**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-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 the reduced disclosureformat.**

 

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

**OF**

**THESECURITIES EXCHANGE ACT OF 1934**

 

**FOR THEQUARTERLY PERIOD ENDED JUNE 30, 2007**

 

**OR**

 

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

**OF**

**THESECURITIES EXCHANGE ACT OF 1934**

 

**Commission file number: 000-31248**

 

**ALLSTATELIFE INSURANCE COMPANY**

(Exact name of registrant as specified in itscharter)

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

 
| **3100 Sanders Road**                    | **60062**  |
|------------------------------------------|------------|
| **Northbrook, Illinois**                 | (Zip code) |
| (Address of principal executive offices) |       |

** **

**Registrant’stelephone number, including area code: (847) 402-5000**

** **

**Indicate bycheck mark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.**

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

** **

**Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.**
| ** ** | **Large accelerated filer** | **Accelerated filer** | **Non-accelerated filer** | ** ** |
|------------|-----------------------------|-----------------------|---------------------------|------------|
| ** ** | **o**                       | **o**                 | **x**                     | ** ** |

** **

**Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).**

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

** **

**None of thecommon equity of the registrant is held by non-affiliates. Therefore, theaggregate market value of the common equity held by non-affiliates of theregistrant is zero.**

** **

**As ofAugust 6, 2007, the registrant had 23,800 common shares, $227 par value,outstanding, all of which are held by Allstate Insurance Company.**

 

 

----

 

**ALLSTATE LIFE INSURANCE COMPANY**

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

##### **June 30, 2007**

#####  

| ** **  | ** ** | ** **                                                                                                                           | ** ** | **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, 2007 and 2006  (unaudited) |       | 1          |
|        |       |                                                                                                                                 |       |       |
|        |       | Condensed Consolidated Statements of Financial  Position as of June 30, 2007 (unaudited) and December 31, 2006                       |       | 2          |
|        |       |                                                                                                                                 |       |       |
|        |       | Condensed Consolidated Statements of Cash Flows  for the Six-Month Periods Ended June 30, 2007 and 2006 (unaudited)                  |       | 3          |
|        |       |                                                                                                                                 |       |       |
|        |       | Notes to Condensed Consolidated Financial  Statements (unaudited)                                                                    |       | 4          |
|        |       |                                                                                                                                 |       |       |
|        |       | Report of Independent Registered Public Accounting  Firm                                                                             |       | 14         |
|        |       |                                                                                                                                 |       |       |
| Item 2.     |       | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                                          |       | 15         |
|        |       |                                                                                                                                 |       |       |
| Item 4.     |       | Controls and Procedures                                                                                                              |       | 30         |
|        |       |                                                                                                                                 |       |       |
| **PART II** | ** ** | **OTHER INFORMATION**                                                                                                                | ** ** | ** ** |
|        |       |                                                                                                                                 |       |       |
| Item 1.     |       | Legal Proceedings                                                                                                                    |       | 31         |
|        |       |                                                                                                                                 |       |       |
| Item 1A.    |       | Risk Factors                                                                                                                         |       | 31         |
|        |       |                                                                                                                                 |       |       |
| Item 5.     |       | Other Information                                                                                                                    |       | 31         |
|        |       |                                                                                                                                 |       |       |
| Item 6.     |       | Exhibits                                                                                                                             |       | 32         |

 

----

 

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

**ITEM 1. FINANCIAL STATEMENTS**

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                            | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| **(in millions)**                                     | ** ** | **2007**               | ** ** | **2006**             | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                            | ** ** | **(Unaudited)**        | ** ** | **(Unaudited)**      | ** ** |
| **Revenues**                                          | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Premiums                                              |       | $                      | 122        |                 | $          | 146 |   | $ | 277 |   | $ | 263 |   |
| Contract charges                                      |       | 230                    |       | 277                  |       | 458 |   | 562 |   |
| Net investment income                                 |       | 1,053                  |       | 1,017                |       | 2,083 |   | 1,991 |   |
| Realized capital gains and losses                     |       | 104                    |       | (80                  | )          | 126 |   | (107 | ) |
|                                                  |       | 1,509                  |       | 1,360                |       | 2,944 |   | 2,709 |   |
|                                                  |       |                   |       |                 |       |   |   |   |   |
| **Costs and expenses**                                | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Contract benefits                                     |       | 331                    |       | 327                  |       | 705 |   | 653 |   |
| Interest credited to contractholder funds             |       | 660                    |       | 635                  |       | 1,295 |   | 1,238 |   |
| Amortization of deferred policy acquisition  costs    |       | 166                    |       | 176                  |       | 281 |   | 281 |   |
| Operating costs and expenses                          |       | 73                     |       | 98                   |       | 160 |   | 201 |   |
| Restructuring and related charges                     |       | (1                     | )          | 3                    |       | (1 | ) | 18 |   |
|                                                  |       | 1,229                  |       | 1,239                |       | 2,440 |   | 2,391 |   |
|                                                  |       |                   |       |                 |       |   |   |   |   |
| Gain (loss) on disposition of operations              |       | 2                      |       | (35                  | )          | 3 |   | (88 | ) |
|                                                  |       |                   |       |                 |       |   |   |   |   |
| **Income from operations before income tax  expense** |       | 282                    |       | 86                   |       | 507 |   | 230 |   |
|                                                  |       |                   |       |                 |       |   |   |   |   |
| Income tax expense                                    |       | 95                     |       | 30                   |       | 171 |   | 78 |   |
|                                                  |       |                   |       |                 |       |   |   |   |   |
| **Net income**                                        |       | $                      | 187        |                 | $          | 56 |   | $ | 336 |   | $ | 152 |   |

 

See notes to condensed consolidated financial statements.

 

1

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF FINANCIALPOSITION**

 
| ** **                                                                                                                               | ** ** | **June 30,**    | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|
| **($ in millions, except par  value data)**                                                                                         | ** ** | **2007**        | ** ** | **2006**         | ** ** |
| ** **                                                                                                                               | ** ** | **(Unaudited)** | ** ** | ** **       | ** ** |
|                                                                                                                                     |       |            |       |             |       |
| **Assets**                                                                                                                               | ** ** | ** **      | ** ** | ** **       | ** ** |
| Investments                                                                                                                              |       |            |       |             |       |
| Fixed income securities, at fair value  (amortized cost $61,760 and $60,851)                                                             |       | $               | 62,403     |             | $          | 62,439 |   |
| Mortgage loans                                                                                                                           |       | 9,084           |       | 8,690            |       |
| Equity securities                                                                                                                        |       | 855             |       | 533              |       |
| Short-term                                                                                                                               |       | 1,209           |       | 805              |       |
| Policy loans                                                                                                                             |       | 747             |       | 752              |       |
| Other                                                                                                                                    |       | 1,045           |       | 941              |       |
|                                                                                                                                     |       |            |       |             |       |
| Total investments                                                                                                                        |       | 75,343          |       | 74,160           |       |
|                                                                                                                                     |       |            |       |             |       |
| Cash                                                                                                                                     |       | 171             |       | 273              |       |
| Deferred policy acquisition costs                                                                                                        |       | 3,718           |       | 3,485            |       |
| Reinsurance recoverables, net                                                                                                            |       | 3,385           |       | 3,392            |       |
| Accrued investment income                                                                                                                |       | 679             |       | 689              |       |
| Other assets                                                                                                                             |       | 739             |       | 585              |       |
| Separate Accounts                                                                                                                        |       | 16,225          |       | 16,174           |       |
|                                                                                                                                     |       |            |       |             |       |
| **Total assets**                                                                                                                         |       | $               | 100,260    |             | $          | 98,758 |   |
|                                                                                                                                     |       |            |       |             |       |
| **Liabilities**                                                                                                                          | ** ** | ** **      | ** ** | ** **       | ** ** |
| Contractholder funds                                                                                                                     |       | $               | 61,173     |             | $          | 60,565 |   |
| Reserve for life-contingent contract  benefits                                                                                           |       | 12,081          |       | 12,204           |       |
| Unearned premiums                                                                                                                        |       | 33              |       | 34               |       |
| Payable to affiliates, net                                                                                                               |       | 119             |       | 84               |       |
| Other liabilities and accrued expenses                                                                                                   |       | 4,542           |       | 3,235            |       |
| Deferred income taxes                                                                                                                    |       | 250             |       | 258              |       |
| Note payable to parent                                                                                                                   |       | —          |       | 500              |       |
| Long-term debt                                                                                                                           |       | 200             |       | 206              |       |
| Separate Accounts                                                                                                                        |       | 16,225          |       | 16,174           |       |
|                                                                                                                                     |       |            |       |             |       |
| **Total liabilities**                                                                                                                    |       | 94,623          |       | 93,260           |       |
|                                                                                                                                     |       |            |       |             |       |
| **Commitments and Contingent Liabilities  (Note 5)**                                                                                     | ** ** | ** **      | ** ** | ** **       | ** ** |
|                                                                                                                                     |       |            |       |             |       |
| **Shareholder’s Equity**                                                                                                            | ** ** | ** **      | ** ** | ** **       | ** ** |
| Redeemable preferred stock – series A, $100  par value, 1,500,000 shares authorized, none and 49,230 shares issued and  outstanding |       | —          |       | 5                |       |
| Redeemable preferred stock – series B, $100  par value, 1,500,000 shares authorized, none issued                                    |       | —          |       | —           |       |
| Common stock, $227 par value, 23,800 shares  authorized and outstanding                                                                  |       | 5               |       | 5                |       |
| Additional capital paid-in                                                                                                               |       | 1,108           |       | 1,108            |       |
| Retained income                                                                                                                          |       | 4,382           |       | 4,055            |       |
| Accumulated other comprehensive income:                                                                                                  |       |            |       |             |       |
| Unrealized net capital gains and losses                                                                                                  |       | 142             |       | 325              |       |
|                                                                                                                                     |       |            |       |             |       |
| **Total accumulated other comprehensive  income**                                                                                        |       | 142             |       | 325              |       |
|                                                                                                                                     |       |            |       |             |       |
| **Total shareholder’s equity**                                                                                                      |       | 5,637           |       | 5,498            |       |
|                                                                                                                                     |       |            |       |             |       |
| **Total liabilities and shareholder’s equity**                                                                                      |       | $               | 100,260    |             | $          | 98,758 |   |

 

See notes to condensed consolidated financial statements.

 

2

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                         | ** ** | **June 30,**         | ** ** |
| **(in millions)**                                                                  | ** ** | **2007**             | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | **(Unaudited)**      | ** ** |
| **Cash flows from operating activities**                                           | ** ** | ** **           | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                    | 336        |   | $ | 152 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                 |       |   |   |
| Amortization and other non-cash items                                              |       | (145                 | )          | (134 | ) |
| Realized capital gains and losses                                                  |       | (126                 | )          | 107 |   |
| (Gain) loss on disposition of operations                                           |       | (3                   | )          | 88 |   |
| Interest credited to contractholder funds                                          |       | 1,295                |       | 1,238 |   |
| Changes in:                                                                        |       |                 |       |   |   |
| Contract benefit and other insurance  reserves                                     |       | (105                 | )          | (148 | ) |
| Unearned premiums                                                                  |       | (1                   | )          | (1 | ) |
| Deferred policy acquisition costs                                                  |       | 27                   |       | (126 | ) |
| Reinsurance recoverables, net                                                      |       | (145                 | )          | (82 | ) |
| Income taxes payable                                                               |       | 29                   |       | 40 |   |
| Other operating assets and liabilities                                             |       | (60                  | )          | (16 | ) |
| Net cash provided by operating activities                                          |       | 1,102                |       | 1,118 |   |
|                                                                               |       |                 |       |   |   |
| **Cash flows from investing activities**                                           | ** ** | ** **           | ** ** | ** ** | ** ** |
| Proceeds from sales:                                                               |       |                 |       |   |   |
| Fixed income securities                                                            |       | 5,774                |       | 7,143 |   |
| Equity securities                                                                  |       | 176                  |       | 76 |   |
| Investment collections:                                                            |       |                 |       |   |   |
| Fixed income securities                                                            |       | 1,857                |       | 1,639 |   |
| Mortgage loans                                                                     |       | 892                  |       | 793 |   |
| Investment purchases:                                                              |       |                 |       |   |   |
| Fixed income securities                                                            |       | (7,608               | )          | (9,097 | ) |
| Equity securities                                                                  |       | (416                 | )          | (133 | ) |
| Mortgage loans                                                                     |       | (1,314               | )          | (1,237 | ) |
|                                                                               |       |                 |       |   |   |
| Change in short-term investments, net                                              |       | 74                   |       | (393 | ) |
| Disposition of operations                                                          |       | —               |       | (812 | ) |
| Change in other investments, net                                                   |       | 83                   |       | (30 | ) |
| Net cash used in investing activities                                              |       | (482                 | )          | (2,051 | ) |
|                                                                               |       |                 |       |   |   |
| **Cash flows from financing activities**                                           | ** ** | ** **           | ** ** | ** ** | ** ** |
| Note payable to parent                                                             |       | (500                 | )          | — |   |
| Redemption of redeemable preferred stock                                           |       | (11                  | )          | (13 | ) |
| Contractholder fund deposits                                                       |       | 4,722                |       | 5,644 |   |
| Contractholder fund withdrawals                                                    |       | (4,933               | )          | (4,419 | ) |
| Dividends paid                                                                     |       | —               |       | (125 | ) |
| Net cash (used in) provided by financing  activities                               |       | (722                 | )          | 1,087 |   |
|                                                                               |       |                 |       |   |   |
| **Net (decrease) increase in cash**                                                |       | (102                 | )          | 154 |   |
| **Cash at beginning of the period**                                                |       | 273                  |       | 154 |   |
| **Cash at end of period**                                                          |       | $                    | 171        |   | $ | 308 |   |

 

See notes to condensed consolidated financial statements.

 

3

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.****             ****General**

 

**Basis of Presentation**

 

The accompanying condensed consolidated financialstatements include the accounts of Allstate Life Insurance Company (“ALIC”) andits wholly owned subsidiaries (together with ALIC, the “Company”). ALIC iswholly owned by Allstate Insurance Company (“AIC”), a wholly owned subsidiaryof The Allstate Corporation (the “Corporation”).

 

The condensed consolidated financial statements andnotes as of June 30, 2007, and for the three-month and six-month periods endedJune 30, 2007 and 2006 are unaudited. The condensed consolidated financialstatements reflect all adjustments (consisting only of normal recurring accruals),which are, in the opinion of management, necessary for the fair presentation ofthe financial position, results of operations and cash flows for the interimperiods. 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 year endedDecember 31, 2006. The results of operations for the interim periods should notbe considered indicative of results to be expected for the full year.

 

**Investments**

 

Equity securities include limited partnershipinterests and non-redeemable preferred and common stocks. Common stocks andnon-redeemable preferred stocks had a carrying value of $111 million and $72million, and cost of $100 million and $61 million at June 30, 2007 and December31, 2006, respectively. Investments in limited partnership interests had acarrying value of $744 million and $461 million at June 30, 2007 and December31, 2006, respectively.

 

**Adopted accounting standards**

 

*Statement of Position (**“**SOP**”**) 05-1, Accounting byInsurance Enterprises for Deferred Acquisition Costs in Connection withModifications or Exchanges of Insurance Contracts (“SOP 05-1”)*

 

 In October 2005, the American Institute ofCertified Public Accountants (“AICPA”) issued SOP 05-1. SOP 05-1 providesaccounting guidance for deferred policy acquisition costs associated withinternal replacements of insurance and investment contracts other than thoseset forth in SFAS No. 97, “Accounting and Reporting by Insurance Enterprisesfor Certain Long-Duration Contracts and for Realized Gains and Losses from theSale of Investments”. SOP 05-1 defines an internal replacement as amodification in product benefits, features, rights or coverages that occursthrough the exchange of an existing contract for a new contract, or byamendment, endorsement or rider to an existing contract, or by the election ofa feature or coverage within an existing contract. In February 2007, the AICPAissued Technical Practice Aids (“TPAs”) that provide interpretive guidance tobe used in applying SOP 05-1. The Company adopted the provisions of SOP 05-1 onJanuary 1, 2007 for internal replacements occurring in fiscal years beginningafter December 15, 2006. The adoption resulted in a $9 million after-taxadjustment to unamortized DAC and DSI related to the impact on future estimatedgross profits from the changes in accounting for certain costs associated withcontract continuations that no longer qualify for deferral under SOP 05-1. Theadjustment was recorded as a reduction of retained income at January 1, 2007,and a reduction of DAC and DSI balances of $13 million pre-tax. The ongoingeffects of SOP 05-1 are not expected to have a material impact on the Company’sresults of operations or financial position.

 

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

 

InFebruary 2006, the FASB issued SFAS No. 155, which permits the fair value remeasurementat the date of adoption of any hybrid financial instrument containing anembedded derivative that otherwise would require bifurcation under paragraph 12or 13 of SFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities*”*(“SFAS No. 133”);clarifies which interest-only strips and principal-only strips are not subjectto the requirements of SFAS No. 133; establishes a requirement to evaluateinterests in securitized financial assets to identify interests that arefreestanding derivatives or hybrid financial instruments that contain embeddedderivatives requiring bifurcation; and clarifies that concentrations of creditrisk in the form of subordination are not embedded derivatives. The Companyadopted the provisions of SFAS No. 155 on January 1, 2007, which were effectivefor all financial instruments acquired, issued or subject to a remeasurementevent occurring after the beginning of the first fiscal year that begins afterSeptember 15, 2006. The Company elected not to remeasure existing hybridfinancial instruments at the date of adoption that contained embeddedderivatives requiring bifurcation pursuant to paragraph 

 

4

----

 

12or 13 of SFAS No. 133. The adoption of SFAS No. 155 did not have a materialeffect on the results of operations or financial position of the Company.

 

*Financial Accounting StandardsBoard Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN48”)*

 

InJuly 2006, the FASB issued FIN 48, which clarifies the accounting foruncertainty in income taxes recognized in an entity’s financial statements inaccordance with SFAS No. 109, “Accounting for Income Taxes”. FIN 48 requires anentity to recognize the tax benefit of uncertain tax positions only when it ismore likely than not, based on the position’s technical merits, that theposition would be sustained upon examination by the respective taxingauthorities. The tax benefit is measured as the largest benefit that is morethan fifty-percent likely of being realized upon final settlement with therespective taxing authorities. On January 1, 2007, the Company adopted theprovisions of FIN 48, which are effective for fiscal years beginning afterDecember 15, 2006. No cumulative effect of a change in accounting principle oradjustment to the liability for unrecognized tax benefits was recognized as aresult of the adoption of FIN 48. Accordingly, the adoption of FIN 48 did nothave an effect on the results of operations or financial position of theCompany.

 

TheCompany had no liability for unrecognized tax benefits at January 1, 2007 orJune 30, 2007, and believes it is reasonably possible that the liabilitybalance will not significantly increase or decrease within the next 12 months.

 

TheInternal Revenue Service (“IRS”) completed its review of the Company’s federalincome tax returns through the 2002 tax year and the statute of limitations hasexpired on those years. The IRS is currently examining the Company’s federalincome tax returns for the 2003 and 2004 tax years.

 

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

 

InSeptember 2006, the SEC issued SAB 108 to eliminate the diversity of practicein the process by which misstatements are quantified for purposes of assessingmateriality in the financial statements. SAB 108 is intended to eliminate thepotential for the build up of improper amounts on the balance sheet due to thelimitations of certain methods of materiality assessment utilized in currentpractice. SAB 108 establishes a single quantification framework wherein thesignificance measurement is based on the effects of the misstatements on eachof the financial statements as well as the related financial statementdisclosures. On December 31, 2006, the Company adopted the provisions of SAB108 which were effective for the first fiscal year ending after November 15,2006. The adoption of SAB 108 did not have any effect on its results ofoperations or financial position.

 

*FASB Staff Position No. FAS 115-1,The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments (“FSP FAS 115-1”)*

 

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

 

*SFAS No. 154, Accounting Changesand Error Corrections (“SFAS No. 154”)*

 

SFASNo. 154 replaces Accounting Principles Board (“APB”) Opinion No. 20,“Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in InterimFinancial Statements”. SFAS No. 154 requires retrospective application to priorperiods’ financial statements for changes in accounting principle, unlessdetermination of either the period specific effects or the cumulative effect ofthe change is impracticable or otherwise promulgated. The Company adopted SFASNo. 154 on January 1, 2006. The adoption of SFAS 154 did not have any effect onthe results of operations or financial position of the Company.

 

5

----

 

## **Pendingaccounting standards**

##  

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

 

InSeptember 2006, the FASB issued SFAS No. 157 which redefines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles (“GAAP”), and expands disclosures about fair valuemeasurements. SFAS No. 157 applies where other accounting pronouncementsrequire or permit fair value measurements. Additional disclosures andmodifications to current fair value disclosures will be required upon adoptionof SFAS No. 157. SFAS No. 157 is effective for fiscal years beginning afterNovember 15, 2007. The Company is currently evaluating the effects of adoptionof SFAS No. 157 on its results of operations and financial position.

 

*SFAS No. 159, The Fair ValueOption for Financial Assets and Financial Liabilities (“SFAS No. 159”)*

 

InFebruary 2007, the FASB issued SFAS No. 159 which provides reporting entitiesan option to report selected financial assets, including investment securitiesdesignated as available for sale, and liabilities, including most insurancecontracts, at fair value. SFAS No. 159 establishes presentation and disclosurerequirements designed to facilitate comparisons between companies that choosedifferent measurement attributes for similar types of financial assets andliabilities. The standard also requires additional information to aid financialstatement users’ understanding of the impacts of a reporting entity’s decisionto use fair value on its earnings and also requires entities to display on theface of the balance sheet the fair value of those assets and liabilities forwhich the reporting entity has chosen to measure at fair value. SFAS No. 159 iseffective as of the beginning of a reporting entity’s first fiscal yearbeginning after November 15, 2007.  Early adoption is permitted as of thebeginning of the previous fiscal year provided the entity makes that choice inthe first 120 days of that fiscal year and also elects to apply the provisionsof SFAS No. 157. Because application of the standard is optional, any impactsare limited to those financial assets and liabilities to which SFAS No. 159would be applied, which have yet to be determined.

 

*SOP 07-1, Clarification of theScope of the Audit and Accounting Guide Investment Companies (“the Guide”) andAccounting by Parent Companies and Equity Method Investors for Investments inInvestment Companies–SOP 07-1 (“SOP 07- 1”)*

 

InJune 2007, the AICPA issued SOP 07-1. Upon adoption of the SOP, the Companymust also adopt the provisions of FASB Staff Position No. FIN 46(R)-7,“Application of FASB Interpretation No. 46(R) to Investment Companies”, whichpermanently exempts investment companies from applying the provisions ofInterpretation 46(R) to investments carried at fair value. SOP 07-1 providesguidance for determining whether an entity falls within the scope of the Guideand whether investment company accounting should be retained by a parentcompany upon consolidation of an investment company subsidiary or by an equitymethod investor in an investment company. In certain circumstances SOP 07-1precludes retention of specialized accounting for investment companies (i.e.fair value accounting) when similar direct investments exist in theconsolidated group and are measured on a basis inconsistent with that appliedto investment companies. Additionally SOP 07-1 precludes retention ofspecialized accounting for investment companies if the reporting entity doesnot distinguish through documented policies the nature and type of investmentsto be held in the investment companies from those made in the consolidatedgroup where other accounting guidance is being applied. SOP 07-1 is effectivefor fiscal years beginning on or after December 15, 2007. The Company isassessing the current and future implications of this standard to the resultsof operations and financial position.

 

*FASB Staff Position No. 39-1**Amendmentof FASB Interpretation No. 39* (“FSP FIN 39-1”)

 

InApril 2007, the FASB issued FSP FIN 39-1, which amends FASB Interpretation No.39, “Offsetting of Amounts Related toCertain Contracts”. FSP FIN 39-1 replaces the terms “conditionalcontracts” and “exchange contracts” with the term “derivative instruments” andpermits a reporting entity to offset fair value amounts recognized for theright to reclaim cash collateral (a receivable) or the obligation to returncash collateral (a payable) against fair value amounts recognized forderivative instruments executed with the same counterparty under the samemaster netting arrangement that have been offset in the statement of financialposition. FSP FIN 39-1 is effective for fiscal years beginning after November15, 2007, with early adoption permitted. The effects of applying FSP FIN 39-1will be recorded as a change in accounting principle through retrospectiveapplication. The adoption of FSP FIN 39-1 is not expected to have a materialimpact on the Company’s results of operations or financial position based onthe current level of derivative activity.

 

6

----

 

**2.****             ****Related Party Transactions**

 

OnDecember 27, 2006, the Company issued an intercompany note in the amount of$500 million payable to its parent, AIC, on demand and, in any event, by March30, 2007. This note was fully repaid in the first quarter of 2007. This notehad an interest rate of 5.25% and was reflected as note payable to parent onthe Company’s Consolidated Statements of Financial Position at December 31,2006. Interest expense on this note, which totaled $5 million in the first sixmonths of 2007, is included as a component of operating costs and expenses onthe Condensed Consolidated Statements of Operations.

 

**3.****             ****Supplemental Cash FlowInformation**

 

Non-cashinvestment exchanges and modifications, which primarily reflect refinancing offixed income securities and mergers completed with equity securities, totaled$29 million and $18 million for the six-month periods ended June 30, 2007 and2006, respectively.

 

Liabilitiesfor collateral received in conjunction with securities lending and otheractivities and for funds received from security repurchase activities arereported in other liabilities and accrued expenses in the CondensedConsolidated Statements of Financial Position. The associated cash flows areincluded in cash flows from operating activities in the Condensed ConsolidatedStatements of Cash Flows along with the related changes in investments, whichare as follows:

 

 
| ** **                                                             | ** ** | **Six months ended** | ** ** |
|------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                             | ** ** | **June 30,**         | ** ** |
| **(in millions)**                                                      | ** ** | **2007**             | ** ** | **2006** | ** ** |
| ** **                                                             | ** ** | ** **           | ** ** | ** ** | ** ** |
| **Net change in proceeds managed**                                     | ** ** | ** **           | ** ** | ** ** | ** ** |
| Net change in fixed income securities                                  |       | $                    | (732       | ) | $ | (216 | ) |
| Net change in short-term investments                                   |       | (446                 | )          | (1,155 | ) |
| Operating cash flow used                                               |       | $                    | (1,178     | ) | $ | (1,371 | ) |
|                                                                   |       |                 |       |   |   |
| **Net change in liabilities**                                          | ** ** | ** **           | ** ** | ** ** | ** ** |
| Liabilities for collateral and security  repurchase, beginning of year |       | $                    | (2,294     | ) | $ | (2,231 | ) |
| Liabilities for collateral and security  repurchase, end of period     |       | (3,472               | )          | (3,602 | ) |
| Operating cash flow provided                                           |       | $                    | 1,178      |   | $ | 1,371 |   |

 

**4.****             ****Reinsurance**

 

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

 
| ** **                                         | ** ** | **Three months ended   June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                                  | ** ** | **2007**                          | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                         | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Premiums and contract charges**                  | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Direct                                             |       | $                                 | 580        |                           | $          | 582 |   | $ | 1,178 |   | $ | 1,128 |   |
| Assumed                                            |       |                              |       |                           |       |   |   |   |   |
| Affiliate                                          |       | 4                                 |       | 4                              |       | 8 |   | 8 |   |
| Non-affiliate                                      |       | 6                                 |       | 8                              |       | 13 |   | 15 |   |
| Ceded–non-affiliate                           |       | (238                              | )          | (171                           | )          | (464 | ) | (326 | ) |
|                                               |       |                              |       |                           |       |   |   |   |   |
| Premiums and contract charges, net of  reinsurance |       | $                                 | 352        |                           | $          | 423 |   | $ | 735 |   | $ | 825 |   |

 

7

----

 

Theeffects of reinsurance on contract benefits are as follows:

 
| ** **                            | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                     | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                            | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Contract benefits**                 | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Direct                                |       | $                                | 494        |                           | $          | 443 |   | $ | 993 |   | $ | 886 |   |
| Assumed                               |       |                             |       |                           |       |   |   |   |   |
| Affiliate                             |       | 1                                |       | 3                              |       | 5 |   | 6 |   |
| Non-affiliate                         |       | 6                                |       | 6                              |       | 14 |   | 11 |   |
| Ceded–non-affiliate              |       | (170                             | )          | (125                           | )          | (307 | ) | (250 | ) |
|                                  |       |                             |       |                           |       |   |   |   |   |
| Contract benefits, net of reinsurance |       | $                                | 331        |                           | $          | 327 |   | $ | 705 |   | $ | 653 |   |

 

Theeffects of reinsurance on interest credited to contractholder funds are asfollows:

 
| ** **                                                     | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                                              | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                     | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest credited to contractholder funds**                  | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Direct                                                         |       | $                                | 662        |                           | $          | 627 |   | $ | 1,303 |   | $ | 1,218 |   |
| Assumed                                                        |       |                             |       |                           |       |   |   |   |   |
| Affiliate                                                      |       | 4                                |       | 8                              |       | 7 |   | 15 |   |
| Non-affiliate                                                  |       | 5                                |       | 7                              |       | 9 |   | 13 |   |
| Ceded–non-affiliate                                       |       | (11                              | )          | (7                             | )          | (24 | ) | (8 | ) |
|                                                           |       |                             |       |                           |       |   |   |   |   |
| Interest credited to contractholder funds,  net of reinsurance |       | $                                | 660        |                           | $          | 635 |   | $ | 1,295 |   | $ | 1,238 |   |

 

*Variable Annuity Business*

 

OnJune 1, 2006, in accordance with the terms of the definitive Master TransactionAgreement and related agreements (collectively the “Agreement”) ALIC, itssubsidiary, Allstate Life Insurance Company of New York (“ALNY”), and theCorporation completed the disposal through reinsurance of substantially all ofour variable annuity business to Prudential Financial, Inc. and itssubsidiary, The Prudential Insurance Company of America (collectively“Prudential”). For Allstate, this disposal achieved the economic benefit oftransferring to Prudential the future rights and obligations associated withthis business.

 

Thedisposal was effected through reinsurance agreements (the “ReinsuranceAgreements”) which include both coinsurance and modified coinsurance provisions.Coinsurance and modified coinsurance provisions are commonly used in thereinsurance of variable annuities because variable annuities generally includeboth separate account and general account liabilities. When contractholdersmake a variable annuity deposit, they must choose how to allocate their accountbalances between a selection of variable-return mutual funds that must be heldin a separate account and fixed-return funds held in the Company’s generalaccount. In addition, variable annuity contracts include various benefitguarantees that are general account obligations of the Company. The ReinsuranceAgreements do not extinguish the Company’s primary liability under the variableannuity contracts.

 

Variableannuity balances invested in variable-return mutual funds are held in separateaccounts, which are legally segregated assets and available only to settleseparate account contract obligations. Because the separate account assets mustremain with the Company under insurance regulations, modified coinsurance istypically used when parties wish to transfer future economic benefits of suchbusiness. Under the modified coinsurance provisions, the separate accountassets remain on the Company’s Condensed Consolidated Statements of FinancialPosition, but the related results of operations are fully reinsured andpresented net of reinsurance on the Condensed Consolidated Statements ofOperations.

 

8

----

 

Thecoinsurance provisions of the Reinsurance Agreements were used to transfer thefuture rights and obligations related to fixed–return fund options and benefitguarantees. $1.37 billion of assets supporting general account liabilities weretransferred to Prudential, net of consideration, under the coinsuranceprovisions as of the transaction closing date.  General accountliabilities of $1.35 billion at June 30, 2007 and $1.49 billion as of December31, 2006, however, remain on the Condensed Consolidated Statements of FinancialPosition with a corresponding reinsurance recoverable.

 

Forpurposes of presentation in the Consolidated Statements of Cash Flows, theCompany treated the reinsurance of substantially all our variable annuitybusiness to Prudential as a disposition of operations, consistent with thesubstance of the transaction which was the disposition of a block of businessaccomplished through reinsurance. Accordingly, the net considerationtransferred to Prudential of $744 million (computed as $1.37 billion of generalaccount liabilities transferred to Prudential on the closing date lessconsideration of $628 million), the cost of hedging the ceding commissionreceived from Prudential of $69 million, pretax, and the costs of executing thetransaction of $13 million, pretax, were classified as a disposition ofoperations in the cash flows from investing activities section of theConsolidated Statements of Cash Flows.

 

Underthe Agreement, the Company has indemnified Prudential for certain pre-closingcontingent liabilities (including extra-contractual liabilities of the Companyand liabilities specifically excluded from the transaction) that the Companyhas agreed to retain. In addition, the Company will indemnify Prudential forcertain post-closing liabilities that may arise from the acts of the Companyand its agents, including in connection with the Company’s provision oftransition services. The Reinsurance Agreements contain no limits orindemnifications with regard to insurance risk transfer, and transferred all ofthe future risks and responsibilities for performance on the underlyingvariable annuity contracts to Prudential, including those related to benefitguarantees, in accordance with the provisions of SFAS No. 113, “Accounting andReporting for Reinsurance of Short-Duration and Long-Duration Contracts”.

 

Theterms of the Agreement give Prudential the right to be the exclusive providerof its variable annuity products through the Allstate proprietary agency forcefor three years and a non-exclusive preferred provider for the following twoyears.  During a transition period, the Company will continue to issue newvariable annuity contracts, accept additional deposits on existing businessfrom existing contractholders on behalf of Prudential and, for a period oftwenty-four months or less from the effective date of the transaction, servicethe reinsured business while Prudential prepares for the migration of thebusiness onto its servicing platform.

 

Pursuantto the Agreement, the final market-adjusted consideration was $628 million. Thedisposal resulted in a gain of $77 million pretax for ALIC, which was deferredas a result of the disposition being executed through reinsurance. The deferredgain is included as a component of other liabilities and accrued expenses onthe Consolidated Statements of Financial Position, and is amortized to loss ondispositions of operations on the Consolidated Statements of Operations overthe life of the reinsured business which is estimated to be approximately 18years. For ALNY, the transaction resulted in a loss of $9 million pretax. ALNY’sreinsurance loss and other amounts related to the disposal of the business,including the initial costs and final market value settlements of thederivatives acquired by ALIC to economically hedge substantially all of theexposure related to market adjustments between the effective date of theAgreement and the closing of the transaction, transactional expenses incurredand amortization of ALIC’s deferred reinsurance gain, were included as acomponent of loss on disposition of operations on the Company’s ConsolidatedStatements of Operations and amounted to $61 million, after-tax during 2006. Forthe six-month and twelve-month periods ended June 30, 2007 and December 31,2006, loss on disposition of operations on the Consolidated Statements ofOperations included $2 million and $1 million, after-tax, respectively, ofamortization of ALIC’s deferred gain. DAC and DSI were reduced by $726 millionand $70 million, respectively, as of the effective date of the transaction forbalances related to the variable annuity business subject to the ReinsuranceAgreements.

 

Theseparate account balances related to the modified coinsurance were $15.05billion as of June 30, 2007 and $15.07 billion as of December 31, 2006. Separate account balances totaling approximately $1.18 billion as of June 30,2007 and $1.10 billion at December 31, 2006 relate primarily to the variablelife business that is being retained, and the variable annuity business inthree affiliated companies that were not included in the Agreement. In thefirst five-months of 2006, prior to this disposition, the Company’s variableannuity business generated approximately $127 million in contract charges.

 

9

----

 

**5.****             ****Guarantees and ContingentLiabilities**

 

**Guarantees**

 

TheCompany owns certain fixed income securities that obligate the Company toexchange credit risk or to forfeit principal due, depending on the nature oroccurrence of specified credit events for the referenced entities. In the eventall such specified credit events were to occur, the Company’s maximum amount atrisk on these fixed income securities, as measured by the amount of theaggregate initial investment was $252 million at June 30, 2007. The obligationsassociated with these fixed income securities expire at various times duringthe next seven years.

 

In the normal course of business, the Companyprovides standard indemnifications to counterparties in contracts in connectionwith numerous transactions, including acquisitions and divestitures. The typesof indemnifications typically provided include indemnifications for breaches ofrepresentations and warranties, taxes and certain other liabilities, such asthird party lawsuits. The indemnification clauses are often standardcontractual terms and were entered into in the normal course of business basedon an assessment that the risk of loss would be remote. The terms of theindemnifications vary in duration and nature. In many cases, the maximumobligation is not explicitly stated and the contingencies triggering theobligation to indemnify have not occurred and are not expected to occur. Consequently,the maximum amount of the obligation under such indemnifications is notdeterminable. Historically, the Company has not made any material payments pursuantto these obligations.

 

The aggregate liability balance related to allguarantees was not material as of June 30, 2007.

 

**Regulation**

 

TheCompany is subject to changing social, economic and regulatory conditions. Fromtime to time, regulatory authorities or legislative bodies seek to imposeadditional regulations regarding agent and broker compensation and otherwiseexpand overall regulation of insurance products and the insurance industry. Theultimate changes and eventual effects of these initiatives on the Company’sbusiness, if any, are uncertain.

 

**Legal and regulatory 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” sub-section below, please note thefollowing:

 

•             These matters raise difficult and complicatedfactual and legal issues and are subject to many uncertainties andcomplexities, including the underlying facts of each matter; novel legalissues; variations between jurisdictions in which matters are being litigated,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 and, in some cases, thetiming of their resolutions relative to other similar matters involving othercompanies; the fact that some of the lawsuits are putative class actions inwhich a class has not been certified and in which the purported class may notbe clearly defined; the fact that some of the lawsuits involve multi-stateclass actions in which the applicable law(s) for the claims at issue is indispute and therefore unclear; and the current challenging legal environmentfaced by large corporations and insurance companies.

 

•             In the lawsuits, plaintiffs seek a variety ofremedies including equitable relief in the form of injunctive and otherremedies and monetary relief in the form of contractual and extra-contractualdamages. In some cases, the monetary damages sought include punitive damages. Oftenspecific information about the relief sought, such as the amount of damages, isnot available because plaintiffs have not requested specific relief in theirpleadings. In our experience, when specific monetary demands are made inpleadings, they bear little relation to the ultimate loss, if any, to theCompany.

 

10

----

 

•                  In connection with regulatory examinationsand proceedings, government authorities may seek various forms of relief,including penalties, restitution and changes in business practices. The Companymay not be advised of the nature and extent of relief sought until the finalstages of the examination or proceeding.

 

•             For the reasons specified above, it is oftennot possible to make meaningful estimates of the amount or range of loss thatcould result from the matters described below in the “Proceedings” subsection. TheCompany reviews these matters on an on-going basis and follows the provisionsof SFAS No. 5, “Accounting for Contingencies”, when making accrual anddisclosure decisions. When assessing reasonably possible and probable outcomes,the Company bases its decisions on its assessment of the ultimate outcomefollowing all appeals.

 

•             Due to the complexity and scope of thematters disclosed in the “Proceedings” subsection below and the manyuncertainties that exist, the ultimate outcome of these matters cannot bereasonably predicted. In the event of an unfavorable outcome in one or more ofthese matters, the ultimate liability may be in excess of amounts currentlyreserved and may be material to the Company’s operating results or cash flowsfor a particular quarter or annual period. 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 have amaterial 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, information about the more significant of theseproceedings is provided in the following paragraph.

 

AICis defending certain matters relating to its agency program reorganizationannounced in 1999. These matters include a lawsuit filed in December 2001by the U.S. Equal Employment Opportunity Commission (“EEOC”) allegingretaliation under federal civil rights laws (the “EEOC I” suit) and a classaction filed in August 2001 by former employee agents alleging retaliation andage discrimination under the Age Discrimination in Employment Act (“ADEA”),breach of contract and ERISA violations (the “Romero I” suit). In March 2004,in the consolidated EEOC I and Romero I litigation, the trial court issued amemorandum and order that, among other things, certified classes of agents,including a mandatory class of agents who had signed a release, for purposes ofeffecting the court’s declaratory judgment that the release is voidable at theoption of the release signer. The court also ordered that an agent who voidsthe release must return to AIC “any and all benefits received by the [agent] inexchange for signing the release.”  Thecourt also stated that, “on the undisputed facts of record, there is no basisfor claims of age discrimination.”  TheEEOC and plaintiffs have asked the court to clarify and/or reconsider itsmemorandum and order and on January 16, 2007, the judge denied their request. OnJune 20, 2007, the court granted AIC’s motions for summary judgment. The EEOCalso filed another lawsuit in October 2004 alleging age discrimination withrespect to a policy limiting the rehire of agents affected by the agencyprogram reorganization (the “EEOC II” suit). In EEOC II, in October 2006, thecourt granted partial summary judgment to the EEOC. Although the court did notdetermine that AIC was liable for age discrimination under the ADEA, itdetermined that the rehire policy resulted in a disparate impact, reserving fortrial the determination on whether AIC had reasonable factors other than age tosupport the rehire policy. AIC’s petitions for interlocutory review of thetrial court’s summary judgment order were granted. AIC’s interlocutory appealis now pending in the Court of Appeals for the Eighth Circuit. AIC is alsodefending a certified class action filed by former employee agents whoterminated their employment prior to the agency program reorganization. Theseplaintiffs have asserted breach of contract and ERISA claims. A putativenationwide class action has also been filed by former employee agents allegingvarious violations of ERISA, including a 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. This matter was dismissed with prejudice by thetrial court, was the subject of further proceedings on appeal, and was reversedand remanded to the trial court in April 2005. On June 20, 2007, the courtgranted AIC’s motion to dismiss the case. In all of these various matters,plaintiffs seek compensatory and punitive damages, and equitable relief. AIChas been vigorously defending these lawsuits and other matters related to itsagency program reorganization. The outcome of these disputes is currently uncertain.

 

11

----

 

TheCompany is defending a certified nationwide class action related to certain ofits universal life policies written prior to 1992. The breach of contract claiminvolves premium increases that the Company charged related to those policies. Otherlife insurance companies have faced similar suits. The parties have reached asettlement, which has been preliminarily approved by the court.

 

**Other Matters**

 

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

 

Oneor more of these matters could have an adverse effect on the Company’soperating results or cash flows for a particular quarter or annual period. However,based on information currently known to it, management believes that theultimate outcome of all matters described in this “Other Matters” subsection,in excess of amounts currently reserved, as they are resolved over time is notlikely to have a material effect on the operating results, cash flows orfinancial position of the Company.

 

**6.****             ****Other Comprehensive Income**

 

The components of other comprehensive (loss) incomeon a pretax and after-tax basis are as follows:

 
| ** **                                                                       | ** ** | **Three months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                       | ** ** | **2007**                        | ** ** | **2006** | ** ** |
| **(in millions)**                                                                | ** ** | **Pretax**                      | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pretax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding losses arising  during the period, net of related offsets |       | $                               | (437       | ) | $ | 153 |   | $ | (284 | ) | $ | (497 | ) | $ | 174 |   | $ | (323 | ) |
| Less: reclassification adjustment of  realized capital gains and losses          |       | (42                             | )          | 15 |   | (27 | ) | (171 | ) | 60 |   | (111 | ) |
| Other comprehensive loss                                                         |       | $                               | (395       | ) | $ | 138 |   | (257 | ) | $ | (326 | ) | $ | 114 |   | (212 | ) |
|                                                                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                       |       |                            |       |   |   | 187 |   |   |   |   |   | 56 |   |
| Comprehensive loss                                                               |       |                            |       |   |   | $ | (70 | ) |   |   |   |   | $ | (156 | ) |

 
| ** **                                                                       | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                       | ** ** | **2007**                      | ** ** | **2006** | ** ** |
| **(in millions)**                                                                | ** ** | **Pretax**                    | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pretax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding losses arising  during the period, net of related offsets |       | $                             | (286       | ) | $ | 100 |   | $ | (186 | ) | $ | (1,131 | ) | $ | 396 |   | $ | (735 | ) |
| Less: reclassification adjustment of  realized capital gains and losses          |       | (4                            | )          | 1 |   | (3 | ) | (296 | ) | 104 |   | (192 | ) |
| Other comprehensive loss                                                         |       | $                             | (282       | ) | $ | 99 |   | (183 | ) | $ | (835 | ) | $ | 292 |   | (543 | ) |
|                                                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                       |       |                          |       |   |   | 336 |   |   |   |   |   | 152 |   |
| Comprehensive income (loss)                                                      |       |                          |       |   |   | $ | 153 |   |   |   |   |   | $ | (391 | ) |

 

12

----

 

**7.****             ****Quarterly Results**

 
| ** **                                                                    | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------|------------|--------------------|------------|
| **(in millions)**                                                             | ** ** | **2007**          | ** ** | **2006**           | ** ** | **2005** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues                                                                      |       | $                 | 1,435      |               | $          | 1,349 |   | $ | 1,290 |   | $ | 1,509 |   | $ | 1,360 |   | $ | 1,315 |   |
| Income before cumulative effect of change  in accounting principle, after-tax |       | 149               |       | 96                 |       | 68 |   | 187 |   | 56 |   | 87 |   |
| Net income                                                                    |       | 149               |       | 96                 |       | 68 |   | 187 |   | 56 |   | 87 |   |
|                                                                               |            |                   |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                    | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| **(in millions)**                                                        | ** ** | **2006**               | ** ** | **2005**                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues                                                                      |       | $                      | 1,352      |                    | $          | 1,347 |   | $ | 1,502 |   | $ | 1,327 |   |
| Income before cumulative effect of change  in accounting principle, after-tax |       | 122                    |       | 159                     |       | 154 |   | 103 |   |
| Net income                                                                    |       | 122                    |       | 159                     |       | 154 |   | 103 |   |
|                                                                               |            |                        |            |                         |            |  |  |  |  |  |  |  |  |

 

13

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholder of

AllstateLife Insurance Company:

 

Wehave reviewed the accompanying condensed consolidated statement of financialposition of Allstate Life Insurance Company and subsidiaries (the “Company”, anaffiliate of The Allstate Corporation) as of June 30, 2007, and the relatedcondensed consolidated statements of operations for the three-month andsix-month periods ended June 30, 2007 and 2006, and the condensed consolidatedstatements of cash flows for the six-month periods ended June 30, 2007 and2006. These interim financial statements are the responsibility of theCompany’s management.

 

Weconducted our reviews in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). A review of interim financialinformation consists principally of applying analytical procedures and makinginquiries of persons responsible for financial and accounting matters. It issubstantially less in scope than an audit conducted in accordance with the standardsof the Public Company Accounting Oversight Board (United States), the objectiveof which is the expression of an opinion regarding the financial statementstaken 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, 2006, and the related consolidated statements of operationsand comprehensive income, shareholder’s equity, and cash flows for the year thenended, not presented herein. In our report dated March 9, 2007, which reportincludes an explanatory paragraph relating to a change in method of accountingfor certain nontraditional long-duration contracts and for separate accounts in2004, we expressed an unqualified opinion on those consolidated financialstatements. In our opinion, the information set forth in the accompanyingcondensed consolidated statement of financial position as of December 31, 2006is fairly 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  6, 2007                |

 

14

----

 

**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF**

**OPERATIONS FOR THE THREE-MONTH AND SIX-MONTH PERIODSENDED JUNE 30, 2007 AND 2006**

 

**OVERVIEW**

 

Thefollowing discussion highlights significant factors influencing the consolidatedfinancial position and results of operations of Allstate Life Insurance Company(referred to in this document as “we”, “our”, “us”, or the “Company”). Itshould be read in conjunction with the condensed consolidated financialstatements and notes thereto found under Part I. Item 1. contained herein, andwith the discussion, analysis, consolidated financial statements and notesthereto in Part I. Item 1. and Part II. Item 7. and Item 8. of the AllstateLife Insurance Company Annual Report on Form 10-K for 2006. We operate as asingle segment entity, based on the manner in which we use financialinformation to evaluate business performance and to determine the allocation ofresources.

 

**HIGHLIGHTS**

 

•                  Net income increased $131 million to $187million in the second quarter of 2007 and $184 million to $336 million in thefirst six months of 2007 compared to the same periods in 2006.

 

•                  Gross margin declined 12.8% to $443 millionin the second quarter of 2007 and 11.7% to $864 million in the first six monthsof 2007 compared to the same periods in 2006.

 

•                  Contractholder fund deposits totaled $2.50billion and $4.73 billion for the second quarter and first six months of 2007,respectively, compared to $3.63 billion and $5.57 billion for the secondquarter and first six months of 2006, respectively.

 

•                  Investments as of June 30, 2007 increased2.3% from June 30, 2006 and net investment income increased 3.5% and 4.6% inthe second quarter and first six months of 2007, respectively, compared to thesame periods of 2006.

 

•                  Return on average shareholder’s equity was11.0% and 7.0% for the twelve months ended June 30, 2007 and 2006,respectively.

 

•                  Effective June 1, 2006, we disposed ofsubstantially all of our variable annuity business through reinsurance withPrudential Financial Inc. (“Prudential”). The following table presents theresults of operations attributable to our variable annuity business for theperiod of 2006 prior to the disposition.

 
| **(in millions)**                                                           | ** ** | **Three Months Ended June 30, 2006** | ** ** | **Six Months Ended June 30, 2006** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **Favorable/(unfavorable)**                                                 | ** ** | ** **                           | ** ** | ** **                         | ** ** |
| Life and annuity premiums and contract  charges                             |       | $                                    | 61         |                               | $          | 136 |   |
| Net investment income                                                       |       | 6                                    |       | 16                                 |       |
| Periodic settlements and accruals on non-  hedge derivative instruments (1) |       | —                               |       | 1                                  |       |
| Contract benefits                                                           |       | (1                                   | )          | (12                                | )          |
| Interest credited to contractholder funds  (2)                              |       | (8                                   | )          | (21                                | )          |
| Gross margin (3)                                                            |       | 58                                   |       | 120                                |       |
| Realized capital gains and losses                                           |       | (1                                   | )          | (9                                 | )          |
| Amortization of DAC and DSI (2)                                             |       | (44                                  | )          | (47                                | )          |
| Operating costs and expenses                                                |       | (18                                  | )          | (43                                | )          |
| Loss on disposition of operations                                           |       | (35                                  | )          | (88                                | )          |
| Income from operations before income tax  expense                           |       | $                                    | (40        | )                                  | $          | (67 | ) |
|                                                                        |       |                                 |       |                               |       |
| Investment margin                                                           |       | $                                    | (2         | )                                  | $          | (4 | ) |
| Benefit margin                                                              |       | 16                                   |       | 15                                 |       |
| Contract charges and fees                                                   |       | 44                                   |       | 109                                |       |
| Gross margin (3)                                                            |       | $                                    | 58         |                               | $          | 120 |   |

 

----

| (1)    | Periodic  settlements and accruals on non-hedge derivative instruments are reflected as  a component of realized capital gains and losses on the Condensed  Consolidated Statements of Operations.                                                                                                                                                                                             |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                           |
| (2)    | For  purposes of calculating gross margin, amortization of deferred sales inducements  (“DSI”) is excluded from interest credited to contractholder funds and  aggregated with amortization of DAC due to the similarity in the substance of  the two items. Amortization of DSI for variable annuities totaled $3 million  in both the second quarter and first six months of 2006. |
|   |                                                                                                                                                                                                                                                                                                                                                                                           |
| (3)    | Gross  margin and its components are measures that are not based on GAAP. Gross  margin, investment margin and benefit margin are defined on pages 19, 20 and  22, respectively.                                                                                                                                                                                                               |

 

15

----

 

**OPERATIONS**

 

**Premiums** represent revenues generated from traditional life, immediateannuities with life contingencies and other insurance products that havesignificant mortality or morbidity risk.

 

**Contract charges** are revenues generated from interest-sensitive life, fixed annuities,institutional products and variable annuities for which deposits are classifiedas contractholder funds or separate accounts liabilities. Contract charges areassessed against the contractholder account values for maintenance,administration, cost of insurance and surrender prior to contractuallyspecified dates. As a result, changes in contractholder funds are considered inthe evaluation of growth and as indicators of future levels of revenues.Subsequent to the close of our reinsurance transaction with Prudential,variable annuity contract charges on the business subject to the transactionare fully reinsured to Prudential and presented net of reinsurance on theCondensed Consolidated Statements of Operations (see Note 4 to the CondensedConsolidated Financial Statements).

 

Thefollowing table summarizes premiums and contract charges by product.

 
| ** **                                  | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                           | ** ** | **2007**                          | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                  | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Premiums**                                | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Traditional life                            |       | $                                 | 61         |                           | $          | 68 |   | $ | 130 |   | $ | 126 |   |
| Immediate annuities with life contingencies |       | 52                                |       | 69                             |       | 129 |   | 118 |   |
| Other                                       |       | 9                                 |       | 9                              |       | 18 |   | 19 |   |
| **Total premiums**                          |       | 122                               |       | 146                            |       | 277 |   | 263 |   |
| ** **                                  | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Contract charges**                        | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-sensitive life                     |       | 210                               |       | 197                            |       | 420 |   | 389 |   |
| Fixed annuities                             |       | 19                                |       | 19                             |       | 37 |   | 36 |   |
| Variable annuities                          |       | 1                                 |       | 61                             |       | 1 |   | 137 |   |
| **Total contract charges**                  |       | 230                               |       | 277                            |       | 458 |   | 562 |   |
| ** **                                  | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total premiums and contract charges**     |       | $                                 | 352        |                           | $          | 423 |   | $ | 735 |   | $ | 825 |   |

 

 

Totalpremiums declined 16.4% in the second quarter of 2007 compared to the secondquarter of 2006 and increased 5.3% in the first six months of 2007 compared tothe same period of 2006. The decline in the second quarter of 2007 was due tolower sales of immediate annuities with life contingencies and traditional lifeproducts. The increase in the first six months of 2007 was the result of highersales of immediate annuities with life contingencies and traditional lifeproducts.

 

Contractcharges decreased 17.0% and 18.5% in the second quarter and first six months of2007, respectively, compared to the same periods of 2006. Excluding contractcharges on variable annuities, substantially all of which are reinsured toPrudential effective June 1, 2006, contract charges increased 6.0% and 7.5% inthe second quarter and first six months of 2007, respectively, compared to thesame periods of 2006. The increase in both periods was driven by highercontract charges on interest-sensitive life products resulting from growth ofbusiness in force.

 

16

----

 

*Contractholder funds* represent interest-bearing liabilitiesarising from the sale of individual and institutional products, such asinterest-sensitive life, fixed annuities and funding agreements. 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.

 

Thefollowing table shows the changes in contractholder funds.

 
| ** **                                                      | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                                               | ** ** | **2007**                          | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Contractholder funds, beginning balance**                     |       | $                                 | 61,014     |                           | $          | 58,412 |   | $ | 60,565 |   | $ | 58,190 |   |
| ** **                                                      | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Deposits**                                                    | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fixed annuities                                                 |       | 879                               |       | 2,015                          |       | 1,575 |   | 3,216 |   |
| Institutional products (funding agreements)                     |       | 1,300                             |       | 1,250                          |       | 2,500 |   | 1,600 |   |
| Interest-sensitive life                                         |       | 323                               |       | 334                            |       | 655 |   | 656 |   |
| Variable annuity and life deposits  allocated to fixed accounts |       | 1                                 |       | 35                             |       | 1 |   | 98 |   |
| Total deposits                                                  |       | 2,503                             |       | 3,634                          |       | 4,731 |   | 5,570 |   |
| ** **                                                      | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest credited**                                           |       | 659                               |       | 647                            |       | 1,304 |   | 1,268 |   |
| ** **                                                      | ** ** | ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Maturities, benefits, withdrawals and other  adjustments**    |       |                              |       |                           |       |   |   |   |   |
| Maturities of institutional products                            |       | (1,243                            | )          | (559                           | )          | (1,995 | ) | (1,263 | ) |
| Benefits                                                        |       | (416                              | )          | (386                           | )          | (831 | ) | (756 | ) |
| Surrenders and partial withdrawals                              |       | (1,120                            | )          | (1,257                         | )          | (2,111 | ) | (2,254 | ) |
| Contract charges                                                |       | (183                              | )          | (173                           | )          | (365 | ) | (341 | ) |
| Net transfers from (to) separate accounts                       |       | 3                                 |       | (62                            | )          | 6 |   | (145 | ) |
| Fair value hedge adjustments for  institutional products        |       | (17                               | )          | (2                             | )          | (34 | ) | (20 | ) |
| Other adjustments                                               |       | (27                               | )          | (46                            | )          | (97 | ) | (41 | ) |
| Total maturities, benefits, withdrawals and  other adjustments  |       | (3,003                            | )          | (2,485                         | )          | (5,427 | ) | (4,820 | ) |
| **Contractholder funds, ending balance**                        |       | $                                 | 61,173     |                           | $          | 60,208 |   | $ | 61,173 |   | $ | 60,208 |   |

 

 

Contractholderfunds increased 0.3% and 3.1% in the second quarters of 2007 and 2006, andincreased 1.0% and 3.5% in the first six months of 2007 and 2006, respectively.Average contractholder funds increased 3.0% and 2.8% in the second quarter andfirst six months of 2007, respectively, compared to the same periods in 2006.This is compared to an increase in average contractholder funds of 5.0% and 6.4%in the second quarter and first six months of 2006, respectively, compared tothe same periods in 2005.

 

Contractholderdeposits declined 31.1% and 15.1% in the second quarter and first six months of2007, respectively, compared to the same periods of 2006. These declines wereprimarily due to lower deposits on fixed annuities partially offset by higherdeposits on funding agreements. Deferred fixed annuity deposits were $828million and $1.45 billion (including indexed annuities) in the second quarter andfirst six months of 2007, respectively, a decrease of 57.4% and 52.3%,respectively, compared to the same periods in the prior year. These declinesare indicative of lower industry-wide fixed annuity sales and our strategy toraise new business returns on capital for these products.

 

Surrendersand partial withdrawals on deferred fixed annuities and interest-sensitive lifeproducts decreased 10.9% and 6.3% in the second quarter and first six months of2007, respectively, compared to the same periods of 2006. Partiallycontributing to these declines is the absence in 2007 of surrenders and partialwithdrawals related to the variable annuity business that was reinsuredeffective June 1, 2006. Subsequent to the effective date of that transaction,the net change in contractholder funds attributable to the reinsured variableannuity business is included as a component of the other adjustments line inthe table above. Excluding variable annuities, the annualized surrender andpartial withdrawal rate, based on the beginning of period contractholder funds,was 9.9% and 10.8% for the first six months of 2007 and 2006, respectively.

 

17

----

 

**Net investment income** increased 3.5% in the second quarter and4.6% in the first six months of 2007 compared to the same periods of 2006. Theincrease in both periods was primarily driven by increased investment yieldsand higher average portfolio balances. The higher portfolio yields wereprimarily due to increased yields on floating rate instruments and, to a lesserextent, improved yields on fixed rate assets. For certain products, the yieldchanges on our floating rate instruments are primarily offset by changes increditing rates to our floating rate contractholders resulting in minimalimpact on our gross margin. Higher average portfolio balances resultedprimarily from the investment of operating cash flows.

 

**Net income** analysis is presented in the following table.

 
| ** **                                                                                            | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                                                                                     | ** ** | **2007**                          | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                                  |       |                              |       |                           |       |   |   |   |   |
| Premiums                                                                                              |       | $                                 | 122        |                           | $          | 146 |   | $ | 277 |   | $ | 263 |   |
| Contract charges                                                                                      |       | 230                               |       | 277                            |       | 458 |   | 562 |   |
| Net investment income                                                                                 |       | 1,053                             |       | 1,017                          |       | 2,083 |   | 1,991 |   |
| Periodic settlements and accruals on  non-hedge derivative instruments(1)                             |       | 12                                |       | 14                             |       | 24 |   | 30 |   |
| Contract benefits                                                                                     |       | (331                              | )          | (327                           | )          | (705 | ) | (653 | ) |
| Interest credited to contractholder  funds(2)                                                         |       | (641                              | )          | (619                           | )          | (1,266 | ) | (1,215 | ) |
| Interest expense(3)                                                                                   |       | (2                                | )          | —                         |       | (7 | ) | — |   |
| **Gross margin**                                                                                      |       | 443                               |       | 508                            |       | 864 |   | 978 |   |
|                                                                                                  |       |                              |       |                           |       |   |   |   |   |
| Amortization of DAC and DSI(2)(4)                                                                     |       | (162                              | )          | (188                           | )          | (287 | ) | (342 | ) |
| Operating costs and expenses(3)                                                                       |       | (71                               | )          | (98                            | )          | (153 | ) | (201 | ) |
| Restructuring and related charges                                                                     |       | 1                                 |       | (3                             | )          | 1 |   | (18 | ) |
| Income tax expense                                                                                    |       | (70                               | )          | (76                            | )          | (142 | ) | (142 | ) |
| Realized capital gains and losses, after-tax                                                          |       | 67                                |       | (51                            | )          | 81 |   | (69 | ) |
| DAC and DSI amortization relating to  realized capital gains and losses, after-tax(4)                 |       | (15                               | )          | (3                             | )          | (15 | ) | 24 |   |
| Reclassification of periodic settlements  and accruals on non-hedge derivative instruments, after-tax |       | (7                                | )          | (9                             | )          | (15 | ) | (19 | ) |
| Gain (loss) on disposition of operations,  after-tax                                                  |       | 1                                 |       | (24                            | )          | 2 |   | (59 | ) |
| **Net income**                                                                                        |       | $                                 | 187        |                           | $          | 56 |   | $ | 336 |   | $ | 152 |   |

 

----

| (1)    | Periodic  settlements and accruals on non-hedge derivative instruments are reflected as  a component of realized capital gains and losses on the Condensed  Consolidated Statements of Operations.                                                                                                                                                                                                                                                                                                     |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (2)    | For  purposes of calculating gross margin, amortization of DSI is excluded from  interest credited to contractholder funds and aggregated with amortization of  DAC due to the similarity in the substance of the two items. Amortization of  DSI totaled $(19) million and $(16) million in the three months ended June  30, 2007 and 2006, respectively, and $(29) million and $(23) million in the  first six months of 2007 and 2006, respectively.                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (3)    | For  purposes of calculating gross margin, interest expense incurred on borrowings  from affiliates that are used to fund asset purchases in advance of incurring  a product liability is included as a component of gross margin. This interest  expense is included as a component of operating costs and expenses on the  Condensed Consolidated Statements of Operations.                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (4)    | Amortization  of DAC and DSI relating to realized capital gains and losses is analyzed  separately because realized capital gains and losses may vary significantly  between periods and obscure trends in our business. Amortization of DAC and  DSI relating to realized capital gains and losses, pretax, was $(23) million  and $(4) million in the second quarter of 2007 and 2006, respectively, and  was $(23) million and $38 million in the first six months of 2007 and 2006,  respectively. |

 

18

----

 

*Gross margin*, a non-GAAP measure, is comprised of premiums and contract charges,and net investment income, less contract benefits and interest credited tocontractholder funds excluding amortization of DSI. Gross margin also includesperiodic settlements and accruals on certain non-hedge derivative instruments(see additional discussion under *“investmentmargin”)*. Gross margin is a component of our evaluation of theprofitability of our life insurance and financial product portfolio. Grossmargin is comprised of three components that are utilized to further analyzethe business: investment margin, benefit margin, and contract charges and fees.We use gross margin to evaluate the performance of the business. We believegross margin and its components are also useful to investors because they allowfor the evaluation of income components separately and in the aggregate whenreviewing performance. This actuarial analysis, which is commonly employedthroughout the life insurance industry, measures the difference between productpremiums and accrued policy benefits and between net investment income and bothinterest credited to contractholder funds and insurance reserves. It revealsthe integrity and propriety of the pricing assumptions and financialperformance. Additionally, for many of our products, including fixed annuities,variable life, and interest-sensitive life insurance, the amortization of DACand DSI is determined based on actual and expected gross margin. Variability ofour results may be caused by this amortization which may be the result of grossmargin variability. The analysis of gross margin and its components, separatelyand in the aggregate, provide transparency to our results of operations. Grossmargin, investment margin and benefit margin should not be considered as asubstitute for net income and do not reflect the overall profitability of thebusiness. Net income is the GAAP measure that is most directly comparable tothese margins. Gross margin is best considered in its context as a component ofnet income and is presented as such and is reconciled to GAAP net income in thetable above.

 

Thecomponents of gross margin are reconciled to the corresponding financialstatement line items in the following tables. 

 
| ** **                                                                | ** ** | **Three Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                | ** ** | **Investment Margin**           | ** ** | **Benefit Margin** | ** ** | **Contract Charges   and Fees** | ** ** | **Gross Margin** | ** ** |
| **(in millions)**                                                         | ** ** | **2007**                        | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Premiums                                                                  |       | $                               | —     |   | $ | — |   | $ | 122 |   | $ | 146 |   | $ | — |   | $ | — |   | $ | 122 |   | $ | 146 |   |
| Contract charges                                                          |       | —                          |       | — |   | 150 |   | 159 |   | 80 |   | 118 |   | 230 |   | 277 |   |
| Net investment income                                                     |       | 1,053                           |       | 1,017 |   | — |   | — |   | — |   | — |   | 1,053 |   | 1,017 |   |
| Periodic settlements and accruals on  non-hedge derivative instruments(1) |       | 12                              |       | 14 |   | — |   | — |   | — |   | — |   | 12 |   | 14 |   |
| Contract benefits                                                         |       | (138                            | )          | (134 | ) | (193 | ) | (193 | ) | — |   | — |   | (331 | ) | (327 | ) |
| Interest credited to contractholder  funds(2)                             |       | (641                            | )          | (619 | ) | — |   | — |   | — |   | — |   | (641 | ) | (619 | ) |
| Interest expense(3)                                                       |       | (2                              | )          | — |   | — |   | — |   | — |   | — |   | (2 | ) | — |   |
|                                                                      |       | $                               | 284        |   | $ | 278 |   | $ | 79 |   | $ | 112 |   | $ | 80 |   | $ | 118 |   | $ | 443 |   | $ | 508 |   |

 

19

----

 
| ** **                                                                | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                | ** ** | **Investment Margin**         | ** ** | **Benefit Margin** | ** ** | **Contract Charges   and Fees** | ** ** | **Gross Margin** | ** ** |
| **(in millions)**                                                         | ** ** | **2007**                      | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Premiums                                                                  |       | $                             | —     |   | $ | — |   | $ | 277 |   | $ | 263 |   | $ | — |   | $ | — |   | $ | 277 |   | $ | 263 |   |
| Contract charges                                                          |       | —                        |       | — |   | 300 |   | 310 |   | 158 |   | 252 |   | 458 |   | 562 |   |
| Net investment income                                                     |       | 2,083                         |       | 1,991 |   | — |   | — |   | — |   | — |   | 2,083 |   | 1,991 |   |
| Periodic settlements and accruals on  non-hedge derivative instruments(1) |       | 24                            |       | 30 |   | — |   | — |   | — |   | — |   | 24 |   | 30 |   |
| Contract benefits                                                         |       | (275                          | )          | (267 | ) | (430 | ) | (386 | ) | — |   | — |   | (705 | ) | (653 | ) |
| Interest credited to contractholder  funds(2)                             |       | (1,266                        | )          | (1,215 | ) | — |   | — |   | — |   | — |   | (1,266 | ) | (1,215 | ) |
| Interest expense(3)                                                       |       | (7                            | )          | — |   | — |   | — |   | — |   | — |   | (7 | ) | — |   |
|                                                                      |       | $                             | 559        |   | $ | 539 |   | $ | 147 |   | $ | 187 |   | $ | 158 |   | $ | 252 |   | $ | 864 |   | $ | 978 |   |

 

----

| (1)    | Periodic  settlements and accruals on non-hedge derivative instruments are reflected as  a component of realized capital gains and losses on the Condensed  Consolidated Statements of Operations.                                                                                                                                                                                                                                            |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (2)    | For  purposes of calculating gross margin, amortization of DSI is excluded from  interest credited to contractholder funds and aggregated with amortization of  DAC due to the similarity in the substance of the two items. Amortization of  DSI totaled $(19) million and $(16) million in the second quarter of 2007 and  2006, respectively, and $(29) million and $(23) million in the first six  months of 2007 and 2006, respectively. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (3)    | For  purposes of calculating gross margin, interest expense incurred on borrowings  from affiliates that are used to fund asset purchases in advance of incurring  a product liability is included as a component of gross margin. This interest  expense is included as a component of operating costs and expenses on the  Condensed Consolidated Statements of Operations.                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                          |

Thedecreases in gross margin of 12.8% in the second quarter of 2007 and 11.7% inthe first six months of 2007 compared to the same periods of 2006 weresignificantly impacted by the absence in 2007 of gross margin on variableannuities that are reinsured effective June 1, 2006. Excluding the impact ofthe reinsured variable annuity business, gross margin declined 1.6% in thesecond quarter and increased 0.7% in the first six months of 2007. The slightdecline in gross margin in the second quarter of 2007, excluding the impact ofthe reinsured variable annuity business, was the result of lower benefit marginpartially offset by higher contract charges and fees. The modest increase ingross margin in the first six months of 2007, excluding the impact of thereinsured variable annuity business, was attributable to higher contractcharges and fees as well as investment margin, partially offset by lowerbenefit margin.

 

*Investment margin* is a component of gross margin, both ofwhich are non-GAAP measures. Investment margin represents the excess of netinvestment income and periodic settlements and accruals on non-hedge derivativeinstruments over interest credited to contractholder funds, the impliedinterest on life-contingent immediate annuities included in the reserve forlife-contingent contract benefits, and interest expense incurred on borrowings fromaffiliates that are used to fund asset purchases in advance of incurring aproduct liability. We utilize derivative instruments as economic hedges ofinvestments or contractholder funds or to replicate fixed income securities.These instruments do not qualify for hedge accounting or are not designated ashedges for accounting purposes. Such derivatives are accounted for at fairvalue, and reported in realized capital gains and losses. Periodic settlementsand accruals on these derivative instruments are included as a component ofgross margin, consistent with their intended use to enhance or maintaininvestment income and margin, and together with the economically hedgedinvestments or product attributes (e.g., net investment income or interestcredited to contractholders funds) or replicated investments, to appropriatelyreflect trends in product performance. Amortization of DSI is excluded frominterest credited to contractholder funds for purposes of calculating investmentmargin. We use investment margin to evaluate our profitability related to thedifference between investment returns on assets supporting certain products andamounts credited to customers (“spread”) during a fiscal period.

 

20

----

 

Investmentmargin by product group is shown in the following table.

 
| ** **              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in millions)**       | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Annuities               |       | $                                | 204        |                           | $          | 206 |   | $ | 396 |   | $ | 391 |   |
| Life insurance          |       | 52                               |       | 38                             |       | 101 |   | 84 |   |
| Institutional products  |       | 28                               |       | 34                             |       | 62 |   | 64 |   |
| Total investment margin |       | $                                | 284        |                           | $          | 278 |   | $ | 559 |   | $ | 539 |   |

 

Investmentmargin increased 2.2% in the second quarter of 2007 and 3.7% in the first sixmonths of 2007 compared to the same periods of 2006. The increase in bothperiods was primarily due to modest growth in contractholder funds and slightincreases in weighted average investment spreads on the product portfolios.

 

Thefollowing table summarizes the annualized weighted average investment yield,interest crediting rates and investment spreads for the three months ended June30.

 
| ** **                                                           | ** ** | **Weighted Average  Investment Yield** | ** ** | **Weighted Average  Interest Crediting Rate** | ** ** | **Weighted Average  Investment Spreads** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                           | ** ** | **2007**                               | ** ** | **2006**                                      | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Interest-sensitive life                                              |       | 6.2                                    | %          | 6.2                                           | %          | 4.7                                      | %          | 4.7 | % | 1.5 | % | 1.5 | % |
| Deferred fixed annuities                                             |       | 5.8                                    |       | 5.7                                           |       | 3.7                                      |       | 3.6 |   | 2.1 |   | 2.1 |   |
| Immediate fixed annuities with and without  life contingencies       |       | 7.2                                    |       | 7.2                                           |       | 6.6                                      |       | 6.6 |   | 0.6 |   | 0.6 |   |
| Institutional products                                               |       | 6.0                                    |       | 6.0                                           |       | 5.1                                      |       | 5.0 |   | 0.9 |   | 1.0 |   |
| Investments supporting capital, traditional  life and other products |       | 6.3                                    |       | 6.9                                           |       | N/A                                      |       | N/A |   | N/A |   | N/A |   |

 

Thefollowing table summarizes the annualized weighted average investment yield,interest crediting rates and investment spreads for the six months ended June30.

 
| ** **                                                           | ** ** | **Weighted Average  Investment Yield** | ** ** | **Weighted Average  Interest Crediting Rate** | ** ** | **Weighted Average  Investment Spreads** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                           | ** ** | **2007**                               | ** ** | **2006**                                      | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Interest-sensitive life                                              |       | 6.2                                    | %          | 6.2                                           | %          | 4.6                                      | %          | 4.7 | % | 1.6 | % | 1.5 | % |
| Deferred fixed annuities                                             |       | 5.8                                    |       | 5.7                                           |       | 3.7                                      |       | 3.7 |   | 2.1 |   | 2.0 |   |
| Immediate fixed annuities with and without  life contingencies       |       | 7.1                                    |       | 7.2                                           |       | 6.6                                      |       | 6.6 |   | 0.5 |   | 0.6 |   |
| Institutional products                                               |       | 6.0                                    |       | 5.8                                           |       | 5.1                                      |       | 4.8 |   | 0.9 |   | 1.0 |   |
| Investments supporting capital, traditional  life and other products |       | 5.9                                    |       | 6.9                                           |       | N/A                                      |       | N/A |   | N/A |   | N/A |   |

 

21

----

 

Thefollowing table summarizes the liabilities for these contracts and policies.

 
| ** **                                                            | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------|------------|
| **(in millions)**                                                     | ** ** | **2007**           | ** ** | **2006** | ** ** |
| Immediate fixed annuities with life  contingencies                    |       | $                  | 8,241      |   | $ | 7,993 |   |
| Other life contingent contracts and other                             |       | 3,840              |       | 3,595 |   |
| Reserve for life-contingent contracts                                 |       | $                  | 12,081     |   | $ | 11,588 |   |
|                                                                  |       |               |       |   |   |
| Interest-sensitive life                                               |       | $                  | 8,668      |   | $ | 8,117 |   |
| Deferred fixed annuities                                              |       | 35,003             |       | 34,946 |   |
| Immediate fixed annuities without life  contingencies                 |       | 3,818              |       | 3,710 |   |
| Institutional products                                                |       | 13,301             |       | 13,067 |   |
| Market value adjustments related to  derivative instruments and other |       | 383                |       | 368 |   |
| Contractholder funds                                                  |       | $                  | 61,173     |   | $ | 60,208 |   |

 

*Benefit margin*is a component of gross margin, both of whichare non-GAAP measures. Benefit margin represents life and life-contingentimmediate annuity premiums, cost of insurance contract charges and, prior tothe disposal of substantially all of our variable annuity business throughreinsurance, variable annuity contract charges for contract guarantees lesscontract benefits. Benefit margin excludes the implied interest onlife-contingent immediate annuities, which is included in the calculation ofinvestment margin. We use benefit margin to evaluate our underwritingperformance, as it reflects the profitability of our products with respect tomortality or morbidity risk during a fiscal period.

 

Benefitmargin by product group is shown in the following table. 

 
| ** **           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in millions)**    | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Life insurance       |       | $                                | 85         |                           | 116        |   | $ | 161 |   | $ | 205 |   |
| Annuities            |       | (6                               | )          | (4                             | )          | (14 | ) | (18 | ) |
| Total benefit margin |       | $                                | 79         |                           | 112        |   | $ | 147 |   | $ | 187 |   |

 

Benefitmargin declined 29.5% in the second quarter of 2007 and 21.4% in the first sixmonths of 2007 compared to the same periods of 2006. The decline in bothperiods was mostly the result of the absence in 2007 of benefit margin on thereinsured variable annuity business, litigation related costs in the form ofadditional policy benefits on certain universal life policies written prior to1992 (see Note 5 to the condensed consolidated financial statements) and lessfavorable life mortality in 2007, compared to exceptionally favorable mortalityin the second quarter of 2006, including a favorable impact in the prior yearrelated to the lapse of certain interest-sensitive life contracts.

 

*Amortization of DAC and DSI*, excluding amortization related to realizedcapital gains and losses, declined 13.8% in the second quarter of 2007 and16.1% in the first six months of 2007 compared to the same periods of 2006 dueto the absence of amortization in 2007 on the variable annuity business thatwas reinsured effective June 1, 2006. Excluding the impact of the reinsuredvariable annuity business and amortization related to realized capital gainsand losses, DAC and DSI amortization increased 12.5% and 8.7% in the secondquarter and first six months of 2007, respectively, compared to the sameperiods in the prior year. The increase in both periods was primarily theresult of improved benefit margin on certain interest-sensitive life contracts.DAC and DSI amortization related to realized capital gains and losses,after-tax, reflected a charge to income of $15 million and $3 million in thesecond quarter of 2007 and 2006, respectively, and reflected a charge to incomeof $15 million in the first six months of 2007 and a credit to income of $24million in the first six months of 2006. The impact of realized capital gainsand losses on amortization of DAC and DSI is dependent upon the relationshipbetween the assets that give rise to the gain or loss and the product liabilitysupported by the assets. Fluctuations result from changes in the impact ofrealized capital gains and losses on actual and expected gross profits.

 

DACand DSI were reduced by $726 million and $70 million, respectively, in 2006 asa result of the disposition of substantially all of our variable annuitybusiness (see Note 4 to the Condensed Consolidated Financial Statements).

 

22

----

 

*Operating costs and expenses* declined 27.6% and 23.9% in the secondquarter of 2007 and first six months of 2007, respectively, compared to thesame periods of 2006. The following table summarizes operating costs andexpenses.

 
| ** **                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                  | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                               |       |                             |       |                           |       |   |   |   |   |
| Non-deferrable acquisition costs   |       | $                                | 22         |                           | $          | 34 |   | $ | 48 |   | $ | 72 |   |
| Other operating costs and expenses |       | 49                               |       | 64                             |       | 105 |   | 129 |   |
| Total operating costs and expenses |       | $                                | 71         |                           | $          | 98 |   | $ | 153 |   | $ | 201 |   |
|                               |       |                             |       |                           |       |   |   |   |   |
| Restructuring and related charges  |       | $                                | (1         | )                              | $          | 3 |   | $ | (1 | ) | $ | 18 |   |

 

Thedecline in total operating costs and expenses in the second quarter and firstsix months of 2007 compared to the same periods of 2006 was due primarily tothe absence of expenses in 2007 related to the variable annuity businessreinsured effective June 1, 2006. For the second quarter of 2006, $9 million ofexpenses relating to the reinsured variable annuity business was included inboth non-deferrable acquisition costs and other operating costs. For the firstsix months of 2006, non-deferrable acquisition costs and other operatingexpenses included $19 million and $24 million, respectively, of expensesrelating to the reinsured variable annuity business.

 

Restructuringand related charges for the first six months of 2006 reflect costs related tothe Voluntary Termination Offer.

 

**INVESTMENTS**

 

Animportant component of our financial results is the return on our investmentportfolio. The composition of the investment portfolio at June 30, 2007 ispresented in the table below.

 
| **(in millions)**           | ** ** | **Investments** | ** ** | **Percent to  total** | ** ** |
|-----------------------------|------------|-----------------|------------|-----------------------|------------|
| ** **                  | ** ** | ** **      | ** ** | ** **            | ** ** |
| Fixed income securities (1) |       | $               | 62,403     |                  | 82.8       | % |
| Mortgage loans              |       | 9,084           |       | 12.1                  |       |
| Equity securities           |       | 855             |       | 1.1                   |       |
| Short-term                  |       | 1,209           |       | 1.6                   |       |
| Policy loans                |       | 747             |       | 1.0                   |       |
| Other                       |       | 1,045           |       | 1.4                   |       |
| Total                       |       | $               | 75,343     |                  | 100.0      | % |

 

----

(1)          Fixedincome securities are carried at fair value. Amortized cost basis for thesesecurities was $61.76 billion.

 

Totalinvestments increased to $75.34 billion at June 30, 2007 from $74.16 billion atDecember 31, 2006, primarily due to positive cash flows from operatingactivities, including increased funds associated with securities lending andsecurities sold with the agreement to repurchase, partially offset by decreasednet unrealized gains on fixed income securities and the repayment of a notepayable to our parent, AIC.

 

Totalinvestments at amortized cost related to collateral received in connection withsecurities lending business activities, funds received in connection withsecurities repurchase agreements, and collateral posted by counterpartiesrelated to derivative transactions, increased to $3.47 billion at June 30, 2007from $2.29 billion at December 31, 2006.

 

23

----

 

Fixedincome securities by type are listed in the table below.

 
| **($ in millions)**              | ** ** | **June 30,   2007** | ** ** | **% to Total  Investments** | ** ** | **December 31, 2006** | ** ** | **% to Total  Investments** | ** ** |
|---------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **            | ** ** | ** **                  | ** ** |
| U.S. government and agencies          |       | $                   | 3,441      |                        | 4.6        | %                     | $          | 3,496                       |       | 4.7 | % |
| Municipal                             |       | 4,842               |       | 6.4                         |       | 4,790                 |       | 6.5                         |       |
| Corporate                             |       | 33,739              |       | 44.8                        |       | 34,309                |       | 46.3                        |       |
| Asset-backed securities               |       | 6,593               |       | 8.8                         |       | 5,681                 |       | 7.7                         |       |
| Commercial mortgage-backed securities |       | 8,104               |       | 10.7                        |       | 7,600                 |       | 10.2                        |       |
| Mortgaged-backed securities           |       | 3,666               |       | 4.9                         |       | 4,518                 |       | 6.1                         |       |
| Foreign government                    |       | 1,992               |       | 2.6                         |       | 2,023                 |       | 2.7                         |       |
| Redeemable preferred stock            |       | 26                  |       | —                      |       | 22                    |       | —                      |       |
| Total fixed income securities         |       | $                   | 62,403     |                        | 82.8       | %                     | $          | 62,439                      |       | 84.2 | % |

 

AtJune 30, 2007, 93.9% of the fixed income securities portfolio was ratedinvestment grade, which is defined as a security having a rating from theNational Association of Insurance Commissioners (“NAIC”) of 1 or 2; a rating ofAaa, Aa, A or Baa from Moody’s or a rating of AAA, AA, A or BBB from Standardand Poor’s (“S&P”), Fitch or Dominion or a rating of aaa, aa, a or bbb fromA.M. Best; or a comparable internal rating if an externally provided rating is notavailable.

 

Certainof our asset-backed securities and mortgage-backed securities arecollateralized by residential mortgage loans that are characterized byborrowers of differing levels of creditworthiness: U.S. agency, prime, Alt-Aand sub-prime. Included in the following table are our asset-backed andmortgage-backed securities categorized by type of collateral. Also included areratings, based on the lower of Moody’s or S&P, and percent to our totalinvestments.

 
| **($ in millions)**                                                              | ** ** | **Aaa**    | ** ** | **Aa**     | ** ** | **A**      | ** ** | **Baa**    | ** ** | **Ba or   lower** | ** ** | **June 30,   2007** | ** ** | **% to Total   Investments** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-------------------|------------|---------------------|------------|------------------------------|------------|
| **Asset-backed securities**                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **        | ** ** | ** **          | ** ** | ** **                   | ** ** |
| Asset-backed securities collateralized by  sub-prime residential mortgage loans: |       |       |       |       |       |       |       |       |       |              |       |                |       |                         |       |
| Sub-prime residential mortgage-backed  securities (“sub-prime RMBS”)        |       | 66.6       | %          | 25.6       | %          | 7.7        | %          | 0.1        | %          | —            | %          | $                   | 2,851      |                         | 3.8        | % |
| Asset-backed collateralized debt  obligations (“ABS CDOs”)                  |       | 58.5       |       | 26.8       |       | 12.6       |       | 2.1        |       | —            |       | 157                 |       | 0.2                          |       |
| Total asset-backed securities  collateralized by sub-prime residential mortgage loans |       |       |       |       |       |       |       |       |       |              |       | 3,008               |       | 4.0                          |       |
|                                                                                  |       |       |       |       |       |       |       |       |       |              |       |                |       |                         |       |
| Other collateralized debt obligations                                                 |       | 33.5       |       | 27.8       |       | 26.2       |       | 8.6        |       | 3.9               |       | 2,155               |       | 2.9                          |       |
| Other asset-backed securities                                                         |       | 54.3       |       | 5.9        |       | 19.7       |       | 15.5       |       | 4.6               |       | 1,430               |       | 1.9                          |       |
| Total asset-backed securities                                                         |       |       |       |       |       |       |       |       |       |              |       | $                   | 6,593      |                         | 8.8        | % |
|                                                                                  |       |       |       |       |       |       |       |       |       |              |       |                |       |                         |       |
| **Mortgage-backed securities**                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **        | ** ** | ** **          | ** ** | ** **                   | ** ** |
| U.S. Agency                                                                           |       | 100.0      |       | —     |       | —     |       | —     |       | —            |       | $                   | 2,048      |                         | 2.7        | % |
| Prime                                                                                 |       | 95.1       |       | 4.9        |       | —     |       | —     |       | —            |       | 953                 |       | 1.3                          |       |
| Alt-A                                                                                 |       | 89.6       |       | 10.3       |       | 0.1        |       | —     |       | —            |       | 665                 |       | 0.9                          |       |
| Total mortgage-backed securities                                                      |       |       |       |       |       |       |       |       |       |              |       | $                   | 3,666      |                         | 4.9        | % |

 

Ourexposure to residential mortgage loans, excluding U.S. Agency and prime loans,are comprised of sub-prime RMBS, which can be first liens at fixed or variablerates or second liens (ours mostly being insured), ABS CDOs and Alt-Amortgage-backed securities at fixed or variable rates. Our practice foracquiring and monitoring sub-prime RMBS and Alt-A mortgage-backed securitiestakes into consideration the quality of the originator, quality of the servicer,security credit rating, underlying characteristics of the mortgages, borrowercharacteristics, level of credit enhancement in the transaction, and bondinsurer strength, where applicable. All of our sub-prime RMBS and Alt-Asecurities are rated investment grade; $630 million are insured; and  the originators and servicers of theunderlying mortgage loans are primarily subsidiaries of large banks andbroker/dealers, or other investment grade entities. Based on our analysis anddue to the seniority of our securities’ claim on the underlying collateral, wecurrently expect to receive all payments on these securities in accordance withtheir original contractual terms. 

 

24

----

 

Thesesecurities are structured to experience losses according to the seniority levelof each tranche, with the least senior tranche taking the first losses. Therehave not been any downgrades in the ratings of these securities since June 30,2007, and we currently do not anticipate significant downgrades in thisportfolio.

 

Thefollowing table presents additional information about our sub-prime RMBSportfolio including a summary by first and second lien collateral.

 
| **($ in millions)**         | ** ** | **Aaa**    | ** ** | **Aa**     | ** ** | **A**      | ** ** | **Baa**    | ** ** | **June 30,  2007** | ** ** | **% to Total   Investments** | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|--------------------|------------|------------------------------|------------|
| **Sub-prime RMBS**               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **         | ** ** | ** **                   | ** ** |
| First lien sub-prime RMBS:       |       |       |       |       |       |       |       |       |       |               |       |                         |       |
| Fixed rate (1)                   |       |       |       |       |       |       |       |       |       | $                  | 847        |                         | 1.1        | % |
| Variable rate (1)                |       |       |       |       |       |       |       |       |       | 1,340              |       | 1.8                          |       |
| Total first lien sub-prime RMBS  |       | 57.7       | %          | 33.6       | %          | 8.6        | %          | 0.1        | %          | 2,187              |       | 2.9                          |       |
| Second lien sub-prime RMBS:      |       |       |       |       |       |       |       |       |       |               |       |                         |       |
| Insured                          |       |       |       |       |       |       |       |       |       | 490                |       | 0.7                          |       |
| Other                            |       |       |       |       |       |       |       |       |       | 174                |       | 0.2                          |       |
| Total second lien sub-prime RMBS |       | 95.5       |       | 4.5        |       | —     |       | —     |       | 664                |       | 0.9                          |       |
| Total sub-prime RMBS             |       |       |       |       |       |       |       |       |       | $                  | 2,851      |                         | 3.8        | % |

 

----

(1)  Fixed rate and variable rate refer to theprimary interest rate characteristic of the underlying mortgages at the time ofissuance.

 

Thesub-prime RMBS portfolio includes securities that are collateralized bymortgage loans issued in the United States to borrowers that cannot qualify forprime or alternative financing terms due in part to an impaired or limitedcredit history. The sub-prime RMBS portfolio also includes securities that arecollateralized by certain second lien mortgages regardless of the borrower’scredit profile. As of June 30, 2007, the sub-prime RMBS portfolio had netunrealized losses of $26 million, which were comprised of $3 million ofunrealized gains and $29 million of unrealized losses. $630 million or 33.2% ofthe Aaa securities are insured.

 

Thesub-prime RMBS portfolio included $1.79 billion or 62.9% of securities thatwere issued during 2006 and 2007. At June 30, 2007, 80.6% of these securitieswere rated Aaa, 16.8% were rated Aa, 2.5% were rated A and 0.1% were rated Baa,and $499 million or 27.8% of the Aaa securities are insured. The expectedweighted average life of our 2006 and 2007 sub-prime RMBS portfolio wasestimated to be approximately 4 years at origination.

 

ABSCDOs are securities collateralized by a variety of residential mortgage-backedand other securities, which may include sub-prime RMBS. As of June 30, 2007,this portfolio had unrealized losses of $7 million.

 

Ourother collateralized debt obligations consist of securitized investments toportfolios collateralized primarily by corporate credit, including bothinvestment grade and high yield corporate credits. Our other asset-backedsecurities consist primarily of securitized investments to portfolios of creditcards, auto loans, student loans and other consumer and corporate obligations.

 

OurAlt-A mortgage-backed securities include securities that are collateralized byresidential mortgage loans issued to borrowers with stronger credit profilesthan sub-prime borrowers, but who do not qualify for prime financing terms dueto high loan-to-value ratios and/or limited supporting documentation. At June30, 2007, the Alt-A portfolio had net unrealized losses of $3 million, whichwere comprised of $2 million of gains and $5 million of unrealized losses. $203million or 30.5% of these securities were issued during 2006 and 2007.

 

Thefollowing table presents information about the collateral in our Alt-Aholdings.

 
| **($ in millions)** | ** ** | **Aaa**    | ** ** | **Aa**     | ** ** | **A**      | ** ** | **June 30,  2007** | ** ** | **% to Total   Investments** | ** ** |
|--------------------------|------------|------------|------------|------------|------------|------------|------------|--------------------|------------|------------------------------|------------|
| **Alt-A**                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **         | ** ** | ** **                   | ** ** |
| Fixed rate               |       |       |       |       |       |       |       | $                  | 427        |                         | 0.6        | % |
| Variable rate            |       |       |       |       |       |       |       | 238                |       | 0.3                          |       |
| Total Alt-A              |       | 89.6       | %          | 10.3       | %          | 0.1        | %          | $                  | 665        |                         | 0.9        | % |

 

25

----

 

Theunrealized net capital gains on fixed income and equity securities at June 30,2007 were $654 million, a decrease of $945 million or 59.1% since December 31,2006. The net unrealized gain for the fixed income portfolio totaled $643million, comprised of $1.58 billion of unrealized gains and $932 million ofunrealized losses at June 30, 2007. This is compared to a net unrealized gainfor the fixed income portfolio totaling $1.59 billion at December 31, 2006,comprised of $2.10 billion of unrealized gains and $507 million of unrealizedlosses.

 

Ofthe gross unrealized losses in the fixed income portfolio at June 30, 2007,$879 million or 94.3% were related to investment grade securities and arebelieved to be primarily a result of rising interest rates. Of the remaining$53 million of unrealized losses in the fixed income portfolio, $46 million or86.8% were in the corporate fixed income portfolio  and were primarily comprised of securities inthe consumer goods, financial services, utilities, communications and capitalgoods sectors. The gross unrealized losses in these sectors were primarilycompany specific and interest rate related.

 

Thenet unrealized gain for the common and non-redeemable preferred stock portfoliototaled $11 million at both June 30, 2007 and December 31, 2006.

 

Ourportfolio monitoring process identifies and evaluates, on a case-by-case basis,fixed income and equity securities whose carrying value may beother-than-temporarily impaired. The process includes a quarterly review of allsecurities using a screening process to identify those securities whose fairvalue compared to amortized cost for fixed income securities or cost for equitysecurities is below established thresholds for certain time periods, or whichare identified through other monitoring criteria such as ratings downgrades orpayment defaults. The securities identified, and other securities for which wemay have a concern, are evaluated based on facts and circumstances forinclusion on our watch-list. We also conduct a portfolio review to recognizeimpairment on securities in an unrealized loss position for which we do nothave the intent and ability to hold until recovery as a result of approvedprograms involving the disposition of investments such as changes in duration,revisions to strategic asset allocations and liquidity actions, as well ascertain dispositions anticipated by portfolio managers. All securities in anunrealized loss position at June 30, 2007 were included in our portfoliomonitoring process for determining which declines in value were notother-than-temporary.

 

Wealso monitor the quality of our fixed income portfolio by categorizing certaininvestments as “problem”, “restructured” or “potential problem.”  Problem fixed income securities aresecurities in default with respect to principal or interest and/or securitiesissued by companies that have gone into bankruptcy subsequent to our acquisitionof the security. Restructured fixed income securities have rates and terms thatare not consistent with market rates or terms prevailing at the time of therestructuring. Potential problem fixed income securities are current withrespect to contractual principal and/or interest, but because of other factsand circumstances, we have concerns regarding the borrower’s ability to payfuture principal and interest, which causes us to believe these securities maybe classified as problem or restructured in the future.

 

Thefollowing table summarizes problem, restructured and potential problem fixedincome securities.

 
| ** **                               | ** ** | **June 30, 2007**    | ** ** | **December 31, 2006** | ** ** |
|------------------------------------------|------------|----------------------|------------|-----------------------|------------|
| **(in millions)**                        | ** ** | **Amortized   cost** | ** ** | **Fair  value**       | ** ** | **Percent of   total Fixed   Income   portfolio** | ** ** | **Amortized cost** | ** ** | **Fair  value** | ** ** | **Percent of   total Fixed   Income   portfolio** | ** ** |
| Problem                                  |       | $                    | 10         |                  | $          | 12 |   | — | % | $ | 13 |   | $ | 16 |   | — | % |
| Restructured                             |       | 6                    |       | 7                     |       | — |   | 4 |   | 4 |   | — |   |
| Potential problem                        |       | 70                   |       | 78                    |       | 0.1 |   | 107 |   | 118 |   | 0.2 |   |
| Total net carrying value                 |       | $                    | 86         |                  | $          | 97 |   | 0.1 | % | $ | 124 |   | $ | 138 |   | 0.2 | % |
| Cumulative write- downs   recognized (1) |       | $                    | 178        |                  |       |   |   |   | $ | 184 |   |   |   |   |   |

 

----

| (1) | Cumulative  write-downs recognized reflect write-downs related to securities within the  problem, potential problem and restructured categories. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------|

 

Wehave experienced a decrease in the amortized cost of fixed income securitiescategorized as problem and potential problem as of June 30, 2007 compared toDecember 31, 2006. The decrease was primarily due to dispositions.

 

Wealso evaluated each of these securities through our portfolio monitoringprocess at June 30, 2007 and recorded write-downs if appropriate. We furtherconcluded that any remaining unrealized losses on these securities weretemporary in nature and that we have the intent and ability to hold untilrecovery. While these balances may increase in the future, particularly ifeconomic conditions are unfavorable, management expects that****the total amount of securities in thesecategories will remain low relative to the total fixed income securitiesportfolio.

 

26

----

 

**Net Investment Income**  Thefollowing table presents net investment income for the three months and sixmonths ended June 30.

 
| ** **                                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                                    | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Fixed income securities                              |       | $                                | 926        |                           | $          | 886 |   | $ | 1,833 |   | $ | 1,752 |   |
| Equity securities(1)                                 |       | 21                               |       | 14                             |       | 34 |   | 21 |   |
| Mortgage loans                                       |       | 134                              |       | 128                            |       | 266 |   | 253 |   |
| Other                                                |       | 44                               |       | 51                             |       | 89 |   | 81 |   |
| Investment income, before expense                    |       | 1,125                            |       | 1,079                          |       | 2,222 |   | 2,107 |   |
| Investment expense                                   |       | (72                              | )          | (62                            | )          | (139 | ) | (116 | ) |
| Net investment income                                |       | $                                | 1,053      |                           | $          | 1,017 |   | $ | 2,083 |   | $ | 1,991 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| (1)Net  investment income from partnership interests |       | $                                | 20         |                           | $          | 13 |   | $ | 33 |   | $ | 19 |   |

 

Netinvestment income increased 3.5% and 4.6% in the three months and six monthsended June 30, 2007 as compared to the same periods in the prior year.

 

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

 
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in millions)**                             | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                          |       |                             |       |                           |       |   |   |   |   |
| Investment write-downs                        |       | $                                | (4         | )                              | $          | (4 | ) | $ | (5 | ) | $ | (9 | ) |
| Dispositions                                  |       | (49                              | )          | (75                            | )          | (15 | ) | (150 | ) |
| Valuation of derivative instruments           |       | 135                              |       | (22                            | )          | 115 |   | 14 |   |
| Settlement of derivative instruments          |       | 22                               |       | 21                             |       | 31 |   | 38 |   |
| Realized capital gains and losses, pretax     |       | 104                              |       | (80                            | )          | 126 |   | (107 | ) |
| Income tax (expense) benefit                  |       | (37                              | )          | 29                             |       | (45 | ) | 38 |   |
| Realized capital gains and losses,  after-tax |       | $                                | 67         |                           | $          | (51 | ) | $ | 81 |   | $ | (69 | ) |

 

Dispositionsin the above table include sales, losses recognized in anticipation ofdispositions and other transactions such as calls and prepayments. We may sellimpaired fixed income or equity securities that were in an unrealized lossposition at the previous reporting date in situations where new factors such asnegative developments, subsequent credit deterioration, changing liquidityneeds, and newly identified market opportunities cause a change in our previousintent to hold a security until recovery or maturity.

 

Achanging interest rate environment will drive changes in our portfolio durationtargets at a tactical level. A duration target and range is established with aneconomic view of liabilities relative to a long-term portfolio view. Tacticalduration adjustments within management’s approved ranges are accomplishedthrough both cash market transactions and derivative activities that generaterealized gains and losses and through new purchases. 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 approachmitigates the impacts of general interest rate changes to the overall financialcondition of the Company.

 

Inthe second quarter of 2007, we recognized $44 million of losses related to achange in our intent to hold certain securities with unrealized losses untilthey recover in value. The change in our intent is primarily related tostrategic asset allocation decisions and ongoing comprehensive reviews of ourportfolio. We identified $1.26 billion of securities which we did not have theintent to hold until recovery.

 

Theimprovement in realized capital gains and losses relating to the valuation ofderivative instruments in the second quarter and first six months of 2007compared to the same periods in the prior year was primarily the result ofequity market fluctuations.

 

27

----

 

**CAPITAL RESOURCES AND LIQUIDITY**

 

**Capital Resources** consist of shareholder’s equity and debt, representing funds deployedor available to be deployed to support business operations. The following tablesummarizes our capital resources.

 

 
| **(in millions)**                                                        | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| Redeemable preferred stock                                               |       | $                 | —     |                  | $          | 5 |   |
| Common stock, retained income and other  shareholder’s equity items |       | 5,495             |       | 5,168                 |       |
| Accumulated other comprehensive income                                   |       | 142               |       | 325                   |       |
| Total shareholder’s equity                                          |       | 5,637             |       | 5,498                 |       |
| Debt                                                                     |       | 200               |       | 706                   |       |
| Total capital resources                                                  |       | $                 | 5,837      |                  | $          | 6,204 |   |

 

*Shareholder’s equity* increased in the first six months of 2007,due primarily to net income, partially offset by lower net unrealized capitalgains.

 

*Debt* decreased in the first six months of 2007, due to the settlement of a$500 million intercompany note issued to AIC and the redemption of mandatorilyredeemable preferred stock.

 

**Financial Ratings and Strength**Our ratings are influenced by many factorsincluding our operating and financial performance, asset quality, liquidity,asset/liability management, overall portfolio mix, financial leverage (i.e.,debt), exposure to risks, the current level of operating leverage, AIC’sratings and other factors. There have been no changes to our insurancefinancial strength ratings since December 31, 2006.

 

**Liquidity Sources and Uses** As reflected in our CondensedConsolidated Statements of Cash Flows,****loweroperating cash flows in the first six months of 2007, compared to the first sixmonths of 2006 were primarily related to lower contract charges due to thedisposition of the variable annuity business in 2006, higher income taxpayments, and increased policy and contract benefit payments, partially offsetby lower operating and capitalized acquisition expenses, an increase ininvestment income and higher premiums received.

 

Cashflows used in investing activities decreased in the first six months of 2007due to an unfavorable change in cash flows from financing activities as well aslower net cash provided by operating activities. Also, cash flows used ininvesting activities in the prior year include the settlement of the disposalof substantially all of our variable annuity business.

 

# Cashflows used in financing activities decreased in the first six months of 2007compared to the first six months of 2006 primarily due to decreasedcontractholder fund deposits and increases in contractholder surrenders andwithdrawals. For quantification of the changes in contractholder funds, see theOperations section of the MD&A.

#  

Wehave access to additional borrowing to support liquidity through The AllstateCorporation as follows:

 

•                  A commercial paper program with a borrowinglimit of $1.00 billion to cover short-term cash needs. As of June 30, 2007,there were no balances outstanding and therefore the remaining borrowingcapacity was $1.00 billion; however, the outstanding balance fluctuates daily.

 

•                  Our new $1.00 billion unsecured revolvingcredit facility, which replaced our primary credit facility covering short-termliquidity requirements, has an initial term of five years expiring in 2012 withtwo one year extensions that can be exercised in the first or second year ofthe facility upon approval of existing or replacement lenders providing morethan two thirds of the commitments to lend. This facility has a financialcovenant requiring The Allstate Corporation not exceed a 37.5% debt to capitalresources ratio as defined in the agreement. This ratio at June 30, 2007 was16.9%. Although the right to borrow under the facility is not subject to aminimum rating requirement, the costs of maintaining the facility and borrowingunder it are based on the ratings of The Allstate Corporation’s senior,unsecured, nonguaranteed long-term debt. There were no borrowings under thisline of credit during the first six months of 2007. The total amountoutstanding at any point in time under the combination of the commercial paperprogram and the credit facility cannot exceed the amount that can be borrowedunder the credit facility.

 

•                  A universal shelf registration statement wasfiled with the Securities and Exchange Commission (“SEC”) in May 2006. TheAllstate Corporation can use it to issue an unspecified amount of debtsecurities, common stock (including 312 million shares of treasury stock as ofJune 30, 2007), preferred stock, depositary shares, warrants, stock purchasecontracts, stock purchase units and securities of subsidiaries. The specificterms of any securities The Allstate Corporation issues under this registrationstatement will be provided in the applicable prospectus supplements.

 

28

----

 

Asdescribed in Note 1 to the Condensed Financial Statements, in accordance withFinancial Accounting Standards Board Interpretation No. 48, “Accounting forUncertainty in Income Taxes” (“FIN 48”), the Company had no liability forunrecognized tax benefits at January 1 or June 30, 2007. We believe it isreasonably possible that the liability balance will not significantly increaseor decrease within the next 12 months.

 

29

----

 

**Item 4.  Controls and Procedures**

 

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

 

*Changes in Internal Control over Financial Reporting.*During the fiscalquarter ended June 30, 2007, there have been no changes in our internal controlover financial reporting that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

 

30

----

 

**PART II. OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

Informationrequired for this Part II, Item 1 is incorporated by reference to thediscussion under the heading “Regulation” and under the heading “Legal andregulatory proceedings and inquiries” in Note 5 of the  Condensed Consolidated Financial Statementsin Part I, Item 1 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. Thesestatements are made subject to the safe-harbor provisions of the PrivateSecurities Litigation Reform Act of 1995. We assume no obligation to update anyforward-looking statements as a result of new information or future events ordevelopments.

 

Theseforward-looking statements do not relate strictly to historical or currentfacts and may be identified by their use of words like “plans,” “seeks,” “expects,”“will,” “should,” “anticipates,” “estimates,” “intends,” “believes,” “likely,” “targets”and other words with similar meanings. These statements may address, amongother things, our strategy for growth, product development, regulatoryapprovals, market position, expenses, financial results, litigation andreserves. We believe that these statements are based on reasonable estimates,assumptions and plans. However, if the estimates, assumptions or plans underlyingthe forward-looking statements prove inaccurate or if other risks oruncertainties arise, actual results could differ materially from thosecommunicated in these forward-looking statements. Risk factors which couldcause actual results to differ materially from those suggested by suchforward-looking statements include but are not limited to those discussed oridentified in this document (including the risks described below), in ourpublic filings with the Securities and Exchange Commission, and thoseincorporated by reference in Part I, Item 1A of Allstate Life Insurance CompanyAnnual Report on Form 10-K for 2006.

 

**Based on our analysis and the seniority of our securities’claim on the underlying collateral, we currently expect to receive all paymentson our sub-prime RMBS and Alt-A mortgage-backed securities portfolio inaccordance with their original contractual terms. We currently do notanticipate significant downgrades in this portfolio.**

 

Onan ongoing basis, rating agencies review ratings of these securities and coulddowngrade or change their outlook due to, for example, a change in theirratings methodology and surveillance procedures, a perceived increase in therisk of default related to housing fundamentals or other developments that havea negative impact on the quality of the underlying mortgages. We believe thatour practices for acquiring and monitoring these securities, which includeconsideration of the security’s rating, provide us with information sufficientto forecast our expected receipt of payments. We continually review informationabout these securities as it becomes known and may revise our payment outlookbased on information such as a particular issuer’s ability to meet theircontractual obligations, housing delinquencies or loss trends.

 

**The change in our unrecognized tax benefit during the next 12months is subject to uncertainty.**

 

Asrequired by Financial Accounting Standards Board Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes” (“FIN 48”), which was adopted as of January 1,2007, we have disclosed our estimate of net unrecognized tax benefits and thereasonably possible change in its balance during the next 12 months. We believethat this estimate has been appropriately established based on available factsand information, however, actual results may differ from our estimate forreasons such as changes in our position on specific issues,  developments with respect to the governments’interpretations of income tax laws or changes in judgment resulting from newinformation obtained in audits or the appeals process.

 

**Item 5. Other Information**

 

On July 23,2007, the Registrant entered into the Investment Management Agreement amongAllstate Investments, LLC and Allstate Insurance Company and The AllstateCorporation and Certain Affiliates effective as of January 1, 2007. Pursuant tothe agreement, Allstate Investments, LLC provides investment managementservices to the Registrant. The Registrant and Allstate Investments, LLC arewholly-owned subsidiaries of The Allstate Corporation. A conformed copy of theagreement, attached hereto as Exhibit 10.2, is incorporated herein byreference.

 

31

----

 

**Item 6.  Exhibits**

 

(a)           Exhibits

 

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

 

32

----

 

**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|            | Allstate  Life Insurance Company    |
|-----------------|-------------------------------------|
|            | (Registrant)                        |
|            |                                |
|            |                                |
| August  6, 2007 |                                |
|            | By                                  | /s/  Samuel H. Pilch |   |
|            | Samuel  H. Pilch                    |
|            | (chief  accounting officer and duly |
|            | authorized  officer of Registrant)  |

 

33

----

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                   |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                              |
| 10.1            |       | Credit  Agreement, dated May 8, 2007, incorporated herein by reference to Exhibit  10.1 to The Allstate Corporation’s current report on Form 8-K filed May 9,  2007 (File Number 001-11840). |
|            |       |                                                                                                                                                                                              |
| 10.2            |       | Investment  Management Agreement among Allstate Investments, LLC and Allstate Insurance  Company and The Allstate Corporation and Certain Affiliates effective as of  January 1, 2007.            |
|            |       |                                                                                                                                                                                              |
| 15              |       | Acknowledgment  of awareness from Deloitte & Touche LLP, dated August 6, 2007, concerning  unaudited interim financial information.                                                           |
|            |       |                                                                                                                                                                                              |
| 31.1            |       | Rule  13a-14(a) Certification of Principal Executive Officer                                                                                                                                      |
|            |       |                                                                                                                                                                                              |
| 31.2            |       | Rule  13a-14(a) Certification of Principal Financial Officer                                                                                                                                      |
|            |       |                                                                                                                                                                                              |
| 32              |       | Section  1350 Certifications                                                                                                                                                                      |

 

E-1

----