**       | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
| United Kingdom (“UK”) |       | $               | 70         |                        | $          | (12             | )          | $ | 48 |   | $ | (6 | ) | $ | 118 |   | $ | (18 | ) |
| Europe (non-UK)                 |       | 159             |       | (2                          | )          | 260             |       | (59 | ) | 419 |   | (61 | ) |
| Asia/Australia                  |       | 11              |       | —                      |       | 112             |       | (11 | ) | 123 |   | (11 | ) |
| North America                   |       | 301             |       | (63                         | )          | 185             |       | (46 | ) | 486 |   | (109 | ) |
| Total                           |       | $               | 541        |                        | $          | (77             | )          | $ | 605 |   | $ | (122 | ) | $ | 1,146 |   | $ | (199 | ) |

 

Hybridsecurities have attributes most similar to those of fixed income securitiessuch as stated interest rates and mandatory redemption dates.  Additionally, some hybrids may have aninterest rate step-up feature which is intended to incent the issuer to redeemthe security at a specified call date. While hybrid securities are generally issued by investment grade-ratedfinancial institutions, they have structural features, such as the ability todefer principal and interest payments, which make them more sensitive to creditmarket deterioration.  $955 million ofour hybrid securities with $194 million of unrealized net capital losses areTier 1 securities, and $191 million with $5 million of unrealized net capitallosses are Tier 2 securities.  Tier 1securities are lower in the capital structure 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 from the collateral paid to the securitization trust are generallyapplied in a pre-determined order and are designed so that each security issuedby the trust, typically referred to as a “class”, qualifies for a specificoriginal rating.  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 by

 

52

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classeswith lower original ratings.  Thecollateral can have fixed interest rates, variable interest rates (such asadjustable rate mortgages (“ARM”)) or may contain features of both fixed andvariable rate mortgages.

 

*RMBS*, including U.S. Agency, Prime, Alt-A and Subprime,totaled $4.97 billion, with 79.6% rated investment grade, at June 30,2010.  The RMBS portfolio is subject tointerest rate risk, but unlike other fixed income securities, is additionallysubject to significant prepayment risk from the underlying residential mortgageloans.  The credit risk associated withour RMBS portfolio is mitigated due to the fact that 51.3% of the portfolioconsists of securities that were issued by or have underlying collateralguaranteed by U.S. government agencies. The unrealized net capital loss of $580 million at June 30, 2010was the result of wider credit spreads than at initial purchase on the non-U.S.Agency portion of our RMBS portfolio, largely due to increased risk premiumscaused by macroeconomic conditions and credit market deterioration, includingthe impact of real estate valuations, which continue to persist in 2010.  The following table shows our RMBS portfolioat June 30, 2010, based upon vintage year of the issuance of thesecurities.

 
| ** **               | ** ** | **U.S.  Agency** | ** ** | **Prime**                   | ** ** | **Alt-A**       | ** ** | **Subprime**                | ** ** | **Total  RMBS** | ** ** |
|--------------------------|------------|------------------|------------|-----------------------------|------------|-----------------|------------|-----------------------------|------------|-----------------|------------|
| **($ in millions)** | ** ** | **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)** | ** ** |
| 2010                     |       | $                | —     |                        | $          | —          |       | $                           | 180        |            | $          | (2 | ) | $ | 60 |   | $ | — |   | $ | — |   | $ | — |   | $ | 240 |   | $ | (2 | ) |
| 2009                     |       | 523              |       | 14                          |       | 56              |       | —                      |       | 10              |       | — |   | — |   | — |   | 589 |   | 14 |   |
| 2008                     |       | 366              |       | 13                          |       | —          |       | —                      |       | —          |       | — |   | — |   | — |   | 366 |   | 13 |   |
| 2007                     |       | 101              |       | 4                           |       | 136             |       | (4                          | )          | 35              |       | (18 | ) | 307 |   | (224 | ) | 579 |   | (242 | ) |
| 2006                     |       | 135              |       | 7                           |       | 158             |       | (8                          | )          | 63              |       | (12 | ) | 251 |   | (161 | ) | 607 |   | (174 | ) |
| 2005                     |       | 336              |       | 17                          |       | 142             |       | (13                         | )          | 123             |       | (32 | ) | 257 |   | (125 | ) | 858 |   | (153 | ) |
| Pre-2005                 |       | 1,089            |       | 68                          |       | 279             |       | (3                          | )          | 160             |       | (30 | ) | 201 |   | (71 | ) | 1,729 |   | (36 | ) |
| Total                    |       | $                | 2,550      |                        | $          | 123             |       | $                           | 951        |            | $          | (30 | ) | $ | 451 |   | $ | (92 | ) | $ | 1,016 |   | $ | (581 | ) | $ | 4,968 |   | $ | (580 | ) |

 

Prime are collateralized by residential mortgage loans issued to primeborrowers.  As of June 30, 2010,$787 million of the Prime were fixed rate and $164 million were variable rate.

 

Alt-A includes securities collateralized by residential mortgage loansissued to borrowers who do not qualify for prime financing terms due to highloan-to-value ratios or limited supporting documentation, but have strongercredit profiles than subprime borrowers. As of June 30, 2010, $370 million of the Alt-A were fixed rate and$81 million were variable rate.

 

Subprimeincludes securities that are collateralized by residential mortgage loansissued to borrowers that cannot qualify for Prime or Alt-A financing terms duein part to weak or limited credit history. It also includes securities that are collateralized by certain secondlien mortgages regardless of the borrower’s credit history.  The Subprime portfolio consisted of $823million and $191 million of first lien and second lien securities,respectively.  Subprime included $546million of fixed rate and $470 million of variable rate securities.

 

*CMBS* totaled $2.04 billion, with 94.0% rated investmentgrade, at June 30, 2010.  The CMBSportfolio is subject to credit risk, but unlike certain other structuredsecurities, is generally not subject to prepayment risk due to protectionswithin the underlying commercial mortgage loans whereby borrowers areeffectively restricted from prepaying their mortgages.  Of the CMBS investments, 96.0% aretraditional conduit transactions collateralized by commercial mortgage loans,broadly diversified across property types and geographical area.  The remainder consists of non-traditionalCMBS such as small balance transactions, large loan pools and single borrowertransactions.

 

Thefollowing table shows our CMBS portfolio at June 30, 2010 based uponvintage year.

 
| **($ in millions)** | ** ** | **Fair********value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
|--------------------------|------------|-----------------------|------------|-----------------------------|------------|
| 2007                     |       | $                     | 436        |                        | $          | (130 | ) |
| 2006                     |       | 526                   |       | (328                        | )          |
| 2005                     |       | 306                   |       | (78                         | )          |
| Pre-2005                 |       | 767                   |       | (17                         | )          |
| Total CMBS               |       | $                     | 2,035      |                        | $          | (553 | ) |

 

Theunrealized net capital loss of $553 million at June 30, 2010 on our CMBSportfolio was the result of wider credit spreads than at initial purchase,largely due to the macroeconomic conditions and credit market deterioration,including the impact of real estate valuations, which continue to persist in2010.  While CMBS spreads tightenedduring 2009 and 2010, credit spreads in most rating classes remain wider thanat initial purchase, which is 

 

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particularlyevident in our 2005-2007 vintage year and non-traditional CMBS.  These holdings accounted for $536 million, or96.9%, of the unrealized net capital loss.

 

*ABS,* including CDO and Consumer and other ABS, totaled$2.34 billion, with 82.6% rated investment grade, at June 30, 2010.  Credit risk is managed by monitoring theperformance of the collateral.  Inaddition, many of the securities in the ABS portfolio are credit enhanced withfeatures such as overcollateralization, subordinated structures, reserve funds,guarantees and/or insurance.  The unrealizednet capital loss of $408 million at June 30, 2010 on our ABS portfolio wasthe result of wider credit spreads than at initial purchase.

 

CDOtotaled $1.53 billion, with 74.6% rated investment grade, at June 30,2010.  CDO consist primarily of obligationscollateralized by high yield and investment grade corporate credits including$1.21 billion of cash flow collateralized loan obligations (“CLO”) and $92million of synthetic CDO with unrealized losses of $202 million and $84million, respectively.  The remaining$227 million of securities consisted of trust preferred CDO, market value CDO,project finance CDO, collateralized bond obligations and other CLO withunrealized losses of $108 million.

 

Cash flow CLO are structures collateralized primarily by belowinvestment grade senior secured corporate loans.  Thecollateral is actively managed by external managers that monitor the collateralperformance.  The underlying collateralis well diversified across industries and among issuers.  A transaction will typically issuenotes with various capital structure classes (i.e. Aaa, Aa, A, etc.) aswell as equity-like tranches.  Ingeneral, these securities are structured with overcollateralization ratios andperformance is impacted by downgrades, defaults and recoveries of theunderlying collateral within the structures. Downgrades of underlying collateral, along with increased defaults,reduce overcollateralization ratios over time. A violation of the senior overcollateralization test could result in anevent of default of the structure.  Thiswould give the controlling class, defined as the majority of the seniorlenders, certain rights which could include diverting cash flows or liquidatingthe underlying portfolio to pay off the senior liabilities.

 

Synthetic CDO primarilyconsist of a portfolio of corporate credit default swaps (“CDS”) which arecollateralized by Aaa, Aa and A rated LIBOR-based securities (i.e. “fullyfunded” synthetic CDO).  Oursynthetic CDO collateral primarily is actively managed by external managersmonitoring the CDS selection and performance.

 

Consumer and other ABS totaled $809 million, with 97.5% ratedinvestment grade, at June 30, 2010. Consumer and other ABS consists of $398 million of auto and $411 millionof other ABS securities with unrealized gains of $4 million for auto andunrealized losses of $18 million for other ABS securities.

 

**Mortgage loans**  Our mortgageloan portfolio totaled $7.04 billion at June 30, 2010, compared to$7.78 billion at December 31, 2009, and primarily comprise loans securedby first mortgages on developed commercial real estate.  Key considerations used to manage ourexposure include property type and geographic diversification.  Our exposure to any metropolitan area ishighly diversified, with the largest exposure not exceeding 9.9% of theportfolio.  The portfolio is alsodiversified across several property types, with the largest concentrations of34.0% in office buildings and 25.6% in retail property.  Debt service coverage ratio represents the amountof cash flows from the property available to the borrower to meet principal andinterest payment obligations.  For fixedrate mortgage loans, which comprise 90.7% and 89.9% of the total portfolio at June 30,2010 and December 31, 2009, respectively, the average debt servicecoverage ratios as of June 30, 2010 and December 31, 2009 were 1.6and 1.7, respectively.  Mortgage loanswith debt service coverage ratios below 1.0 generally have a higher level ofrisk.  5.9% of the mortgage loanportfolio had a debt service coverage ratio under 1.0 as of June 30, 2010compared to 5.8% as of December 31, 2009. As of June 30, 2010, 30.3% or $125 million of these loans areimpaired and have valuation allowances totaling $62 million compared to 18.7%totaling $26 million as of December 31, 2009.  Mortgage loans with debt service coveragebelow 1.0 which are not impaired primarily relate to instances where theborrower has the financial capacity to fund the revenue shortfalls from theproperties for the foreseeable term, the decrease in occupancy is consideredtemporary, or there are other risk mitigating circumstances such as additionalcollateral, escrow balances or borrower guarantees.

 

Inthe first six months of 2010, $494 million of commercial mortgage loanswere contractually due.  Of these, 26%were paid as due, 10% were extended, 58% were refinanced for an average of sixyears at market rates using our standard underwriting criteria and 6% wereforeclosed or in the process of foreclosure. In addition, $329 million that were not contractually due in the firstsix months of 2010 were paid in full.  Wehave eight additional loans totaling $81 million in the process of foreclosurethat were not contractually due in the first six months of 2010.  In 

 

54

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total,we have ten loans totaling $109 million in the process of foreclosure,reflecting an increase from five loans totaling $49 million as of December 31,2009.

 

Thenet carrying value of impaired loans at June 30, 2010 andDecember 31, 2009 was $245 million and $377 million,respectively.  Total valuation allowancesof $97 million were held on impaired loans at June 30, 2010, compared to$94 million at December 31, 2009. We recognized $28 million and $41 million of realized capitallosses related to net increases in the valuation allowances on impaired loansfor the three months and six months ended June 30, 2010,respectively.  The net increases in bothperiods were primarily due to deteriorating debt service coverage resultingfrom a decrease in occupancy and the risk associated with refinancing near-termmaturities due to declining collateral valuations.  Realized capital losses recognized onmortgage loans held for sale totaled $6 million for the six months ended June 30,2010.  There were no realized capitallosses recognized on mortgage loans held for sale for the three months ended June 30,2010.

 

**Limited partnership interests** consist of investments inprivate equity/debt funds, real estate funds and hedge funds.  The overall limited partnership interestsportfolio is well diversified across a number of characteristics including fundsponsors, vintage years, strategies, geography (including international), andcompany/property types.  The followingtable presents information about our limited partnership interests as of June 30,2010.

 
| **($ in millions)**                       | ** ** | **Private  equity/debt  funds** | ** ** | **Real estate  funds** | ** ** | **Hedge  funds** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|------------------------|------------|------------------|------------|-----------|------------|
| Cost method of  accounting (“Cost”)  |       | $                               | 469        |                   | $          | 121              |       | $         | —     |   | $ | 590 |   |
| Equity method of  accounting (“EMA”) |       | 354                             |       | 112                    |       | 8                |       | 474       |       |
| Total                                          |       | $                               | 823        |                   | $          | 233              |       | $         | 8          |   | $ | 1,064 |   |
|                                           |       |                            |       |                   |       |             |       |      |       |
| Number of sponsors                             |       | 74                              |       | 30                     |       | 1                |       |      |       |
| Number of individual  funds                    |       | 114                             |       | 57                     |       | 2                |       |      |       |
| Largest exposure to  single fund               |       | $                               | 22         |                   | $          | 16               |       | $         | 7          |   |   |   |

 

Ouraggregate limited partnership exposure represented 1.8% and 1.7% of totalinvested assets as of June 30, 2010 and December 31, 2009,respectively.

 

The following table showsthe results from our limited partnership interests by fund type and accountingclassification.

 
| ** **                | ** ** | **Three months ended  June 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **($ in  millions)** | ** ** | **Cost**                              | ** ** | **EMA** | ** ** | **Total  income** | ** ** | **Impairment  write-downs (1)** | ** ** | **Cost** | ** ** | **EMA** | ** ** | **Total  income** | ** ** | **Impairment  write-downs (1)** | ** ** |
| Private equity/debt funds |       | $                                     | 4          |   | $ | 10 |   | $ | 14 |   | $ | — |   | $ | 2 |   | $ | (12 | ) | $ | (10 | ) | $ | (4 | ) |
| Real estate funds         |       | —                                |       | (3 | ) | (3 | ) | (5 | ) | — |   | (23 | ) | (23 | ) | (17 | ) |
| Hedge funds               |       | —                                |       | 1 |   | 1 |   | — |   | — |   | 2 |   | 2 |   | — |   |
| Total                     |       | $                                     | 4          |   | $ | 8 |   | $ | 12 |   | $ | (5 | ) | $ | 2 |   | $ | (33 | ) | $ | (31 | ) | $ | (21 | ) |

 
| ** **                | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------|------------|-------------------------------------|------------|
| ** **                | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| ** **                | ** ** | **Cost**                            | ** ** | **EMA** | ** ** | **Total  income** | ** ** | **Impairment  write-downs (1)** | ** ** | **Cost** | ** ** | **EMA** | ** ** | **Total  income** | ** ** | **Impairment  write-downs (1)** | ** ** |
| Private equity/debt funds |       | $                                   | 7          |   | $ | 19 |   | $ | 26 |   | $ | (2 | ) | $ | 4 |   | $ | (45 | ) | $ | (41 | ) | $ | (41 | ) |
| Real estate funds         |       | —                              |       | (21 | ) | (21 | ) | (14 | ) | — |   | (66 | ) | (66 | ) | (74 | ) |
| Hedge funds               |       | —                              |       | 6 |   | 6 |   | — |   | — |   | 1 |   | 1 |   | — |   |
| Total                     |       | $                                   | 7          |   | $ | 4 |   | $ | 11 |   | $ | (16 | ) | $ | 4 |   | $ | (110 | ) | $ | (106 | ) | $ | (115 | ) |

 

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(1)       Impairment write-downsrelated to Cost limited partnerships were $4 million and $15 million in thethree months and six months ended June 30, 2010, respectively, compared to$21 million and $110 million in the three months and six months ended June 30,2009, respectively.  Impairmentwrite-downs related to EMA limited partnerships were $1 million in both thethree months and six months ended June 30, 2010 compared to $5 million inthe six months ended June 30, 2009. There were no impairment write-downs related to EMA limited partnershipsin the three months ended June 30, 2009.

 

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Limited partnershipinterests, excluding impairment write-downs, produced income of $12 million and$11 million in the three months and six months ended June 30, 2010compared to losses of $31 million and $106 million in the three months and sixmonths ended June 30, 2009.  Incomeon EMA limited partnerships is recognized on a delay due to the availability ofthe related financial statements.  Therecognition of income on hedge funds is primarily on a one-month delay and theincome recognition on private equity/debt funds and real estate funds aregenerally on a three-month delay.  Incomeon Cost limited partnerships is recognized only upon cash distributions by thepartnership.

 

**Unrealized net capital gains** totaled $189 million as of June 30,2010 compared to unrealized net capital losses of $2.18 billion as of December 31,2009.  The improvement since December 31,2009 for fixed income securities was primarily a result of declining risk-freeinterest rates.  The decline since December 31,2009 for equity securities was a result of declines in equity markets over theperiod.  The following table presentsunrealized net capital gains and losses, pre-tax and after-tax.

 
| **($ in millions)**                           | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------|------------|
| U.S. government and  agencies                      |       | $                       | 334        |                     | $          | 157                         |       | $ | 155 |   |
| Municipal                                          |       | (126                    | )          | (347                     | )          | (469                        | )          |
| Corporate                                          |       | 1,184                   |       | 728                      |       | 225                         |       |
| Foreign government                                 |       | 320                     |       | 263                      |       | 247                         |       |
| RMBS                                               |       | (580                    | )          | (770                     | )          | (930                        | )          |
| CMBS                                               |       | (553                    | )          | (766                     | )          | (922                        | )          |
| ABS                                                |       | (408                    | )          | (398                     | )          | (489                        | )          |
| Redeemable preferred stock                         |       | —                  |       | —                   |       | (1                          | )          |
| Fixed income securities (1)                        |       | 171                     |       | (1,133                   | )          | (2,184                      | )          |
| Equity securities                                  |       | 11                      |       | 44                       |       | 24                          |       |
| Short-term investments                             |       | —                  |       | —                   |       | —                      |       |
| Derivatives                                        |       | 7                       |       | (13                      | )          | (18                         | )          |
| Unrealized net capital gains and losses, pre-tax   |       | 189                     |       | (1,102                   | )          | (2,178                      | )          |
| Amounts recognized for:                            |       |                    |       |                     |       |                        |       |
| Insurance reserves (2)                             |       | (292                    | )          | —                   |       | —                      |       |
| DAC and DSI (3)                                    |       | 406                     |       | 727                      |       | 990                         |       |
| Amounts recognized                                 |       | 114                     |       | 727                      |       | 990                         |       |
| Deferred income taxes                              |       | (111                    | )          | 126                      |       | 411                         |       |
| Unrealized net capital gains and losses, after-tax |       | $                       | 192        |                     | $          | (249                        | )          | $ | (777 | ) |

 

----

| (1)     Unrealized  net capital gains and losses for fixed income securities as of June 30,  2010, March 31, 2010 and December 31, 2009 comprise $(319) million,  $(376) million and $(422) million, respectively, related to unrealized net  capital losses on fixed income securities with other-than-temporary  impairment and $490 million, $(757) million and $(1,762) million,  respectively, related to other unrealized net capital gains and losses.

 

(2)     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 we  evaluate 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.

 

(3)     The DAC and  DSI adjustment balance represents the amount by which the amortization of DAC  and DSI would increase or decrease if the unrealized gains or losses in the  respective product portfolios were realized.   Only the unrealized net capital gains and losses on the fixed annuity  and interest-sensitive life product portfolios are used in this calculation.  The reduction in unrealized net capital  losses in the first and second quarter of 2010 for these product portfolios  was less than the reduction in unrealized net capital losses for the total  portfolio.  The DAC and DSI adjustment  balance, subject to limitations, is determined by applying the DAC and DSI  amortization rate to unrealized net capital gains or losses.  Recapitalization of the DAC and DSI  balances is limited to the originally deferred costs plus interest.

  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

Thenet unrealized gains for the fixed income portfolio totaled $171 million andcomprised $2.72 billion of gross unrealized gains and $2.55 billion of grossunrealized losses at June 30, 2010. This is compared to a net unrealized loss for the fixed income portfoliototaling $2.18 billion and comprised $1.65 billion of gross unrealized gainsand $3.83 billion of gross unrealized losses at December 31, 2009.

 

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Gross unrealized gains and losses as of June 30, 2010 on fixedincome securities by type and sector are provided in the table below.

 
| ** **                                 | ** ** | **Par**       | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | **Fair**   | ** ** | **Amortized  cost as a  percent of** | ** ** | **Fair value  as a  percent of** | ** ** |
|--------------------------------------------|------------|---------------|------------|---------------|------------|----------------------|------------|------------|------------|--------------------------------------|------------|----------------------------------|------------|
| **($ in  millions)**                  | ** ** | **value (1)** | ** ** | **cost**      | ** ** | **Gains**            | ** ** | **Losses** | ** ** | **value**                            | ** ** | **par value (2)**                | ** ** | **par value (2)** | ** ** |
| Corporate:                                 |       |          |       |          |       |                 |       |       |       |                                 |       |                             |       |   |   |
| Banking                                    |       | $             | 3,280      |          | $          | 3,166                |       | $          | 87         |                                 | $          | (217                             | )          | $ | 3,036 |   | 96.5 | % | 92.6 | % |
| Financial services                         |       | 2,527         |       | 2,501         |       | 105                  |       | (44        | )          | 2,562                                |       | 99.0                             |       | 101.4 |   |
| Consumer goods (cyclical and non-cyclical) |       | 4,245         |       | 4,283         |       | 285                  |       | (38        | )          | 4,530                                |       | 100.9                            |       | 106.7 |   |
| Transportation                             |       | 1,437         |       | 1,453         |       | 97                   |       | (33        | )          | 1,517                                |       | 101.1                            |       | 105.6 |   |
| Utilities                                  |       | 5,423         |       | 5,436         |       | 443                  |       | (32        | )          | 5,847                                |       | 100.2                            |       | 107.8 |   |
| Energy                                     |       | 1,759         |       | 1,776         |       | 100                  |       | (20        | )          | 1,856                                |       | 101.0                            |       | 105.5 |   |
| Capital goods                              |       | 3,027         |       | 3,028         |       | 218                  |       | (19        | )          | 3,227                                |       | 100.0                            |       | 106.6 |   |
| Basic industry                             |       | 1,306         |       | 1,322         |       | 74                   |       | (12        | )          | 1,384                                |       | 101.2                            |       | 106.0 |   |
| Communications                             |       | 1,589         |       | 1,591         |       | 93                   |       | (10        | )          | 1,674                                |       | 100.1                            |       | 105.3 |   |
| Technology                                 |       | 905           |       | 916           |       | 61                   |       | (7         | )          | 970                                  |       | 101.2                            |       | 107.2 |   |
| FDIC guaranteed                            |       | 635           |       | 638           |       | 13                   |       | —     |       | 651                                  |       | 100.5                            |       | 102.5 |   |
| Other                                      |       | 1,284         |       | 1,158         |       | 57                   |       | (17        | )          | 1,198                                |       | 90.2                             |       | 93.3 |   |
| Total corporate fixed income portfolio     |       | 27,417        |       | 27,268        |       | 1,633                |       | (449       | )          | 28,452                               |       | 99.5                             |       | 103.8 |   |
|                                       |       |          |       |          |       |                 |       |       |       |                                 |       |                             |       |   |   |
| U.S. government and agencies               |       | 3,935         |       | 3,233         |       | 334                  |       | —     |       | 3,567                                |       | 82.2                             |       | 90.6 |   |
| Municipal                                  |       | 8,750         |       | 5,320         |       | 178                  |       | (304       | )          | 5,194                                |       | 60.8                             |       | 59.4 |   |
| Foreign government                         |       | 2,418         |       | 1,981         |       | 326                  |       | (6         | )          | 2,301                                |       | 81.9                             |       | 95.2 |   |
| RMBS                                       |       | 5,945         |       | 5,548         |       | 139                  |       | (719       | )          | 4,968                                |       | 93.3                             |       | 83.6 |   |
| CMBS                                       |       | 2,649         |       | 2,588         |       | 45                   |       | (598       | )          | 2,035                                |       | 97.7                             |       | 76.8 |   |
| ABS                                        |       | 3,137         |       | 2,747         |       | 61                   |       | (469       | )          | 2,339                                |       | 87.6                             |       | 74.6 |   |
| Redeemable preferred stock                 |       | 20            |       | 15            |       | —               |       | —     |       | 15                                   |       | 75.0                             |       | 75.0 |   |
| Total fixed income securities              |       | $             | 54,271     |          | $          | 48,700               |       | $          | 2,716      |                                 | $          | (2,545                           | )          | $ | 48,871 |   | 89.7 |   | 90.0 |   |

 

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(1) Included in parvalue are zero-coupon securities that are generally purchased at a deepdiscount to the par value that is received at maturity.  These primarily included corporate,municipal, foreign government and U.S. government and agencies zero-couponsecurities with par value of $852 million, $4.71 billion, $1.19 billion and$1.65 billion, respectively.

 

(2) Excluding theimpact of zero-coupon securities, the percentage of amortized cost to par valuewould be 100.1% for corporates, 99.0% for municipals, 104.4% for foreigngovernments and 103.6% for U.S. government and agencies.  Similarly, excluding the impact ofzero-coupon securities, the percentage of fair value to par value would be104.4% for corporates, 100.3% for municipals, 110.7% for foreign governmentsand 108.4% for U.S. government and agencies.

 

Thebanking, financial services, consumer goods, transportation and utilitiessectors had the highest concentration of gross unrealized losses in ourcorporate fixed income securities portfolio at June 30, 2010.  In general, credit spreads remain wider thanat initial purchase for most of the securities in these categories.

 

The net unrealized gain for the equity portfolio totaled $11 millionand comprised $19 million of gross unrealized gains and $8 million of grossunrealized losses at June 30, 2010. This is compared to a net unrealized gain for the equity portfoliototaling $24 million, comprised of $31 million of gross unrealized gains and $7million of gross unrealized losses at December 31, 2009.  Within the equity portfolio, the losses werein the financial services and banking sectors. The unrealized losses in these sectors were company and sector specific.  As of June 30, 2010, we have the intentand ability to hold our equity securities with unrealized losses untilrecovery.

 

We have a comprehensive portfolio monitoring process to identify andevaluate each fixed income and equity security whose carrying value may beother-than-temporarily impaired.  The processincludes a quarterly review of all securities through a screening process whichidentifies instances where the fair value compared to amortized cost (for fixedincome securities) and cost (for equity securities) is below establishedthresholds.  The screening process alsoincludes the monitoring of other criteria such as ratings, ratings downgradesand payment defaults.  The securitiesidentified, in addition to other securities for which we may have a concern, areevaluated based on facts and circumstances for inclusion on ourwatch-list.  All investments in anunrealized loss position at June 30, 2010 were included in our portfoliomonitoring process for determining whether declines in value were other thantemporary.

 

Theextent and duration of a decline in fair value have become less indicative ofactual credit deterioration with respect to an issue or issuer.  While we continue to use declines in fairvalue and the length of time a security is in an unrealized loss position asindicators of potential credit deterioration, our determination of whether asecurity’s decline in fair value is other than temporary has placed greateremphasis on our analysis of the underlying credit and collateral.

 

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Thefollowing table summarizes the fair values and gross unrealized losses of fixedincome securities by type and investment grade classification as of June 30,2010.

 
| ** **                 | ** ** | **Investment grade** | ** ** | **Below investment grade** | ** ** | **Total**       | ** ** |
|----------------------------|------------|----------------------|------------|----------------------------|------------|-----------------|------------|
| **($ in  millions)**  | ** ** | **Fair  value**      | ** ** | **Unrealized  losses**     | ** ** | **Fair  value** | ** ** | **Unrealized  losses** | ** ** | **Fair  value** | ** ** | **Unrealized  losses** | ** ** |
| Municipal                  |       | $                    | 1,762      |                       | $          | (246            | )          | $ | 76 |   | $ | (58 | ) | $ | 1,838 |   | $ | (304 | ) |
| Corporate                  |       | 4,218                |       | (368                       | )          | 793             |       | (81 | ) | 5,011 |   | (449 | ) |
| Foreign government         |       | 128                  |       | (6                         | )          | —          |       | — |   | 128 |   | (6 | ) |
| RMBS                       |       | 1,085                |       | (205                       | )          | 834             |       | (514 | ) | 1,919 |   | (719 | ) |
| CMBS                       |       | 1,109                |       | (404                       | )          | 118             |       | (194 | ) | 1,227 |   | (598 | ) |
| ABS                        |       | 1,178                |       | (250                       | )          | 345             |       | (219 | ) | 1,523 |   | (469 | ) |
| Redeemable preferred stock |       | 14                   |       | —                     |       | —          |       | — |   | 14 |   | — |   |
| Total                      |       | $                    | 9,494      |                       | $          | (1,479          | )          | $ | 2,166 |   | $ | (1,066 | ) | $ | 11,660 |   | $ | (2,545 | ) |

 

Wehave experienced declines in the fair values of fixed income securitiesprimarily due to wider credit spreads resulting from larger risk premiums sincethe time of initial purchase, largely due to macroeconomic conditions andcredit market deterioration, including the impact of declining residential andcommercial real estate valuations, which continue to persist in 2010.  Consistent with their ratings, our portfoliomonitoring process indicates that investment grade securities have a relativelylow risk of default.  Securities ratedbelow investment grade, comprising securities with a rating of Ba, B and Caa orlower, have a higher default risk.

 

Asof June 30, 2010, our below investment grade gross unrealized losses wereprimarily concentrated in RMBS, specifically Alt-A and Subprime, CMBS andABS.  Gross unrealized losses on thesesecurities as of June 30, 2010 totaled $910 million.

 

Fairvalues for our structured securities are obtained from third-party valuationservice providers and are subject to review as disclosed in our Application ofCritical Accounting Estimates.  Inaccordance with GAAP, when fair value is less than the amortized cost of asecurity and we have not made the decision to sell the security and it is notmore likely than not we will be required to sell the security before recoveryof its amortized cost basis, we evaluate if we expect to receive cash flowssufficient to recover the entire amortized cost basis of the security bycomparing the estimated recovery value, calculated by discounting our best estimateof future cash flows at the security’s original or current effective rate, asappropriate, to the amortized cost of the security.  If the Company does not expect to receivecash flows sufficient to recover the entire amortized cost basis of thesecurity, the credit loss component of the impairment is recorded in earnings,with the remaining amount of the unrealized loss related to other factors (“non-credit-related”)recognized in other comprehensive income.

 

Thenon-credit-related unrealized losses for our structured securities, includingour below investment grade Alt-A, Subprime, CMBS and ABS, are heavilyinfluenced by risk factors other than those related to our best estimate offuture cash flows.  The differencebetween these securities’ original or current effective rates and the yieldsimplied by their fair value indicates that a larger risk premium is included inthe valuation of these securities than existed at initial issue orpurchase.  This higher risk premiumrepresents the return that a market participant requires as compensation toassume the risk associated with the uncertainties regarding the futureperformance of the underlying commercial and residential real estatecollateral.  The risk premium is comprisedof: default risk, which reflects the increased probability of default and theuncertainty related to collection of contractual principal and interest;liquidity risk, which reflects the risk associated with exiting the investmentin an illiquid market, both in terms of timeliness and cost; and volatilityrisk, which reflects the potential valuation volatility during an investor’sholding period.  Other factors reflectedin the risk premium include the costs associated with underwriting, monitoringand holding these types of complex securities. Certain aspects of the default risk are included in the development ofour best estimate of future cash flows, as appropriate.  Other aspects of the risk premium are consideredto be temporary in nature and are expected to reverse over the remaining livesof the securities as our future cash flows are received.

 

*Other-than-temporaryimpairment assessment for below investment grade Alt-A and Subprime RMBS*

 

Grossunrealized losses for our below investment grade Alt-A and Subprime portfoliostotaled $74 million and $423 million, respectively, while gross unrealizedgains for these portfolios totaled $4 million and $2 million, respectively, asof June 30, 2010.  For our belowinvestment grade Alt-A and Subprime securities with gross unrealized gains, we haverecognized cumulative write-downs in earnings totaling $15 million and $62million, respectively, as of June 30, 2010.

 

58

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Thecredit loss evaluation for Alt-A and Subprime securities with gross unrealizedlosses is performed in two phases.  Thefirst phase estimates the future cash flows of the entire securitization trustfrom which our security was issued.  Acritical part of this estimate involves forecasting delinquency rates and lossseverities of the residential mortgage loans that collateralize thesecuritization trust.  The factors thataffect the delinquency rates and loss severities include, but are not limitedto, collateral type, transaction vintage year, geographic concentrations,borrower credit quality, origination practices of the transaction sponsor, andpractices of the mortgage loan servicers. The delinquency rate and loss severity forecasts result in a trust-levelprojected cumulative collateral loss estimate.

 

Wethen analyze the position of the class of securities we own in thesecuritization trust relative to the trust’s other classes to determine whetherany of the projected cumulative collateral loss will be applied to ourclass.  If we have sufficient creditenhancement, measured in terms of subordination from other classes ofsecurities in the trust that are contractually obligated to absorb lossesbefore the class of security we own, no collateral losses will be realized byour class and we expect to collect all contractual principal and interest ofthe security we own.

 

Forsecurities where there is insufficient credit enhancement for the class ofsecurities we own, a second, security-specific estimate of future cash flows iscalculated.  This estimate is based onthe contractual principal and interest of the securities we own, reduced by theprojected cumulative collateral losses applied to them.  This estimate takes into considerationadditional secondary sources of credit enhancement, such as reliable bondinsurance.  For securities withoutsecondary sources of credit enhancement or for which the secondary sources donot fully offset the projected cumulative collateral losses applied to them, acredit loss is recorded in earnings to the extent amortized cost exceedsrecovery value.

 

98.6%and 1.4% of our below investment grade Alt-A securities with gross unrealizedlosses were issued with Aaa and Aa original ratings and capital structureclassifications, respectively.  86.3%,11.6% and 1.6% of our below investment grade Subprime securities with grossunrealized losses were issued with Aaa, Aa and A original ratings and capitalstructure classifications, respectively. Alt-A and Subprime securities with higher original ratings typicallyhave priority in receiving the principal repayments on the collateral comparedto those with lower original ratings. Our projected cash flow assumptions for our below investment grade Alt-Aand Subprime securities with gross unrealized losses have deteriorated sincethe securities were originated, as reflected by their current credit ratings.

 

59

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The following tables show trust-level, class-level andsecurity-specific detailed information for our below investment grade Alt-Asecurities with gross unrealized losses, by credit rating.

 
| ** **                                        | ** ** | **June 30, 2010**                                          | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                        | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Other** | ** ** | ** ** | ** ** |
| **($ in  millions)**                         | ** ** | **Ba**                                                          | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                       | ** ** | ** **                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Delinquency rates (1)                             |       | 11.2                                                            | %          | 41.4 | % | 26.6 | % | 26.5 | % | 2.8 | % | 10.8 | % | 10.0 | % | 8.9 | % | 19.6 | % |
| Cumulative collateral losses (2)                  |       | 0.3                                                             |       | 0.6 |   | 5.1 |   | 4.9 |   | 0.1 |   | 1.0 |   | 1.5 |   | 1.3 |   | 3.5 |   |
| Class-level                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement (3)          |       | 10.9                                                            |       | 19.1 |   | 5.9 |   | 6.3 |   | 5.2 |   | 25.8 |   | 8.5 |   | 8.1 |   | 7.0 |   |
| Security-specific                                 | ** ** | ** **                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Number of positions                               |       | 1                                                               |       | 1 |   | 10 |   | 12 |   | 2 |   | 1 |   | 4 |   | 7 |   | 19 |   |
| Par value                                         |       | $                                                               | 4          |   | $ | 3 |   | $ | 162 |   | $ | 169 |   | $ | 17 |   | $ | 1 |   | $ | 92 |   | $ | 110 |   | $ | 279 |   |
| Fair value                                        |       | 1                                                               |       | 1 |   | 94 |   | 96 |   | 13 |   | — |   | 65 |   | 78 |   | 174 |   |
| Gross unrealized losses                           |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | (3                                                              | )          | (1 | ) | (41 | ) | (45 | ) | (3 | ) | — |   | (26 | ) | (29 | ) | (74 | ) |
| 12-24 months (4)                                  |       | —                                                          |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Over 24 months (5)                                |       | (3                                                              | )          | (1 | ) | (41 | ) | (45 | ) | (3 | ) | — |   | (26 | ) | (29 | ) | (74 | ) |
| Cumulative write-downs recognized (6)        |       | —                                                          |       | (1 | ) | (21 | ) | (22 | ) | — |   | — |   | — |   | — |   | (22 | ) |
| Principal payments received during the period (7) |       | 2                                                               |       | — |   | 6 |   | 8 |   | 3 |   | — |   | 5 |   | 8 |   | 16 |   |
|                                                   |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                        | ** ** | **December 31, 2009**                                      | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                        | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Other** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **Ba**                                                          | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                       | ** ** | ** **                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Delinquency rates (1)                             |       | 13.1                                                            | %          | 17.6 | % | 27.0 | % | 25.6 | % | 7.1 | % | 37.8 | % | — | % | 6.8 | % | 19.1 | % |
| Cumulative collateral losses (2)                  |       | 0.2                                                             |       | 1.6 |   | 3.7 |   | 3.4 |   | 0.5 |   | 0.5 |   | 1.2 |   | 0.6 |   | 2.4 |   |
| Class-level                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement (3)          |       | 11.3                                                            |       | 8.7 |   | 7.3 |   | 7.6 |   | 7.3 |   | 19.3 |   | 4.0 |   | 7.1 |   | 7.4 |   |
| Security-specific                                 |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                               |       | 1                                                               |       | 2 |   | 8 |   | 11 |   | 4 |   | 1 |   | 1 |   | 6 |   | 17 |   |
| Par value                                         |       | $                                                               | 4          |   | $ | 19 |   | $ | 151 |   | $ | 174 |   | $ | 71 |   | $ | 3 |   | $ | 18 |   | $ | 92 |   | $ | 266 |   |
| Fair value                                        |       | 1                                                               |       | 13 |   | 82 |   | 96 |   | 45 |   | 1 |   | 13 |   | 59 |   | 155 |   |
| Gross unrealized losses                           |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | (3                                                              | )          | (6 | ) | (44 | ) | (53 | ) | (25 | ) | (3 | ) | (3 | ) | (31 | ) | (84 | ) |
| 12-24 months (4)                                  |       | (3                                                              | )          | (2 | ) | (16 | ) | (21 | ) | (18 | ) | — |   | (3 | ) | (21 | ) | (42 | ) |
| Over 24 months (5)                                |       | —                                                          |       | (4 | ) | (28 | ) | (32 | ) | (6 | ) | (3 | ) | — |   | (9 | ) | (41 | ) |
| Cumulative write-downs recognized (6)        |       | —                                                          |       | (1 | ) | (19 | ) | (20 | ) | — |   | — |   | — |   | — |   | (20 | ) |
| Principal payments received during the period (7) |       | 4                                                               |       | 3 |   | 13 |   | 20 |   | 26 |   | — |   | 3 |   | 29 |   | 49 |   |
|                                                   |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) Weighted averagedelinquency rates as of period end are based on the principal amount of loansthat are 60 days or more past due as a percentage of the remaining principalamount of the loans in the trust as reported by the servicers.  The weighting calculation is based on the parvalue of each security.

(2) Weighted averagecumulative collateral losses as of period end are based on the actual principallosses incurred as a percentage of the remaining principal amount of the loansin the trust.  The weighting calculationis based on the par value of each security. Actual losses on the securities we hold are significantly less than thelosses on the underlying collateral as presented in this table, as a majorityof the securities we hold include substantial credit enhancements.  Actual cumulative realized principal lossesreduced the par value of the below investment grade Alt-A securities we own by$3 million as of June 30, 2010.

(3) Weighted averageremaining credit enhancement as of period end is based on structuralsubordination and reflects the principal losses that can occur as a percentageof the remaining principal amount of the loans in the trust before the class ofthe security we own will incur its first dollar of principal loss.  The weighting calculation is based on the parvalue of each security.

(4) Includes total gross unrealized losses onsecurities in an unrealized loss position for a period of 12 to 24 consecutivemonths.

(5) Includes total gross unrealized losses onsecurities in an unrealized loss position for a period more than 24 consecutivemonths.  As of June 30, 2010, $18million of unrealized losses on securities with other-than-temporaryimpairments recognized in earnings and $1 million of unrealized losses on othersecurities are greater than or equal to 20% of those securities’ amortizedcost.  As of December 31, 2009,there were no Alt-A securities with gross unrealized losses greater than orequal to 20% for a period of more than 24 consecutive months.

(6) Includes cumulative write-downs recorded inaccordance with GAAP.

(7)  Reflects principal payments for the sixmonths ended June 30, 2010 or the year ended December 31, 2009,respectively.

 

60

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The above tables include information about below investment grade Alt-Asecurities with gross unrealized losses as of each period presented.  As such, the par value and composition ofsecurities included can vary significantly from period to period due to changesin variables such as credit ratings, purchases, principal payments, sales andrealized principal losses.

 

Asof June 30, 2010, our below investment grade Alt-A securities with grossunrealized losses and with other-than-temporary impairments recorded inearnings had actual cumulative collateral losses of 4.9%, with remainingaverage credit enhancement of 6.3%.  Ourimpairment evaluation forecasts more severe assumptions than the trusts areactually experiencing, including a projected weighted average underlyingdelinquency rate of 40.2% and a projected weighted average loss severity of50.9%, which resulted in projected cumulative collateral losses of 20.1%.  The difference between the actual cumulativecollateral loss experience of 4.9% and our projections of cumulative collaterallosses of 20.1% reflects our expectations of future losses due to furtherdeterioration in the performance of the securities’ underlying collateral.  Accordingly, we have recognized cumulativewrite-downs in earnings on these securities as reflected in the table above.

 

Asof June 30, 2010, our below investment grade Alt-A securities with grossunrealized losses that are not other-than-temporarily impaired had actualcumulative collateral losses of 1.3%, with remaining average credit enhancementof 8.1%.  Our impairment evaluationforecasts more severe assumptions than the trusts are actually experiencingincluding a projected weighted average underlying delinquency rate of 30.4% anda projected weighted average loss severity of 43.0%, which resulted inprojected cumulative collateral losses of 14.0%.  In instances where the projected cumulativecollateral losses exceed the remaining credit enhancement and the security hasnot been impaired, the recovery value of the security exceeds the currentamortized cost.

 

Thefollowing table shows other trust-level and class-level key metrics specific tothe trusts and classes from which our below investment grade Alt-A securitieswith gross unrealized losses were issued.

 
| ** **                           | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** | **December 31,********2009** | ** ** | **September 30,  2009** | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------------------|------------|-------------------------|------------|
| Trust-level statistics               |       |                    |       |                     |       |                              |       |                         |       |                    |       |
| Delinquency rates                    |       | 19.6                    | %          | 19.7                     | %          | 19.1                              | %          | 18.9                         | %          | 17.9                    | %          |
| Cumulative collateral losses         |       | 3.5                     |       | 3.1                      |       | 2.4                               |       | 2.1                          |       | 1.5                     |       |
| Class-level statistics               |       |                    |       |                     |       |                              |       |                         |       |                    |       |
| Average remaining credit enhancement |       | 7.0                     |       | 6.9                      |       | 7.4                               |       | 7.9                          |       | 8.9                     |       |

 

In general and as discussed above, our average credit enhancementremains strong while the cumulative collateral losses continue to be appliedagainst lower classes issued by the securitization trusts.

 

61

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The following tables show trust-level, class-level andsecurity-specific detailed information for our below investment grade Subprimesecurities with gross unrealized losses, by credit rating.

 
| ** **                                        | ** ** | **June 30, 2010**                                          | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                        | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Other** | ** ** | ** ** | ** ** |
| **($ in  millions)**                         | ** ** | **Ba**                                                          | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                       | ** ** | ** **                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Delinquency rates                                 |       | —                                                          | %          | 18.0 | % | 27.4 | % | 27.0 | % | 32.6 | % | 11.2 | % | 30.9 | % | 24.0 | % | 25.8 | % |
| Cumulative collateral losses (1)                  |       | —                                                          |       | 9.7 |   | 15.8 |   | 15.6 |   | 11.6 |   | 21.3 |   | 7.3 |   | 12.8 |   | 14.4 |   |
| Class-level                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement              |       | —                                                          |       | 12.4 |   | 6.5 |   | 6.8 |   | 31.3 |   | 5.8 |   | 25.7 |   | 19.3 |   | 12.0 |   |
| Security-specific                                 |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                               |       | —                                                          |       | 3 |   | 59 |   | 62 |   | 12 |   | 17 |   | 39 |   | 68 |   | 130 |   |
| Par value                                         |       | $                                                               | —     |   | $ | 28 |   | $ | 643 |   | $ | 671 |   | $ | 60 |   | $ | 171 |   | $ | 246 |   | $ | 477 |   | $ | 1,148 |   |
| Fair value                                        |       | —                                                          |       | 16 |   | 212 |   | 228 |   | 41 |   | 96 |   | 139 |   | 276 |   | 504 |   |
| Gross unrealized losses                           |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | —                                                          |       | (9 | ) | (214 | ) | (223 | ) | (19 | ) | (75 | ) | (106 | ) | (200 | ) | (423 | ) |
| Insured (2)                                       |       | —                                                          |       | (9 | ) | (90 | ) | (99 | ) | (1 | ) | (65 | ) | (6 | ) | (72 | ) | (171 | ) |
| 12-24 months (3)                                  |       | —                                                          |       | — |   | (17 | ) | (17 | ) | — |   | (1 | ) | — |   | (1 | ) | (18 | ) |
| Over 24 months (4)                                |       | —                                                          |       | (9 | ) | (197 | ) | (206 | ) | (19 | ) | (74 | ) | (106 | ) | (199 | ) | (405 | ) |
| Cumulative write-downs recognized (5)        |       | —                                                          |       | (3 | ) | (217 | ) | (220 | ) | — |   | — |   | — |   | — |   | (220 | ) |
| Principal payments received during the period (6) |       | —                                                          |       | 7 |   | 16 |   | 23 |   | 10 |   | 20 |   | 7 |   | 37 |   | 60 |   |
|                                                   |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                        | ** ** | **December 31, 2009**                                      | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                        | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Other** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **Ba**                                                          | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                       | ** ** | ** **                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Delinquency rates                                 |       | 5.5                                                             | %          | 9.8 | % | 32.4 | % | 29.4 | % | 31.7 | % | 14.8 | % | 30.8 | % | 25.6 | % | 27.5 | % |
| Cumulative collateral losses                      |       | 15.0                                                            |       | 15.8 |   | 14.8 |   | 14.8 |   | 6.9 |   | 17.9 |   | 9.2 |   | 11.7 |   | 13.3 |   |
| Class-level                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement              |       | —                                                          |       | — |   | 7.6 |   | 6.7 |   | 24.7 |   | 4.6 |   | 15.6 |   | 13.9 |   | 10.3 |   |
| Security-specific                                 |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                               |       | 1                                                               |       | 3 |   | 39 |   | 43 |   | 14 |   | 19 |   | 27 |   | 60 |   | 103 |   |
| Par value                                         |       | $                                                               | 30         |   | $ | 35 |   | $ | 469 |   | $ | 534 |   | $ | 117 |   | $ | 180 |   | $ | 233 |   | $ | 530 |   | $ | 1,064 |   |
| Fair value                                        |       | 10                                                              |       | 15 |   | 110 |   | 135 |   | 74 |   | 75 |   | 106 |   | 255 |   | 390 |   |
| Gross unrealized losses                           |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | (14                                                             | )          | (17 | ) | (209 | ) | (240 | ) | (43 | ) | (105 | ) | (126 | ) | (274 | ) | (514 | ) |
| Insured (2)                                       |       | (14                                                             | )          | (14 | ) | (63 | ) | (91 | ) | (3 | ) | (94 | ) | (39 | ) | (136 | ) | (227 | ) |
| 12-24 months (3)                                  |       | —                                                          |       | (3 | ) | (19 | ) | (22 | ) | (2 | ) | (2 | ) | (13 | ) | (17 | ) | (39 | ) |
| Over 24 months (4)                                |       | (14                                                             | )          | (12 | ) | (188 | ) | (214 | ) | (41 | ) | (102 | ) | (113 | ) | (256 | ) | (470 | ) |
| Cumulative write-downs recognized (5)        |       | (6                                                              | )          | (4 | ) | (146 | ) | (156 | ) | — |   | — |   | — |   | — |   | (156 | ) |
| Principal payments received during the period (6) |       | —                                                          |       | 4 |   | 24 |   | 28 |   | 32 |   | 30 |   | 29 |   | 91 |   | 119 |   |
|                                                   |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) Actual cumulativerealized principal losses reduced the par value of the below investment gradeSubprime securities we own by $23 million as of June 30, 2010.

(2) Includes grossunrealized losses on securities with reliable bond insurance.  These unrealized losses are included in theaging below.

(3) Includes totalgross unrealized losses on securities in an unrealized loss position for aperiod of 12 to 24 consecutive months.

(4) Includes totalgross unrealized losses on securities in an unrealized loss position for aperiod more than 24 consecutive months. As of June 30, 2010, $141 million of unrealized losses onsecurities with other-than-temporary impairments recognized in earnings and$128 million of unrealized losses on other securities are greater than or equalto 20% of those securities’ amortized cost, and as of December 31, 2009,$63 million of unrealized losses on securities with other-than-temporaryimpairments recognized in earnings and $26 million of unrealized losses onother securities are greater than or equal to 20% of those securities’amortized cost.

(5) Includes cumulativewrite-downs recorded in accordance with GAAP.

(6)  Reflects principalpayments for the six months ended June 30, 2010 or the year ended December 31,2009, respectively.

 

62

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Theabove tables include information about below investment grade Subprimesecurities with gross unrealized losses as of each period presented.  As such, the par value and composition ofsecurities included can vary significantly from period to period due to changesin variables such as credit ratings, purchases, principal payments, sales andrealized principal losses.

 

Asof June 30, 2010, our below investment grade Subprime securities withgross unrealized losses and with other-than-temporary impairments recorded inearnings had actual cumulative collateral losses of 15.6%, with remainingaverage credit enhancement of 6.8%.  Ourimpairment evaluation forecasts more severe assumptions than the trusts areactually experiencing, including a projected weighted average underlyingdelinquency rate of 54.9% and a projected weighted average loss severity of77.0%, which resulted in projected cumulative collateral losses of 40.8%.  The difference between the actual cumulativecollateral loss experience of 15.6% and our projections of cumulativecollateral losses of 40.8% reflects our expectations of future losses due tofurther deterioration in the performance of the securities’ underlyingcollateral.  Accordingly, we haverecognized cumulative write-downs in earnings on these securities as reflectedin the table above.

 

Asof June 30, 2010, our below investment grade Subprime securities withgross unrealized losses that are not other-than-temporarily impaired had actualcumulative collateral losses of 12.8%, with remaining average creditenhancement of 19.3%.  Our impairmentevaluation forecasts more severe assumptions than the trusts are actuallyexperiencing including a projected weighted average underlying delinquency rateof 49.7% and a projected weighted average loss severity of 73.5%, whichresulted in projected cumulative collateral losses of 36.6%.  In instances where the projected cumulativecollateral losses exceed the remaining credit enhancement and the security hasnot been impaired, sufficient secondary credit enhancement exists, such asreliable bond insurance, and the recovery value of the security exceeds thecurrent amortized cost.

 

The following table shows other trust-level and class-level key metricsspecific to the trusts and classes from which our below investment gradeSubprime securities with gross unrealized losses were issued.

 
| ** **                           | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** | **December 31,********2009** | ** ** | **September 30,  2009** | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------------------|------------|-------------------------|------------|
| Trust-level statistics               |       |                    |       |                     |       |                              |       |                         |       |                    |       |
| Delinquency rates                    |       | 25.8                    | %          | 28.5                     | %          | 27.5                              | %          | 26.6                         | %          | 26.4                    | %          |
| Cumulative collateral losses         |       | 14.4                    |       | 14.4                     |       | 13.3                              |       | 11.4                         |       | 10.3                    |       |
| Class-level statistics               |       |                    |       |                     |       |                              |       |                         |       |                    |       |
| Average remaining credit enhancement |       | 12.0                    |       | 11.2                     |       | 10.3                              |       | 11.1                         |       | 12.3                    |       |

 

Ingeneral and as discussed above, our average credit enhancement remains strongwhile the cumulative collateral losses continue to be applied against lowerclasses issued by the securitization trusts.

 

*Other-than-temporaryimpairment assessment for below investment grade CMBS*

 

Grossunrealized losses for our below investment grade CMBS portfolio totaled $194million, while gross unrealized gains were $1 million as of June 30,2010.  For below investment grade CMBSwith gross unrealized gains, we have recognized cumulative write-downs inearnings totaling $8 million as of June 30, 2010.

 

The credit loss evaluationfor CMBS with gross unrealized losses is performed in two phases.  The first phase estimates the future cashflows of the entire securitization trust from which our security wasissued.  A critical part of this estimateinvolves forecasting the cumulative collateral losses of the commercialmortgage loans that collateralize the securitization trust.  Factors affecting these estimates include,but are not limited to, estimates of current and future property prices,current and projected rental incomes, the propensity of the commercial mortgageloans to default under these assumptions and loss severities in cases ofdefault.  Estimates of future propertyprices and rental incomes consider specific property-type and geographiceconomic trends such as employment, property vacancy and rental rates, andforecasts of new supply in the commercial real estate markets.  Estimates of delinquency rates and lossseverities consider factors such as borrower payment history, the originationpractices of the transaction sponsor, overall collateral quality anddiversification, transaction vintage year, maturity date, overall transactionstructure and other factors that may influence performance.  Realized losses in the CMBS market havehistorically been low and, we believe, are not predictive of futurelosses.  Therefore, our projections ofcollateral performance rely on probability-weighted scenarios informed bycredit opinions obtained from third parties, such as nationally recognizedcredit rating agencies, industry analysts and a CMBS loss modeling advisoryservice.

 

63

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We then analyze the positionof the class of securities we own in the securitization trust relative to thetrust’s other classes to determine whether any of the projected cumulativecollateral loss will be applied to our class. If we have sufficient credit enhancement, measured in terms ofsubordination from other classes of securities in the trust being contractuallyobligated to absorb losses before the class of security we own, no collaterallosses will be realized by our class and we expect to collect all contractualprincipal and interest of the security we own.

 

For securities where thereis insufficient credit enhancement for the class of securities we own, asecond, security-specific estimate of future cash flows is calculated.  This estimate is based on the contractualprincipal and interest of the securities we own, reduced by the projectedcumulative collateral losses applied to them. In instances where the recovery value of the security is less thanamortized cost, a credit loss is recorded in earnings.

 

39.8%,50.2% and 8.1% of our below investment grade CMBS with gross unrealized losseswere issued with Aaa, Aa and A original ratings and capital structureclassifications, respectively.  CMBS withhigher original ratings typically have priority in receiving the principalrepayments on the collateral compared to those with lower originalratings.  Commercial property prices havedeteriorated substantially during the last 24 months and property rentalincomes are declining as the commercial real estate sector adjusts to lower macroeconomicactivity.  In addition, tight creditmarkets and conservative underwriting standards continue to stress commercialmortgage borrowers’ ability to refinance obligations.  Our projected cash flow assumptions for ourbelow investment grade CMBS securities with gross unrealized losses havedeteriorated since the securities were originated, as reflected by theircurrent credit ratings.

 

64

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Thefollowing tables show trust-level, class-level and security-specific detailedinformation for our below investment grade CMBS securities with grossunrealized losses, by credit rating.

 
| ** **                                        | ** ** | **June 30, 2010**                                          | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                        | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Other** | ** ** | ** ** | ** ** |
| **($ in  millions)**                         | ** ** | **Ba**                                                          | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** | ** ** | ** ** |
| Delinquency rates                                 |       | 3.4                                                             | %          | 11.6 | % | 12.8 | % | 11.7 | % | 5.3 | % | 3.5 | % | — | % | 4.9 | % | 8.5 | % |
| Cumulative collateral losses                      |       | —                                                          |       | 0.3 |   | 3.5 |   | 2.5 |   | 0.5 |   | 0.9 |   | — |   | 0.6 |   | 1.6 |   |
| Class-level                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement              |       | 7.6                                                             |       | 10.2 |   | 19.0 |   | 16.1 |   | 8.6 |   | 8.3 |   | — |   | 8.6 |   | 12.5 |   |
| Security-specific                                 |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                               |       | 2                                                               |       | 2 |   | 6 |   | 10 |   | 14 |   | 4 |   | — |   | 18 |   | 28 |   |
| Par value                                         |       | $                                                               | 20         |   | $ | 43 |   | $ | 141 |   | $ | 204 |   | $ | 140 |   | $ | 42 |   | $ | — |   | $ | 182 |   | $ | 386 |   |
| Fair value                                        |       | 5                                                               |       | 14 |   | 28 |   | 47 |   | 54 |   | 17 |   | — |   | 71 |   | 118 |   |
| Gross unrealized losses                           |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | (5                                                              | )          | (8 | ) | (61 | ) | (74 | ) | (90 | ) | (30 | ) | — |   | (120 | ) | (194 | ) |
| 12-24 months (1)                                  |       | —                                                          |       | — |   | — |   | — |   | (6 | ) | — |   | — |   | (6 | ) | (6 | ) |
| Over 24 months (2)                                |       | (5                                                              | )          | (8 | ) | (61 | ) | (74 | ) | (84 | ) | (30 | ) | — |   | (114 | ) | (188 | ) |
| Cumulative write-downs recognized (3)             |       | (10                                                             | )          | (19 | ) | (58 | ) | (87 | ) | — |   | — |   | — |   | — |   | (87 | ) |
| Principal payments received during the period (4) |       | —                                                          |       | — |   | 2 |   | 2 |   | 1 |   | — |   | — |   | 1 |   | 3 |   |
|                                                   |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                        | ** ** | **December 31, 2009**                                      | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                        | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Other** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **Ba**                                                          | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                       | ** ** | ** **                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Delinquency rates                                 |       | 7.3                                                             | %          | 9.4 | % | — | % | 8.9 | % | 2.2 | % | 3.8 | % | — | % | 2.8 | % | 5.2 | % |
| Cumulative collateral losses                      |       | 1.4                                                             |       | 0.6 |   | — |   | 0.8 |   | — |   | — |   | — |   | — |   | 0.3 |   |
| Class-level                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement              |       | 17.4                                                            |       | 9.8 |   | — |   | 11.5 |   | 9.1 |   | 8.5 |   | — |   | 8.9 |   | 9.9 |   |
| Security-specific                                 |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                               |       | 1                                                               |       | 5 |   | — |   | 6 |   | 6 |   | 6 |   | — |   | 12 |   | 18 |   |
| Par value                                         |       | $                                                               | 20         |   | $ | 69 |   | $ | — |   | $ | 89 |   | $ | 87 |   | $ | 49 |   | $ | — |   | $ | 136 |   | $ | 225 |   |
| Fair value                                        |       | 9                                                               |       | 16 |   | — |   | 25 |   | 29 |   | 13 |   | — |   | 42 |   | 67 |   |
| Gross unrealized losses                           |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | (5                                                              | )          | (25 | ) | — |   | (30 | ) | (55 | ) | (37 | ) | — |   | (92 | ) | (122 | ) |
| 12-24 months (1)                                  |       | —                                                          |       | — |   | — |   | — |   | (13 | ) | — |   | — |   | (13 | ) | (13 | ) |
| Over 24 months (2)                                |       | (5                                                              | )          | (25 | ) | — |   | (30 | ) | (42 | ) | (37 | ) | — |   | (79 | ) | (109 | ) |
| Cumulative write-downs recognized (3)             |       | (7                                                              | )          | (34 | ) | — |   | (41 | ) | — |   | — |   | — |   | — |   | (41 | ) |
| Principal payments received during the period (4) |       | 1                                                               |       | — |   | — |   | 1 |   | 1 |   | — |   | — |   | 1 |   | 2 |   |
|                                                   |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)  Includestotal gross unrealized losses on securities in an unrealized loss position fora period of 12 to 24 consecutive months.

 

(2)  Includestotal gross unrealized losses on securities in an unrealized loss position fora period more than 24 consecutive months. As of June 30, 2010, $18 million of unrealized losses on securitieswith other-than-temporary impairments recognized in earnings and $79 million ofunrealized losses on other securities are greater than or equal to 20% of thosesecurities’ amortized cost.  As of December 31,2009, there were no CMBS securities with gross unrealized losses greater thanor equal to 20% for a period of more than 24 consecutive months.

 

(3)  Includescumulative write-downs recorded in accordance with GAAP.

 

(4)  Reflectsprincipal payments for the six months ended June 30, 2010 or the yearended December 31, 2009, respectively.

 

Theabove tables include information about below investment grade CMBS with grossunrealized losses as of each period presented. As such, the par value and composition of securities included can varysignificantly from period to period due to changes in variables such as creditratings, purchases, principal payments and sales.

 

Asof June 30, 2010, our below investment grade CMBS with gross unrealizedlosses and with other-than-temporary impairments recorded in earnings hadactual cumulative collateral losses of 2.5%, with remaining average creditenhancement of 16.1%.  As of June 30,2010, our below investment grade CMBS with gross unrealized losses that werenot other-than-temporarily impaired had actual cumulative collateral losses of0.6%, with remaining average credit enhancement of 8.6%.

 

Our impairment evaluation for CMBS forecasts moresevere assumptions than the trusts are actually experiencing.  We assume that all loans delinquent 60 daysor more default and project delinquency rates on

 

65

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otherwise performing loans.  Projected loss severities are then appliedagainst the resulting delinquency rates, arriving at our projected cumulativecollateral loss rates.  The projected cumulative collateral lossrates by vintage year of the security range from a low of 2.1% for holdingswith a vintage year of 2003 to a high of 10.5% for holdings with a vintage yearof 2007.** **The projected cumulative collateral loss rate for ourentire CMBS portfolio at June 30, 2010 was 8.0%.  The difference between the actual cumulativecollateral loss experience of 1.6% and our projections of cumulative collaterallosses of 8.0% reflects our expectations of future losses due to furtherdeterioration in the performance of the securities’ underlying collateral.  Accordingly, we have recognized cumulativewrite-downs in earnings on these securities as reflected in the tableabove.  In instances where the projectedcumulative collateral losses exceed the remaining credit enhancement and thesecurity has not been impaired, the recovery value of the security exceeds thecurrent amortized cost.

 

Thefollowing table shows other trust-level and class-level key metrics specific tothe trusts and classes from which our below investment grade CMBS with grossunrealized losses were issued.

 
| ** **                           | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** | **December 31,********2009** | ** ** | **September 30,  2009** | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------------------|------------|-------------------------|------------|
| Trust-level statistics               |       |                    |       |                     |       |                              |       |                         |       |                    |       |
| Delinquency rates                    |       | 8.5                     | %          | 8.6                      | %          | 5.2                               | %          | 4.9                          | %          | 6.0                     | %          |
| Cumulative collateral losses         |       | 1.6                     |       | 0.8                      |       | 0.3                               |       | 0.1                          |       | 0.2                     |       |
| Class-level statistics               |       |                    |       |                     |       |                              |       |                         |       |                    |       |
| Average remaining credit enhancement |       | 12.5                    |       | 11.6                     |       | 9.9                               |       | 11.3                         |       | 10.0                    |       |

 

Ingeneral and as discussed above, our average credit enhancement remains strongwhile the cumulative collateral losses continue to be applied against lowerclasses issued by the securitization trusts.

 

*Other-than-temporaryimpairment assessment for below investment grade ABS*

 

Grossunrealized losses for our below investment grade ABS portfolio totaled $219million, while gross unrealized gains were $33 million as of June 30,2010.  For below investment grade ABSwith gross unrealized gains, we have recognized cumulative write-downs in earningstotaling $197 million as of June 30, 2010.

 

TheABS portfolio is composed of various holdings with unique features; andtherefore, our credit loss evaluation primarily relies on expectations offuture losses on the underlying collateral and structural considerations ofeach issue.  The projection of futurelosses is based on our expectations for investment grade corporate, bank loanand high yield markets.  Our expectationsare formulated through ongoing monitoring and participation in these markets,and consider opinions from third parties, such as industry analysts andstrategists, and credit rating agencies as well as our overall economic outlookfor indicators such as unemployment and GDP. The expected performance of each security considers expected collaterallosses and credit enhancement levels, as well as factors including defaultrates, expected recoveries, prepayment rates, changes in interest rates andother characteristics.  In addition, theperformance of collateral underlying certain ABS securities is activelymonitored by external managers, allowing for enhanced collateral managementactions which help mitigate the risk of loss.

 

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The following table shows certain statistics for our below investmentgrade ABS securities with gross unrealized losses.

 
| ** **                | ** ** | **June 30, 2010**                                          | ** ** |
|---------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Other** | ** ** |
| **($ in  millions)** | ** ** | **Fair  value**                                                 | ** ** | **Total  unrealized  loss** | ** ** | **Unrealized  loss aged  over  24 months** | ** ** | **Cumulative  write-  downs  recognized** | ** ** | **Fair  value** | ** ** | **Total  unrealized  loss** | ** ** | **Unrealized  loss aged  over  24 months** | ** ** |
| Cash flow CLO             |       | $                                                               | 10         |   | $ | — |   | $ | — |   | $ | (7 | ) | $ | 172 |   | $ | (97 | ) | $ | (96 | ) |
| Market value CDO          |       | —                                                          |       | — |   | — |   | — |   | 30 |   | (14 | ) | (14 | ) |
| Synthetic CDO             |       | 24                                                              |       | (25 | ) | (24 | ) | (81 | ) | 66 |   | (59 | ) | (59 | ) |
| Trust preferred CDO       |       | 5                                                               |       | (4 | ) | (3 | ) | (15 | ) | 18 |   | (15 | ) | (11 | ) |
| Consumer and other ABS    |       | 8                                                               |       | (1 | ) | — |   | (6 | ) | 12 |   | (4 | ) | (4 | ) |
| Total                     |       | $                                                               | 47         |   | $ | (30 | ) | $ | (27 | ) | $ | (109 | ) | $ | 298 |   | $ | (189 | ) | $ | (184 | ) |

 
| ** **             | ** ** | **December 31, 2009**                                      | ** ** |
|------------------------|------------|-----------------------------------------------------------------|------------|
| ** **             | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Other** | ** ** |
| ** **             | ** ** | **Fair  value**                                                 | ** ** | **Total  unrealized  loss** | ** ** | **Unrealized  loss aged  over  24 months** | ** ** | **Cumulative  write-  downs  recognized** | ** ** | **Fair  value** | ** ** | **Total  unrealized  loss** | ** ** | **Unrealized  loss aged  over  24 months** | ** ** |
| Cash flow CLO          |       | $                                                               | 8          |   | $ | (2 | ) | $ | — |   | $ | (5 | ) | $ | 180 |   | $ | (98 | ) | $ | (95 | ) |
| Market value CDO       |       | —                                                          |       | — |   | — |   | — |   | 30 |   | (14 | ) | (14 | ) |
| Synthetic CDO          |       | 28                                                              |       | (44 | ) | (40 | ) | (130 | ) | 61 |   | (44 | ) | (44 | ) |
| Trust preferred CDO    |       | 4                                                               |       | (5 | ) | (5 | ) | (15 | ) | 3 |   | (6 | ) | — |   |
| Consumer and other ABS |       | 5                                                               |       | (3 | ) | — |   | (14 | ) | 23 |   | (6 | ) | (4 | ) |
| Total                  |       | $                                                               | 45         |   | $ | (54 | ) | $ | (45 | ) | $ | (164 | ) | $ | 297 |   | $ | (168 | ) | $ | (157 | ) |

 

The above tables include information about below investment grade ABSwith gross unrealized losses as of each period presented.  As such, the composition of securitiesincluded can vary significantly from period to period due to changes invariables such as credit ratings, purchases, principal payments, sales andrealized principal losses.

 

Asof June 30, 2010, our below investment grade ABS with gross unrealizedlosses that are not other-than-temporarily impaired are concentrated in Cashflow CLO and Synthetic CDO securities, which together comprise 82.5% of thetotal unrealized loss on such securities.

 

Cashflow CLO are collateralized primarily by below investment grade senior securedcorporate loans and are structured with overcollateralization which serves ascredit enhancement for the class of securities we own.  Our best estimate of future cash flows,supported by the applicable overcollateralization, indicates that the nature ofthe unrealized loss on these securities is temporary and will reverse overtime.

 

SyntheticCDO primarily consist of a portfolio of corporate CDS collateralized by Aaa, Aaand A rated LIBOR-based securities (i.e. “fully funded” synthetic CDO).  Our best estimate of future cash flows as of June 30,2010 indicates that the remaining unrealized loss is not predictive of theirultimate performance and will recover in line with our best estimate of futurecash flows.

 

Webelieve that the unrealized losses on our fixed income securities are notpredictive of their ultimate performance and the unrealized losses shouldreverse over the remaining lives of the securities.  We anticipate thatthese securities will recover in line with our best estimate of the expectedcash flows which are used for other-than-temporary impairment evaluations.  As of June 30, 2010, we do not have theintent to sell and it is not more likely than not we will be required to sellthese securities before the recovery of their amortized cost basis.  Ourevaluation of whether it is more likely than not we will be required to sell asecurity before recovery of its amortized cost basis is supported by ourliquidity position, which cushions us from the need to liquidate securitieswith significant unrealized losses to meet cash obligations.

 

*Problem,restructured, or potential problem*

 

Wealso monitor the quality of our fixed income and bank loan portfolios bycategorizing certain investments as “problem”, “restructured” or “potentialproblem.”  Problem fixed incomesecurities and bank loans are in default with respect to principal or interestand/or are investments issued by companies that have gone into bankruptcysubsequent to our acquisition or loan. Fixed income and bank loan investments are categorized as restructuredwhen

 

67

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thedebtor is in financial difficulty and we grant a concession.  Potential problem fixed income or bank loaninvestments are current with respect to contractual principal and/or interest,but because of other facts and circumstances, we have concerns regarding theborrower’s ability to pay future principal and interest according to theoriginal terms, which causes us to believe these investments may be classifiedas problem or restructured in the future.

 

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

 
| ** **                            | ** ** | **June 30, 2010** | ** ** |
|---------------------------------------|------------|------------------------|------------|
| **($ in millions)**              | ** ** | **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                          |       | $                      | 74         |   | $ | 52 |   | 70.3 | % | $ | 57 |   | 77.0 | % | 0.1 | % |
| Problem                               |       | 480                    |       | 125 |   | 26.0 |   | 82 |   | 17.1 |   | 0.2 |   |
| Potential problem                     |       | 1,509                  |       | 925 |   | 61.3 |   | 608 |   | 40.3 |   | 1.2 |   |
| Total                                 |       | $                      | 2,063      |   | $ | 1,102 |   | 53.4 |   | $ | 747 |   | 36.2 |   | 1.5 | % |
| Cumulative write-downs recognized (3) |       |                   |       | $ | 830 |   |   |   |   |   |   |   |   |   |

 
| ** **                            | ** ** | **December 31, 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                          |       | $                          | 75         |   | $ | 53 |   | 70.7 | % | $ | 51 |   | 68.0 | % | 0.1 | % |
| Problem                               |       | 480                        |       | 165 |   | 34.4 |   | 100 |   | 20.8 |   | 0.2 |   |
| Potential problem                     |       | 1,735                      |       | 1,080 |   | 62.2 |   | 645 |   | 37.2 |   | 1.3 |   |
| Total                                 |       | $                          | 2,290      |   | $ | 1,298 |   | 56.7 |   | $ | 796 |   | 34.8 |   | 1.6 | % |
| Cumulative write-downs recognized (3) |       |                       |       | $ | 805 |   |   |   |   |   |   |   |   |   |

 

----

(1)  The difference between par valueand amortized cost of $961 million at June 30, 2010 and $992 million at December 31,2009 is primarily attributable to write-downs. Par value has been reduced by principal payments.

 

(2)  Bank loans arereflected at amortized cost.

 

(3)  Cumulativewrite-downs recognized only reflect impairment write-downs related toinvestments within the problem, potential problem and restructured categories.

 

At June 30, 2010, amortized cost for the problem category was $125million and comprised $51 million of Subprime, $19 million of Alt-A, $16million of CMBS, $5 million of other CDO, and $4 million of Consumer and otherABS.  Also included were $20 million ofcorporates (primarily privately placed), $7 million of municipal bonds, and $3million of bank loans.  The decrease of$40 million compared to December 31, 2009 is primarily attributable to areduction in corporate bonds.  Theamortized cost of problem investments with a fair value less than 80% ofamortized cost totaled $85 million with unrealized losses of $51 million andfair value of $34 million.

 

At June 30, 2010, amortized cost for the potential problemcategory was $925 million and comprised $432 million of Subprime, $182 millionof Alt-A, $124 million of CMBS, $80 million of other CDO and $9 million ofConsumer and other ABS.  Also includedwere $58 million of corporates (primarily privately placed), $31 million ofprime and $9 million of bank loans.  Thedecrease of $155 million from December 31, 2009 is primarily attributableto a reduction in corporate bonds.  Theamortized cost of potential problem investments with a fair value less than 80%of amortized cost totaled $677 million with unrealized losses of $343 millionand fair value of $334 million.

 

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**Netinvestment income** The following tablepresents net investment income.

 
| ** **                         | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in millions)**           | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities            |       | $                                     | 629        |                                | $          | 639 |   | $ | 1,264 |   | $ | 1,320 |   |
| Mortgage loans                     |       | 98                                    |       | 129                                 |       | 199 |   | 263 |   |
| Equity securities                  |       | 1                                     |       | 1                                   |       | 2 |   | 2 |   |
| Cost limited partnership interests |       | 4                                     |       | 2                                   |       | 7 |   | 4 |   |
| Short-term                         |       | 1                                     |       | 3                                   |       | 2 |   | 10 |   |
| Other                              |       | (5                                    | )          | (10                                 | )          | (13 | ) | (16 | ) |
| Investment income, before expense  |       | 728                                   |       | 764                                 |       | 1,461 |   | 1,583 |   |
| Investment expense                 |       | (28                                   | )          | (23                                 | )          | (54 | ) | (45 | ) |
| Net investment income              |       | $                                     | 700        |                                | $          | 741 |   | $ | 1,407 |   | $ | 1,538 |   |

 

Net investment income decreased5.5% or $41 million to $700 million in the second quarter of 2010 and 8.5% or$131 million to $1.41 billion in the first six months of 2010 from $741 millionand $1.54 billion in the second quarter and first six months of 2009,respectively, primarily due to lower yields and actions to reduce the portfolio’sexposure to commercial real estate, along with reduced average assetbalances.  Net investment incomewas $722 million, $714 million and $707 million in the third quarter of 2009,fourth quarter of 2009 and first quarter of 2010, respectively.

 

**Net realized capital gains and losses **The following table presentsthe components of realized capital gains and losses and the related tax effect.

 
| ** **                                                         | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in millions)**                                           | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Impairment write-downs                                             |       | $                                     | (141       | )                                   | $          | (203 | ) | $ | (283 | ) | $ | (555 | ) |
| Change in intent write-downs                                       |       | (57                                   | )          | (25                                 | )          | (80 | ) | (57 | ) |
| Net other-than-temporary impairment losses  recognized in earnings |       | (198                                  | )          | (228                                | )          | (363 | ) | (612 | ) |
| Sales                                                              |       | 17                                    |       | 163                                 |       | 60 |   | 521 |   |
| Valuation of derivative instruments                                |       | (149                                  | )          | 179                                 |       | (203 | ) | 262 |   |
| Settlements of derivative instruments                              |       | (30                                   | )          | 41                                  |       | (11 | ) | 23 |   |
| EMA limited partnership income                                     |       | 8                                     |       | (33                                 | )          | 4 |   | (110 | ) |
| Realized capital gains and losses, pre-tax                         |       | (352                                  | )          | 122                                 |       | (513 | ) | 84 |   |
| Income tax benefit (expense)                                       |       | 122                                   |       | (39                                 | )          | 179 |   | (168 | ) |
| Realized capital gains  and losses, after-tax                      |       | $                                     | (230       | )                                   | $          | 83 |   | $ | (334 | ) | $ | (84 | ) |

 

*Impairment write-downs* are presented in thefollowing table.

 
| ** **                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**     | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities       |       | $                                     | (108       | )                                   | $          | (158 | ) | $ | (226 | ) | $ | (347 | ) |
| Mortgage loans                |       | (28                                   | )          | (15                                 | )          | (41 | ) | (43 | ) |
| Equity securities             |       | —                                |       | (1                                  | )          | — |   | (20 | ) |
| Limited partnership interests |       | (5                                    | )          | (21                                 | )          | (16 | ) | (115 | ) |
| Other investments             |       | —                                |       | (8                                  | )          | — |   | (30 | ) |
| Impairment write-downs        |       | $                                     | (141       | )                                   | $          | (203 | ) | $ | (283 | ) | $ | (555 | ) |

 

Impairmentwrite-downs for the three months and six months ended June 30, 2010 wereprimarily driven by RMBS, which experienced deterioration in expected cashflows; investments with commercial real estate exposure, including CMBS, limitedpartnership interests, and mortgage loans, which were impacted by declines inreal estate valuations or experienced deterioration in expected cash flows; andprivately placed corporate bonds and municipal bonds impacted by issuerspecific circumstances.  Impairmentwrite-downs on below investment grade RMBS, CMBS and ABS for the three monthsended June 30, 2010 were $58 million, $27 million and $20 million,respectively.  Impairment write-downs onbelow investment grade RMBS, CMBS and ABS for the six months

 

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endedJune 30, 2010 were $103 million, $51 million and $24 million,respectively.  $83 million or 76.9% and$182 million or 80.5% of the fixed income security write-downs for the threemonths and six months ended June 30, 2010, respectively, related to impairedsecurities that were performing in line with anticipated or contractual cashflows but were written down primarily because of expected deterioration in theperformance of the underlying collateral or our assessment of the probabilityof future default.  For these securities,as of June 30, 2010, there were either no defaults or defaults onlyimpacted classes lower than our position in the capital structure.  $14 million and $30 million of the fixedincome security write-downs for the three months and six months ended June 30,2010, respectively, related to securities experiencing a significant departurefrom anticipated cash flows; however, we believe they retain economicvalue.  $11 million and $14 million forthe three months and six months ended June 30, 2010, respectively, relatedto fixed income securities for which future cash flows are not anticipated.

 

Limited partnership impairment write-downs related 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:significantly reduced valuations of the investments held by the limitedpartnerships; actual recent cash flows received being significantly less thanexpected cash flows; reduced valuations based on financing completed at a lowervalue; completed sale of a material underlying investment at a pricesignificantly lower than expected; or any other recent adverse events since thelast financial statements received that might affect the fair value of theinvestee’s capital.

 

*Change in intent write-downs* are presented in thefollowing table.

 
| ** **                   | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **($ in  millions)**    | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities      |       | $                                     | (57        | )                                   | $          | (20 | ) | $ | (74 | ) | $ | (40 | ) |
| Mortgage loans               |       | —                                |       | —                              |       | (6 | ) | (6 | ) |
| Equity securities            |       | —                                |       | —                              |       | — |   | (6 | ) |
| Other investments            |       | —                                |       | (5                                  | )          | — |   | (5 | ) |
| Change in intent write-downs |       | $                                     | (57        | )                                   | $          | (25 | ) | $ | (80 | ) | $ | (57 | ) |

 

Change in intent write-downs in the three months andsix months ended June 30, 2010 related primarily to municipal bonds andSubprime RMBS for which we have the intent to sell.  Change in intent write-downs on belowinvestment grade RMBS for the three months and six months ended June 30,2010 were $29 million and $31 million, respectively.

 

*Sales*generated $17 million and $60 million of netrealized gains for the three months and six months ended June 30, 2010,respectively.  Net realized gains for thethree months ended June 30, 2010 primarily related to $50 million of gainson sales of corporate and U.S. and foreign government fixed income securitiesand $20 million of net gains on sales of equity securities, offset by $61million of losses on sales of CMBS and municipal securities.  Net realized gains for the six months ended June 30,2010 primarily related to $108 million of gains on sales of corporate and U.S.and foreign government fixed income securities and $20 million of net gains onsales of equity securities, offset by $74 million of losses on sales of CMBSand municipal securities.

 

*Valuation and settlement of derivative instruments*recorded as netrealized capital losses totaling $214 million for the six months ended June 30,2010 included $203 million of losses on the valuation of derivative instrumentsand $11 million of losses on the settlement of derivative instruments.  Losses from the risk management programsprimarily occurred in duration gap management programs and are related to adecrease in interest rates and a decline in volatility.

 

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, sales and 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 our overall financial condition.

 

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At June 30, 2010, our securities with embeddedoptions totaled $714 million, a decrease in fair value of $53 million from December 31,2009, resulting in realized capital losses on valuation of $56 million, netsales activity of $42 million, and unrealized net capital gains reported in OCIof $45 million for the host securities. Net unrealized capital gains were further decreased by $12 million dueto amortization of the host securities. The change in fair value of embedded options is bifurcated from the hostsecurities, separately valued and reported in realized capital gains andlosses, while the change in the difference between the fair value and theamortized cost of the host securities is reported in OCI.  Total fair value exceeded total amortizedcost by $18 million at June 30, 2010. Valuation gains and losses are converted into cash for securities withembedded options upon our election to sell these securities.  In the event the economic value of theoptions is not realized, we will recover the par value if held to maturityunless the issuer of the note defaults. Total par value exceeded fair value by $33 million at June 30,2010.

 

71

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

 
| ** **                                              | ** ** | **Six months ended June 30,** | ** ** | ** **      | ** ** |
|---------------------------------------------------------|------------|------------------------------------|------------|-----------------|------------|
| ** **                                              | ** ** | **2010**                           | ** ** | **2009**        | ** ** | **2010 Explanations** | ** ** |
| **($ in millions)**                                | ** ** | **Valuation**                      | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| **Risk reduction**                                      |       |                               |       |            |       |   |   |   |   |   |   |
| Duration gap management                                 |       | $                                  | (137       | )               | $          | (21 | ) | $ | (158 | ) | $ | 277 |   | Interest  rate caps, floors, swaptions 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, floors and  swaptions 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 2010  losses, resulting from decreasing 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                                    |       | 22                                 |       | 5               |       | 27 |   | (15 | ) | Futures  and interest rate swaps 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  investment’s unrealized loss in OCI. The 2010 gains were caused by a decrease  in risk-free interest rates over the life of the net short position as  liability issuances exceeded asset acquisitions. |   |
|                                                    |       |                               |       |            |       |   |   |   |   |   |   |
| Hedging of interest rate  exposure in annuity contracts |       | (16                                | )          | —          |       | (16 | ) | 12 |   | 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, decreased due to a decrease in interest rates. |   |
|                                                    |       |                               |       |            |       |   |   |   |   |   |   |
| Hedge ineffectiveness                                   |       | 1                                  |       | —          |       | 1 |   | 3 |   | The  hedge ineffectiveness of $1 million includes $104 million in realized capital  losses on swaps that were offset by $105 million in realized capital gains on  the hedged risk. |   |
|                                                    |       |                               |       |            |       |   |   |   |   |   |   |
| Foreign currency contracts                              |       | (3                                 | )          | 7               |       | 4 |   | — |   | Currency  forwards are used to protect our foreign bond portfolio from changes in  currency rates. |   |
|                                                    |       |                               |       |            |       |   |   |   |   |   |   |
| Credit risk reduction                                   |       | 15                                 |       | (6              | )          | 9 |   | (14 | ) | Valuation  gain is the result of widening credit spreads on referenced credit entities. |   |
|                                                    |       |                               |       |            |       |   |   |   |   |   |   |
| **Total Risk****reduction**                             |       | (118                               | )          | (15             | )          | (133 | ) | 263 |   |   |   |
|                                                    |       |                               |       |            |       |   |   |   |   |   |   |
| **Income generation**                                   |       |                               |       |            |       |   |   |   |   |   |   |
| Asset replication - credit exposure                     |       | (29                                | )          | 4               |       | (25 | ) | 20 |   | The  2010 changes in valuation are due to the widening credit spreads on  referenced credit entities. The losses are primarily on first-to-default CDS  and credit derivative index CDS. The changes in valuation would only be  converted to cash upon disposition, which can be done at any time, or if the  credit event specified in the contract occurs. For further discussion on CDS,  see Note 6 of the condensed consolidated financial statements. |   |
| **Accounting**                                          |       |                               |       |            |       |   |   |   |   |   |   |
| Equity indexed notes                                    |       | (23                                | )          | —          |       | (23 | ) | (11 | ) | 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 $43 million at June 30, 2010.  Equity-indexed notes are subject to our comprehensive portfolio monitoring  and watchlist processes to identify and evaluate when the carrying value may  be other-than-temporarily impaired. The following table compares the  June 30, 2010 and December 31, 2009 holdings, respectively. |   |
|                                                    |       |                               |       |            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                    |       |                               |       |            |       |   |   |   |   | **($ in  millions)** | ** ** | June 30,  2010 |   | Change  in fair  value |   | Change due  to net sale  activity |   | December 31,  2009 |   |
|                                                    |       |                               |       |            |       |   |   |   |   | Par value |   | $ | 425 |   | $ | — |   | $ | (50 | ) | $ | 475 |   |
|                                                    |       |                               |       |            |       |   |   |   |   | Amortized cost of host contract |   | $ | 316 |   | $ | 9 |   | $ | (37 | ) | $ | 344 |   |
|                                                    |       |                               |       |            |       |   |   |   |   | Fair value of equity-indexed call option |   | 57 |   | (23 | ) | (9 | ) | 89 |   |
|                                                    |       |                               |       |            |       |   |   |   |   | Total amortized cost |   | $ | 373 |   | $ | (14 | ) | $ | (46 | ) | $ | 433 |   |
|                                                    |       |                               |       |            |       |   |   |   |   | Total fair value |   | $ | 382 |   | $ | 1 |   | $ | (49 | ) | $ | 430 |   |
|                                                    |       |                               |       |            |       |   |   |   |   | Unrealized gain/loss |   | $ | 9 |   | $ | 15 |   | $ | (3 | ) | $ | (3 | ) |
|                                                         |            |                                    |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                                     | ** ** | **Six months ended June 30,** | ** ** | ** **      | ** ** |
|------------------------------------------------|------------|------------------------------------|------------|-----------------|------------|
| ** **                                     | ** ** | **2010**                           | ** ** | **2009**        | ** ** | **2010 Explanations** | ** ** |
| **($ in millions)**                       | ** ** | **Valuation**                      | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| Conversion options in  fixed income securities |       | (33                                | )          | —          |       | (33 | ) | 13 |   | 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 $10 million at June 30, 2010.   Convertible bonds are subject to our comprehensive portfolio  monitoring and watchlist processes to identify and evaluate when the carrying  value may be other-than-temporarily impaired.   The following table compares the June 30, 2010 and December 31,  2009 holdings, respectively. |   |
|                                           |       |                               |       |            |       |   |   |   |   |   |   |
|                                           |       |                               |       |            |       |   |   |   |   | **($ in  millions)** | ** ** | June 30,  2010 |   | Change  in fair  value |   | Change due  to net sale  activity |   | December 31,  2009 |   |
|                                           |       |                               |       |            |       |   |   |   |   | Par value |   | $ | 322 |   | $ | — |   | $ | 7 |   | $ | 315 |   |
|                                           |       |                               |       |            |       |   |   |   |   | Amortized cost of host contract |   | $ | 247 |   | $ | 3 |   | $ | 20 |   | $ | 224 |   |
|                                           |       |                               |       |            |       |   |   |   |   | Fair value of conversion option |   | 76 |   | (33 | ) | (8 | ) | 117 |   |
|                                           |       |                               |       |            |       |   |   |   |   | Total amortized cost |   | $ | 323 |   | $ | (30 | ) | $ | 12 |   | $ | 341 |   |
|                                           |       |                               |       |            |       |   |   |   |   | Total fair value |   | $ | 332 |   | $ | (12 | ) | $ | 7 |   | $ | 337 |   |
|                                           |       |                               |       |            |       |   |   |   |   | Unrealized gain/loss |   | $ | 9 |   | $ | 18 |   | $ | (5 | ) | $ | (4 | ) |
|                                           |       |                               |       |            |       |   |   |   |   |   |   |
| **Total Accounting**                           |       | (56                                | )          | —          |       | (56 | ) | 2 |   |   |   |
|                                           |       |                               |       |            |       |   |   |   |   |   |   |
| **Total**                                      |       | $                                  | (203       | )               | $          | (11 | ) | $ | (214 | )(1) | $ | 285 |   |   |   |
|                                                |            |                                    |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)     Does not include $2 million of derivative gainsrelated to the termination of fair value and cash flow hedges which areincluded in sales and reported with the hedged risk.

 

**CAPITAL RESOURCES AND LIQUIDITY HIGHLIGHTS**

 

·               Shareholder’sequity as of June 30, 2010 was$5.21 billion, an increase of 18.8% from $4.39 billion as of December 31,2009.

·               The AllstateCorporation (the “Corporation”) has at the parent holding company level $3.05billion of deployable invested assets at June 30, 2010 compared to $3.07billion at December 31, 2009.

·               At June 30, 2010, we held 25.0% of ourtotal cash and investment portfolio, or $14.96 billion, in cash and liquidinvestments that are saleable within one quarter without significant additionalnet realized capital losses.

 

**CAPITAL RESOURCES AND LIQUIDITY**

 

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

 
| **($ in  millions)**                                     | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Common stock, additional capital paid-in and  retained income |       | $                       | 5,018      |                        | $          | 5,163 |   |
| Accumulated other comprehensive income (loss)                 |       | 192                     |       | (777                        | )          |
| Total shareholder’s equity                               |       | 5,210                   |       | 4,386                       |       |
| Notes due to related parties                                  |       | 681                     |       | 675                         |       |
| Total capital resources                                       |       | $                       | 5,891      |                        | $          | 5,061 |   |

 

*Shareholder’s equity* increased inthe first six months of 2010, due primarily to unrealized net capital gains oninvestments, partially offset by a net loss.

 

**Financial ratings and strength **Our ratings are influencedby many factors including our operating and financial performance, assetquality, liquidity, asset/liability management, overall portfolio mix,financial leverage (i.e., debt), exposure to risks, the current level ofoperating leverage and Allstate Insurance Company’s (“AIC’s”) ratings.  There have been no changes to our insurancefinancial strength ratings from Moody’s, S&P and A.M. Best since December 31,2009.

 

The Company, AIC and the Corporation are party to the Amended andRestated Intercompany Liquidity Agreement (“Liquidity Agreement”) which allowsfor short-term advances of funds to be made between parties for liquidity andother general corporate purposes.  TheLiquidity Agreement does not establish a commitment to advance funds on thepart of any party.  The Company and AICeach serve as a lender and borrower and the

 

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Corporation serves only as a lender. The Company also has a capital support agreement with AIC.  Under the capital support agreement, AIC iscommitted to provide capital to the Company to maintain an adequate capitallevel.  The maximum amount of potentialfunding under each of these agreements is $1.00 billion.

 

Inaddition to the Liquidity Agreement, the Company also has an intercompany loanagreement with the Corporation.  Theamount of intercompany loans available to the Company is at the discretion ofthe Corporation.  The maximum amount ofloans the Corporation will have outstanding to all its eligible subsidiaries atany given point in time is limited to $1.00 billion.  The Corporation may use commercial paperborrowings, bank lines of credit and repurchase agreements to fund intercompanyborrowings.

 

**Liquidity sources and uses **We activelymanage our financial position and liquidity levels in light of changing market,economic, and business conditions. Liquidity is managed at both the entity and enterprise level across theCompany, and is assessed on both base and stressed level liquidity needs.  We believe we have sufficient liquidity tomeet these needs, with $14.96 billion of cash and liquid investments saleablewithin 90 days without generating significant additional capital losses (25.0%of the total cash and investment portfolio). We expect $6.61 billion of investment portfolio cash flows frommaturities, calls, and interest receipts over the next 12 months.  Additionally, we have existing intercompanyagreements in place that facilitate liquidity management across the Company toenhance flexibility.

 

*Allstate parent holding company capital capacity*****The Corporationhas at the parent holding company level $3.05 billion of deployable investedassets at June 30, 2010.  Theseassets include investments that are generally saleable within one quartertotaling $2.69 billion.  This providesfunds for the parent company’s relatively low fixed charges.

 

TheCompany 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 June 30, 2010, there were nobalances outstanding and therefore the remaining borrowing capacity was $1.00billion; however, the outstanding balance can fluctuate daily.

 

·                  A primarycredit facility is available for short-term liquidity requirements and backsthe commercial paper facility.  The $1.00billion unsecured revolving credit facility has an initial term of five yearsexpiring in 2012 with two optional one-year extensions that can be exercised atthe end of any of the remaining anniversary years of the facility upon approvalof existing or replacement lenders providing more than two-thirds of thecommitments to lend.  The program isfully 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 a financialcovenant requiring that the Corporation not exceed a 37.5% debt to capitalresources ratio as defined in the agreement. This ratio at June 30, 2010 was 19.9%.  Although the right to borrow under thefacility 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 second quarter and first six months of 2010.  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.

 

·                  A universalshelf registration statement was filed by the Corporation with the Securitiesand Exchange Commission on May 8, 2009. The Corporation can use the current shelf registration to issue anunspecified amount of debt securities, common stock (including 362 millionshares of treasury stock as of June 30, 2010), preferred stock, depositaryshares, warrants, stock purchase contracts, stock purchase units and securitiesof trust subsidiaries.  The specificterms of any securities the Corporation issues under this registrationstatement will be provided in the applicable prospectus supplements.

 

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*Liquidity Exposure*** **Contractholder funds as of June 30, 2010 were $47.70 billion.  The following table summarizes contractholderfunds by their contractual withdrawal provisions at June 30, 2010.

 
| **($ in  millions)**                                    | ** ** | ** ** | ** ** | **Percent to   total** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------------------|------------|
| Not subject to discretionary withdrawal                      |       | $          | 6,820      |                   | 14.3       | % |
| Subject to discretionary withdrawal with  adjustments:       |       |       |       |                   |       |
| Specified surrender charges (1)                              |       | 20,308     |       | 42.6                   |       |
| Market value adjustments (2)                                 |       | 8,327      |       | 17.4                   |       |
| Subject to discretionary withdrawal without  adjustments (3) |       | 12,242     |       | 25.7                   |       |
| Total contractholder funds (4)                               |       | $          | 47,697     |                   | 100.0      | % |

 

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(1)   Includes $9.33billion of liabilities with a contractual surrender charge of less than 5% ofthe account balance.

 

(2)   $6.91 billionof the contracts with market value adjusted surrenders have a 30-45 day periodat the end of their initial and subsequent interest rate guarantee periods(which are typically 5 or 6 years) during which there is no surrender charge ormarket value adjustment.

 

(3)   67% of thesecontracts have a minimum interest crediting rate guarantee of 3% or higher.

 

(4)   Includes $1.28 billion ofcontractholder funds on variable annuities reinsured to The PrudentialInsurance Company of America, a subsidiary of Prudential Financial, Inc.effective June 1, 2006.

 

Whilewe are able to quantify remaining scheduled maturities for our institutionalproducts, 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 increased 24.5% and 17.1% in thesecond quarter and first six months of 2010, respectively, compared to the sameperiods of 2009.  The annualizedsurrender and partial withdrawal rate on deferred annuities andinterest-sensitive life insurance, based on the beginning of yearcontractholder funds, was 10.3% and 8.7% for the first six months of 2010 and2009, respectively.  We strive topromptly pay customers who request cash surrenders, however, statutoryregulations generally provide up to six months in most states to fulfillsurrender requests.

 

Ourinstitutional products are primarily funding agreements sold to unaffiliatedtrusts used to back medium-term notes. As of June 30, 2010, total institutional products outstanding were$2.64 billion.  The following tablepresents the remaining scheduled maturities for our institutional productsoutstanding as of June 30, 2010.

 

| **($ in  millions)** | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|
| 2010                      |       | $          | —     |   |
| 2011                      |       | 760        |       |
| 2012                      |       | 40         |       |
| 2013                      |       | 1,750      |       |
| 2016                      |       | 85         |       |
|                      |       | $          | 2,635      |   |

 

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

 

*Cash Flows*  As reflectedin our Condensed Consolidated Statements of Cash Flows, operating cash flows in the first six months of 2010 declinedcompared with the same period in 2009 as lower investment income and highercontract benefits paid were partially offset by decreased expenses paid.

 

Lowercash flows provided by investing activities in the first six months of 2010compared to the first six months of 2009 were primarily related to lower net reductionsin short-term investments to fund reductions in contractholder funds.

 

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Lowercash flows used in financing activitiesin the first six months of 2010 compared to the first six months of 2009 wereprimarily due to decreased maturities and retirements of institutionalproducts, partially offset by lower deposits on fixed annuities and highersurrenders and partial withdrawals on fixed annuities.

 

**Item 4. Controls and Procedures**

 

*Evaluation of Disclosure Controls andProcedures. *We maintaindisclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934.  Underthe supervision and with the participation of our management, including our principalexecutive officer and principal financial officer, we conducted an evaluationof the effectiveness of our disclosure controls and procedures as of the end ofthe period covered by this report.  Basedupon this evaluation, the principal executive officer and the principalfinancial officer concluded that our disclosure controls and procedures areeffective in providing reasonable assurance that material information requiredto be disclosed in our reports filed with or submitted to the Securities and ExchangeCommission under the Securities Exchange Act is made known to management,including the principal executive officer and the principal financial officer,as appropriate to allow timely decisions regarding required disclosure.

 

*Changes in Internal Control over FinancialReporting. *During thefiscal quarter ended June 30, 2010, there have been no changes in ourinternal control over financial reporting that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II.  OTHER INFORMATION**

 

**Item 1.****          ****LegalProceedings**

 

Information required for this Part II, Item 1 is incorporatedby reference to the discussion under the heading “Regulation and Compliance”and under the heading “Legal and regulatory proceedings and inquiries” in Note8 of the condensed consolidated financial statements in Part I, Item1 of this Form 10-Q.

 

**Item 1A.  Risk Factors**

 

Thisdocument contains “forward-looking statements” that anticipate results based onour estimates, assumptions and plans that are subject to uncertainty.  These statements are made subject to thesafe-harbor provisions of the Private Securities Litigation Reform Act of1995.  We assume no obligation to updateany forward-looking statements as a result of new information or future eventsor developments.

 

Theseforward-looking statements do not relate strictly to historical or currentfacts and may be identified by their use of words like “plans,” “seeks,” “expects,”“will,” “should,” “anticipates,” “estimates,” “intends,” “believes,” “likely,” “targets”and other words with similar meanings. These statements may address, among other things, our strategy forgrowth, product development, investment results, regulatory approvals, marketposition, 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 the forward-lookingstatements prove inaccurate or if other risks or uncertainties arise, actualresults could differ materially from those communicated in theseforward-looking statements.  Risk factorswhich could cause actual results to differ materially from those suggested bysuch forward-looking statements include but are not limited to those discussedor identified in this document, in our public filings with the Securities andExchange Commission, and those incorporated by reference in Part I, Item1A of the Allstate Life Insurance Company Annual Report on Form 10-K for2009.

 

**Item6.  Exhibits**

 

(a)                                  Exhibits

 

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

 

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**SIGNATURE**

 

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

 
|                 | Allstate  Life Insurance Company |
|----------------------|----------------------------------|
|                 | (Registrant)                     |
|                 |                             |
|                 |                             |
| August 9,  2010 |                             |
|                 | By                               | /s/  Samuel H. Pilch |
|                 |                             | Samuel  H. Pilch |
|                 |                             | (chief  accounting officer and duly |
|                 |                             | authorized  officer of Registrant) |

 

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                       |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                  |
| 10.1                 |       | Form of  Asset Purchase Agreement between American Heritage Life Insurance Company and  Road Bay Investments, LLC.                                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                  |
| 10.2                 |       | Form of  Pledge and Security Agreement between Road Bay Investments, LLC and American  Heritage Life Insurance Company.                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                  |
| 10.3                 |       | Reinsurance  Agreement effective July 1, 2010 between Allstate Life Insurance Company  and American Heritage Life Insurance Company, incorporated herein by  reference to Exhibit 10.1 to Allstate Life Insurance Company’s Current  Report on Form 8-K filed July 15, 2010. |
|                 |       |                                                                                                                                                                                                                                                                                                  |
| 15                   |       | Acknowledgment  of awareness from Deloitte & Touche LLP, dated August 9, 2010,  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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